European Banks Still Treat Their Sovereign Debt Holdings As Risk-Free, BIS Finds

Tyler Durden's picture

In case there is still any wonder why absolutely nobody has no faith in the centrally planned house of cards that is the modern capital markets system, not retail investors, not institutional ones, not HFT vacuum tubes lately, and as of Monday, not even the Bank of International Settlements, aka the central banks' bank, here it is. In a report released yesterday, the BIS complained surprisingly loudly that in glaring disregard for the ever stricter demands of the Basel III rules (which incidentally will never be met), a very broke Europe continues to ignore every regulatory demand. To wit: "The EU’s plans for tightening bank capital rules fail to live up to the Basel III banking reform, an inspection team of global regulators has decided. The draft EU directive is “noncompliant” with the global deal in two important areas. Its definitions of top-quality capital are looser in at least seven ways and a loophole allows many big banks to assume that their sovereign debt holdings are risk-free."

Needless to say the reason why there is a loophole allowing European banks to keep such "assets" as Spanish and Greek bonds as risk-free, is because banks are doing precisely that. In doing so, the banks are massively misrepresenting the true health (and we use the term loosely) of their balance sheets, taking credit for up to a majority of fictious capital (and in the Greek bonds' case: 95% or so of the original bonds) that just does not exist.

And then some wonder why nobody in their right mind is stupid enough to buy bank "book values"... or Spanish "stress tests" which with Oliver Wyman's complicity, give full credit for sovereign bond holdings as part of a bank's current capitalization.

Sure enough, from the FT:

Taken together, the divergences from the Basel III rules would make it substantially easier for many EU banks to boost their capital ratios – an important measure of bank safety – because they would be able to count items that are not allowed in other countries towards the top half of the ratio and because they could exclude sovereign debt from the bottom of the ratio.

Obviously Europe does not enjoy being called not only a liar, but a broke and begging liar at that.

Michel Barnier, the EU commissioner in charge of financial services, swiftly questioned the findings, complaining in a statement that the report cards “do not appear to be supported by rigorous evidence and a well-defined methodology. I believe that this has led to an apparently significant lack of consistency in the way judgement and gradings have, in this preliminary phase, been applied.”

What he really meant is: "Please ignore us for one more month, and at that point America's incumbent president whom we promised we would do everything to get reelected, will bail us all out, even if those disorganized amateurs from the IMF or the cheapskates from Germany end up doing nothing. KomIntern for ever!"

As for Basel III, and why it will never get implemented, the reason is simple. For Basel III to work, banks needs to shore up, get this, nearly $4 trillion in capital. Even the BIS said this has a snow flake's chance in hell of happening: "These figures compare with global GDP of US$59 trillion (€45 trillion). In other words, the NSFR shortfall is equivalent to over 6% of global GDP. We would not regard this as insignificant." The full Zero Hedge article explaining why Europe, and the entire world will go broke, before any Basel 3 reform passes, is reposted below.

“A Trillion Here, A Trillion There...” – Why 90% Of The European Bank Sector’s Market Cap Is Vaporware

Two weeks ago the BIS released the Basel Quantitative Impact Survey, "Results of the Basel, III monitoring exercise as of June 2011" which contained several very scary numbers that were noted in Zero Hedge yet which barely received any mention in the broader press. Because the numbers were all very, very large (think eyes glazing over 11-12 digits large), and because their existence meant that the long-term, chronic pain for Europe, which is and has been one of public (and selected private) sector deleveraging (which oddly enough is called “austerity” by everyone to no doubt habituate people to associate debt reduction with pain - where is "mean-reversionism" when you need it?), they, and the BIS report, were promptly buried under the dense foliage of the signal-to-noise forest. Yet it is numbers such as these, that provide us with the best possible glance at the entire forest, no matter how much the various global financial authorities enjoy inundating the hapless speculator crowd with endless irrelevant “trees” on a daily basis.

The numbers referred to are the BIS-suggested bank solvency deficiency to reach a viable capital level (not liquidity) explained as follows by UBS:

The QIS states that the June 2011 shortfall of common equity to a 7% common equity tier 1 ratio for major banks globally was €486 billion. We can estimate from this that the shortfall to a 10% common equity tier 1 is €1.02 trillion. Some years hence and before the mitigation that banks will undertake aggressively, but nevertheless, a trillion is a striking number.

UBS is perfectly happy to "go there":

A trillion here, a trillion there...


The QIS then goes on. The shortfall to the Liquidity Coverage Ratio is €1.8 trillion and 40% of banks have a LCR below 75%. And the shortfall to the Net Stable Funding Ratio is €2.9 trillion. A third of large banks would not meet the 3% tier one leverage ratio. These are gigantic figures relative to the size of the real economy.


Total bank debt issuance globally in the last 12 months was €1.1 trillion. That is, the shortfall in the Net Stable Funding Ratio is almost three year’s worth of issuance capacity.

In other words we not only finally have a problem quantified in terms of scale, but the scale happens to be very, very big:

These figures compare with global GDP of US$59 trillion (€45 trillion). In other words, the NSFR shortfall is equivalent to over 6% of global GDP. We would not regard this as insignificant.

One can just feel the smirk on the author's face as they added that last bit...

But forget global GDP - a number goosed by debt creation itself, and thus one which benefits from leverage, the very process the BIS is warning against.  Far more disturbing is this number when juxtaposed in the context of the European financial segment, also the inspiration for our title:

For Europe specifically, a related EBA publication15 implies a €511 billion equity shortfall to a 10% common equity tier 1 ratio. This is 90% of the €565 billion in free float market capitalisation of the European bank sector. The Basel III leverage ratio of large banks as of June 2011 would have been a measly 2.7%; the LCR just 71%, representing a shortfall of €1.2 trillion; the NSFR shortfall is €1.9 trillion. Total European bank debt issuance over the last 12 months has been less than €600 billion.

In simple terms, virtually the entire equity buffer of the European financial system, or 90% to be exact, would be wiped out if instead of focusing on maxing out risk returns by unsustainable leverage, Europe’s banks were to actually seek to transform into viable, stable entities, in the process marking their massively mismarked asset base to market. Something tells us that the equity tranche in Europe, and elsewhere, would be rather averse this dramatic writedown in valuation merely for the sake of avoiding future taxpayer bailouts. After all that’s what naïve, stupid, $0.99 cent iApp-fascinated taxpayers are there for: to be abused.

In other words, thanks BIS but your math is not welcome here. The can will promptly be kicked down the road or else.

Yet what is most troubling is that there appear to be no way out for European banks, in other words not even the status quo’s favorite pastime – can kicking – is very sustainable at this point:

Returns on banking are now quite inadequate to attract significant fresh equity into the sector. The regulatory agenda means that there is likely to be little confidence in this changing over the next several years. Banks must therefore turn to the state for their incremental capital or seek to shrink their profile into the amount of stable funding and equity they presently have. Deleveraging is alive and well and living in the euro area.

And just a tangent, the BIS data and analysis was of June 30. That's before all the fun in Europe really started.

Needless to say, raising $2+ trillion in new capital over the next 5 years will be next to impossible as European banks are hardly what one would call profitable (implying retained earnings as a source of capital is nothing but a cruel joke; now as for retained losses...), and as we saw when UniCredit tried to raise some equity in the open market only to see its stock get annihilated in January, pitching capital raises through equity issuance to Euro fins is the surest way for any investment banker to get sacked.

Which means one thing: as markets get progressively smarter (yes, it will take a while) that there is a difference between capital and liquidity, and demand it from banks that otherwise risk a Lehman-like fate, the asset dispositions, i.e., sales of the blue-light special variety, are about to kick into high gear. Here, while for every buyer there may be a seller, when faced with a known onslaught of about $2.9 trillion in asset sales over a period of time, one thing is certain: it will be a mecca of a buyer’s market as liquidations become wholesale and prices across most asset classes tumble as a result.

And as noted in the post just prior, courtesy of Europe’s Dead Bank Walking list, the market will know just where to go first (and second, and third, etc) for the biggest liquidation deals once the “For Sale” signs are posted.

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chump666's picture

Europe is a neurotic joke.

disabledvet's picture

you wanna know what a neurotic joke is? "A girl walks into a bar and says to all the guys: i'm easy...who wants me first?" and all the patrons point to the dead animals hanging on the wall. Now THAT'S a neurotic joke!

swabeyjw's picture

Let's find a way to increase their profits so they can have better coverage. Damned if you do! Damned if yo don't!

Debtonation's picture

I don't understand why someone would loan money without collateral, all the debtor has to do is say FU! and you're screwed.

Big Ben's picture

Well, it depends on the particulars. If you are a loan shark with a few burly collectors on payroll and the borrower is just an ordinary guy, you might end up OK. Of course, in that case I suppose you could consider the borrower's unbroken legs to be collateral.

But I can't understand why anyone would loan money to a government. In that case there is no collateral and the borrower is capable of breaking your legs or just printing a bunch of fiat whenever he wants. I'm sure that will end well.

My guess is that most of the people who are purchasing government bonds are institutional investors who are "managing" other people's money. Just like the bankers who were perfectly happy to make 125% loan-to-value home loans to people with no documented incomes. They didn't care because it wasn't their money.

max2205's picture

I am suspending the free market system": G W Bush circa 2007

ET, ObamaPhone home.....

Dr. Engali's picture

The real joke is... There was never a free market to suspend.

topspinslicer's picture

Top quality asset you say? Can't think of any off hand......

ACP's picture

It's totally risk free if you don't buy any.

Robslob's picture

The free market system died along with the Twin Towers circa 2001

topspinslicer's picture

I'd like to get a head start -- what comes after trillion?

topspinslicer's picture

Nice place to visit but it won't be an escape destination if master obama wins

zorba THE GREEK's picture

If you believe that European debt is risk free, I have a bridge in NYC I would like to sell you.

Or maybe you would prefer investing in a gold mine on Mars.

Mediocritas's picture

The BIS only just now figured this out? People on ZH and elsewhere have been talking about this for years now.

It has been noted many times that it's utterly irrelevant that eurozone banks be sitting on very low quality sovereign debt because the ECB allows that shit to be pledged as AAA collateral meaning that banks can quickly borrow their way out of trouble and stay that way indefinitely while the ECB maintains its mark to fantasy policies (in violation of Basel II).

The BIS can afford to pontificate and take the moral high ground all it wants because central banks no longer give a shit about the BIS. Let's see now, when banks tried to comply in times gone by we had the Japanese crash (Basel I - minimum capital requirements), then we had the US crash (Basel II - mark to market). Once again, the BIS proposes hitting the brakes when the wall has already been hit (Basel III - deleverage). Where were you guys 20 years ago? Oh yeah, you were busy being way behind the game as always.

Member banks are insolvent but the ECB can never go broke while it still has a printer, so it will simply continue to swap insolvency away from member banks until the little people have been robbed enough to make it go away via relentless erosion of purchasing power.