The LIBOR scandal will be a field day for our learned friends. An estimated $350 trillion worth of financial instruments is tied to the benchmark interest rates. The potential cost of litigation against the banks from those who own and trade those swaps and other securities that were priced using LIBOR could be substantial, as will be the legal fees involved. Contingent provisioning against that has yet to be fully priced into bank stocks.
Barclays’ settlement with U.K. and U.S. regulators over LIBOR rigging is just the start. Several other international banks are still being investigated by authorities. Heftier fines than even the £290 million ($450 million) one imposed on Barclays are quite possible, as will be taking away LIBOR-setting from the hands of the bankers themselves. No longer will it be the responsibility of their industry group, the British Banking Association. That latter step will be part of an urgent rebuffing of London’s reputation as a transparent internal financial centre that will need to be undertaken by the U.K. authorities.
One other consequence of the LIBOR scandal will be to make U.S. lawmakers even less inclined to embrace international financial regulation. It will be argued that benchmark interest rates that affect American consumers and investors should be regulated at home, even if many in the U.S. Congress had been blissfully unaware of LIBOR until very recently.
China looks set to give a big boost to its nascent muni-bond market this year. The Finance Ministry is to quintuple the quota for local government bond issuance to 250 billion yuan ($40 billion) this year, Caixin, a Beijing-based financial newspaper, reports.
In addition, more provinces will reportedly be added to the list of those able to issue bonds directly. Since 1994, the ministry has done that on behalf of local governments but started an experiment in direct issuance in October last year with Shanghai, Shenzhen, Guangdong and Zhejiang. That privilege will be extended to six more provinces and municipalities. The ministry is expected to maintain the close control over the bond issuance by the larger group that it has exercised over the trial quartet, including having a big say over what the funds raised can be used for.
Expanding the muni-bond market is both part of the broader reforms of the financial system and local government finances. The latter are teetering under the burden of 10.7 trillion yuan of debt, at least 3 trillion yuan of which falls due by the end of this year. Much of the debt piled up as a result of the stimulus spending in the wake of the 2008 global financial crisis. Much of it is infrastructure loans, for things like toll roads to nowhere, that are weighing heavily on the creditworthiness of China’s banks.
Earlier this month the China Banking Regulatory Commission ordered banks to clean up their balance sheets with regard to local government lending. It first told them to do that in June last year, but progress clearly hasn’t been rapid enough, or, as a result of the cooling of both the economy and the property market, problem loans are mounting. Good and bad loans alike were probably rolled over when banks tackled the 2 trillion yuan of local government loans that fell due last year. Another red flag raised by China’s audit office: irregularities it has found with 530 billion yuan worth of the lending. Taken together, an estimated 2 trillion-3 trillion yuan of local government lending has soured, which would be sufficient to raise the banks’ non-performing loan ratios to 5% from their current average of 1.1%.
The new quota of 250 billion yuan for bond issuance won’t wipe away the problem but every little bit helps–and places like Greece serve as a reminder that bond issuance is not an infallible inoculation against government profligacy. Yet while the immediate priority is to deflate China’s local-government debt bubble before it can go damagingly pop, an expanded muni-bond market also pushes provincial and municipal governments in three other desirable directions: less reliance of land sales to raise revenue, less need for the off-balance sheet financing via captive investment vehicles that local authorities have resorted to get round restrictions on official borrowings, and more transparency generally about their finances.
This is an edited version of a post first published by China Bystander.
Filed under Banking, China
The markets’ giddy response to the eurozone debt-crisis solution agreed by European leaders this week is a case of investors willing themselves to see the glass half full. The combination of the eurozone’s bailout fund, the European Financial Stability Facility (EFSF), being bulked up to €1 trillion, a €100 billion recapitalization of Europe’s banks by June next year and private bondholders being asked to take a 50% haircut on Greek debt is at least more palatable than any of the doomsday alternatives–an unruly Greek default, an unraveling of the euro and a collapse of the banking system.
Yet the euroleaders’ plan, belatedly pulled together with all the one minute to midnight brinkmanship that Congressional leaders in the U.S. showed in July over America’s debt-ceiling debate, similarly depends on the details being fleshed out after the event. These include whence to raise the money for the EFSB and on what conditions to ensure the participation of the likes of China and the IMF. They also include the sleight of legal hand that will be needed to ensure that an orderly part Greek debt fault–for that is what the bondholders haircut is–does not trigger a credit default swaps crisis.
Getting those and all the other many, many other implementation details right will determine how much risk this solution has really taken out of the euro crisis, or whether it has just papered over the cracks.
Officials attending the IMF-World Bank annual meetings in Washington are tantalizing the markets. While they kicked any action to deal with the euro-zone crisis down the road to the EU council in Brussels in late October and/or the G20 summit in Cannes in November, they are letting the idea float that a course of action is finally in the making. This would provide for private holders of Greek debt to take a 50% haircut for, an increase in the size and flexibility of the 440 billion-euro ($600 billion) European Financial Stability Facility (EFSF) and a recapitalization of European banks most exposed to sovereign debt. If this plan for what is in effect a partial Greek default comes to fruition, it will need at least that much time to overcome some significant legal and political hurdles, notably, on the latter, the role the ECB will play in strengthening the EFSF, and some grisly horse trading with the banks and other private holders of Greece’s debt. The biggest risk to the euro-area — and to the global economy — remains a disorderly sovereign default or an unexpected shock triggering bank runs in the meantime.
Has there been a subtle shift of emphasis within the club of international bank regulators from primarily protecting depositors in failing banks to insulating taxpayers from the costs of public bailouts, or at least shoving them behind shareholders in the queue? The new restrictions on banks’ hybrid securities announced by the Basel Committee on Banking Supervision earlier this month suggests there has. They follow a broader clamping down on banks using preference shares and other forms of debt as a cut-price way to shore up their regulatory capital, all of which will be phased out under the Basel III banking-reform proposal.
Hybrid securities have characteristics of both debt and equity. They were intended to serve as an alternative source of capital to public bailouts when a financial institution got into trouble. Banks like them because they are a cheaper way to raise capital than equity; an estimated $1 trillion worth are in issue. Existing rules let failing banks count some hybrids as Tier 1 capital and so shield investors from losses that taxpayers then had to pick up through bailouts; the new rules close that loophole from the start of 2013 by requiring that hybrids trigger an automatic conversion to equity (a bail-in) or a write-off in the event of a bank becoming ‘non-viable’ and needing an injection of public capital.
Non-viability is a new regulatory concept that has fallen out of the 2008 global financial crisis and has yet to crystalize into firm meaning in national rules and regs. Plenty of arguing over its implementation to come, you can bet — and plenty of bleating by banks in developed economies that this will increase their cost of capital and so make them less able to lend. But with the need to convert existing hybrid’s into compliant securities within a couple of years (and to harvest the considerable fees that will involve), those conversations will have to be cut short. Investors in hybrids will find themselves pushed down the queue regardless.
The new bank lending binge continues. Five hundred billion yuan’s worth of new loans were extended in the first week of the month. That just about matched the 481 million yuan of new loans made in December, when banks were under the cosh to keep the year’s lending within touching distance of the government’s target of 7.5 trillion yuan. New loans for 2010 came out at 7.95 trillion yuan (down from 2009′s stimulus-fueled 9.6 trillion yuan). As happened last year, plenty of new lending was just pushed out into the first month of this year.
New lending tends anyway to be heaviest early in the year. The first quarter typically accounts for a third of a year’s lending. Only 42% of the new loans in the first week of January were extended by the big four state-owned banks, indicating the weakening power of centrally set quotas to control monetary policy. The central bank is increasingly being thrown back onto raising interest rates and reserve requirements to rein in liquidity. More of both to come.
This post was first published on China Bystander.
Filed under Banking, China
Bank of China’s new if limited yuan trading facility for its U.S. customers is another small step in the direction of internationalizing the currency. It is the first time customers can to buy and sell yuan using accounts at the state-owned bank’s U.S. branches, rather than go through Hong Kong. A limit of 20,000 yuan ($3,000) a day can be bought per individual’s account, the same cap that applies in Hong Kong to limit speculation. Business accounts are uncapped.
Beijing has been pushing its importers and exports to settle trade less in dollars and more in yuan, and allowing the development of an offshore market in the yuan. Cross-border trade settlements in Hong Kong grew from an average of 4 billion yuan a month in the first half of last year to 68 billion yuan in October. China Bank of Construction forecast recently that this number could reach 1.6 trillion yuan a month by 2015. However, the trend is more pronounced in the trade with countries other than the U.S.
Nevertheless, it has helped swell the yuan deposit base in Hong Kong to 260 billion yuan at end-November 2010, and the introduction of markets in the currency and of yuan-denominated financial instruments, including so-called dim sum bonds. Trading in the currency was allowed in Hong Kong last July. Daily trading has now reached $400 million. Given $4 trillion is the total of all daily currency trading, the internationalization of the yuan still has a long way to go, but it is clear where it is headed however cautiously.
The post was first published on China Bystander.