A Perfect Storm is Brewing in Banking and Finance
Now that interest rates are rising with much further to go, the global banking system faces a crisis on a scale like no other in history. Central banks loaded with financial securities acquired through QE face growing losses, and their balance sheet liabilities are now significantly greater than their assets—a condition which in the private sector is termed bankruptcy. They will need to be recapitalized urgently to retain credibility.
Furthermore, banking regulators have made a prodigious error in their oversight of the commercial banking system by focusing almost solely on bank balance sheet liquidity as the principal determinant of risk exposure. And on the few occasions in the past when they have demanded banks increase their own capital, it has always been through the creation of preference shares and pseudo-equities to avoid diluting the true shareholders. The consequence is that the level of leverage for common equity shareholders in the global systemically important banks has risen to stratospheric levels.
The regulators may be comfortable with their liquidity approach, but they have ignored the periodic certainty of a contraction in bank credit and the consequences for banks’ equity interests. Meanwhile, G-SIBs have asset to common equity ratios often more than fifty times, with some in the eurozone over seventy. It is hardly surprising that most G-SIBs are valued in the equity markets at substantial discounts to book value.
G-SIBs have accumulated excessive exposure to financial assets, both on-balance sheet and as loan collateral. With vicious bear markets now evident and further interest rate rises guaranteed by falling purchasing powers for currencies, the one thing regulators have not allowed for is now happening: like a deepening meteorological low, bank credit is contracting into a perfect storm.
Jamie Dimon’s recent warning that his bank (JPMorgan Chase) faces hurricane conditions confirms the timing. Central banks, bankrupt in all but name, will be tasked with rescuing entire commercial banking networks, bankrupted by a collapse in bank credit.
Why Are Markets Crashing?
It is becoming clear that financial assets are in a bear market, driven by persistent rises in producer inputs and consumer prices, which in turn are pushing interest rates and bond yields higher. So far, investors have been reluctant to lose trust in their central banks which have been instrumental in supporting financial markets. But this is now being tested, more so in the summer months as global food shortages develop.
We have increasing evidence that bank credit is either contracting or on the verge of doing so. This wa
Article from Mises Wire