Markets cheered Wednesday’s move by a handful of the world’s biggest central banks to ensure financial system liquidity, but CIBC World Markets cautions that the move may be largely symbolic.
In a research note, CIBC says that while markets were “in dire need of some reassurances that leaders have their act together”, and so Wednesday’s move to reduce near-term funding risks for banks is cause for celebration, it cautions that, “the underlying solvency risks for European financial institutions that continue to hold sovereign exposures are not diminished by today’s move.”
Central banks to support global financial system with added liquidity
In a move that is reminiscent of co-ordinated central bank actions at the height of the 2008 crisis, the banks (including the US Federal Reserve Board, the European Central Bank, Bank of England, Bank of Japan, Bank of Canada and Swiss National Bank) agreed to lower the pricing of the US dollar swap agreements and extend the operation of the facility until February 1, 2013. And, in the case of the ECB, it lowered margin requirements for its three-month operation to match those of its one-week operation.
However, CIBC points out that the current US$2.4 billion in outstanding swaps that the other central banks hold with the Fed is “a pittance” compared to the facility’s use during the last crisis, when it reached $553 billion at its height. “At present it’s only the ECB and (to a lesser extent) the Bank of Japan that are drawing on the funding line to help their under-pressure financial institutions,” it notes.
“All of this could be seen as a precautionary move to mitigate growing funding strains,” CIBC says, and it reassures markets that avenues are available to financial institutions for affordable US$ funding.
“The benefits of the move will mostly trickle to a small sample of banks in the eurozone as that region accounts for the lion’s share of tapping of Fed lines. Thus, the ‘co-ordinated’ multi-nation nature of today’s move is largely symbolic,” it says.
Moreover, while Wednesday’s announcement reduces liquidity and funding risks for some sound European banks, CIBC stresses that “deeper issues not addressed by today’s move continue to plague that region’s financial system.”
It points to the plan for a 50% haircut on Greek debt among private sector bond-holders, which it says remains a threat to capital positions for banks in the region. And, it notes that the push for aggressive capital raising to beef up tier-1 capital ratios among European banks also “threaten to exacerbate the recession that Europe faces in the coming year since banks are choosing to cut assets and tighten lending rather than raise new equity.”
“And with the ongoing sell-off in Spanish and Italian bond markets, underlying exposures to sovereign debt on the balance sheets of the region’s banks continues to pose solvency risks that will increase if the fiscal crisis continues to escalate,” it says.