Wednesday 16 May 2012

Waiting For The End in New York and London


Say what you like about the Euro, but you can't call its agony a surprise. When Greece finally exits the Eurozone, it will be probably the most lengthily-anticipated financial catastrophe in history. The world's financial systems have had literally years to prepare, and I suspect we're about to find out whether they've spent the time well.

Let's look first at New York, where we've previously tracked the dramatic change in behaviour of foreign banks' operations over the last 18 months. As of end-April foreign banks operating in New York had raised the amount that those operations are funded by their home head offices to a net US$262 billion. In a crisis, this has advantages and disadvantages. The advantage is that the sudden closure of New York money markets to European banks won't immediately cause a liquidity crisis for their US operations, since they are, on a net basis, no longer funding from them. The disadvantage is that if Greek's exit from the Eurozone triggers a massive express unwinding of European foreign capital flows, then we should expect that that US$262bn will exit New York quickly.   
A capital outflow of that kind will inevitably cause funding strains, and we can expect those to be accompanied and intensified by outflows of deposits from non-US banks. But foreign banks in New York have spent the last 18 months structuring their local balance sheets to give themselves the best chance of surviving just such a collapse in confidence. First, deposits as a proportion of total liabilities have fallen from just under 80% at the end of 2010 to around 46% now, and during that time total deposits have fallen by 17.2%, or US$182.5bn. Secondly, during the same period, banks have added US$404.3bn to their holdings of cash, more than doubling the total. As a result, at the end of April, these banks held enough cash to pay out 84.4% of all deposits. My bet is that proportion is even higher now. Clearly, this is a pretty good defensive crouch.
In New York, we can only track the mass of foreign banks: but the Bank of England provides data specifically on the operations of European banks in London. These report that even though total Euro deposits have fallen by Eu39.bn in the year to end-March, these deposits still make up 92% of Euro-denominated liabilities, and 31.8% of their total London-based liabilities – a proportion which actually has crept higher as the crisis has evolved. The proportion of these Euro-denominated deposits which are covered by Euro cash, near-cash or time deposits at the end of March 2012 had risen to 72%, only mildly higher than the 68.6% a year earlier.

In other words, European banks in London are running a net short Euro-position, which first appeared in June 2011, and by March 2012 was equivalent to £23.6 billion. London banks are not, therefore immediately in a position to fund any emergency call from their head offices for Euros.  


On the other hand, their London operations are running long positions in other currencies, amounting to £13.6bn in Sterling and £10.0bn in other foreign currencies.

Conclusion: If Greece exits the Euro, in its wake we can that capital will exit European institutions all over the world, whilst pooling in the Eurozone principally in German banks. Foreign banks in New York can be expected to be an immediate source of rapid liquidity, and probably do have the capital structure to manage this role effectively even during a severe loss of confidence. European banks in London, however, cannot be expected to emerge as an immediate source of Euro-funding, since they now structurally short Euro. However, we can expect the net long positions in other currencies to be unwound rapidly as the Euro-shorts are covered.

The irony is this: European banks' operations in both New York and London are positioned extremely conservatively, so that cash can be rushed 'back home' in an emergency. Result? When the balloon goes up, expect interbank rates to spike in New York and London, and the Euro to have a short-run period of strength as short-covering kicks in. If capital controls are imposed, or threatened, that spike could hurt.





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