Petrodollar drought another blow to banks
Banks in Europe and Britain, and their unfortunate would-be borrowers, face another blow as plunging oil prices tighten the spigot of petrodollar deposits.
Billions of dollars worth of funds from oil exporting nations have made their way into banks from Zurich to London in recent years. These inflows helped banks withstand credit crisis losses and, given much of the money was in dollars, was a source of dollar liquidity during recent money market difficulties.
Petrodollars also arguably fed the lending boom while it lasted and cushioned the effects when the boom turned to bust. But, with oil having tumbled to around $55 per barrel from almost $150 this summer and the mid-$90s a year ago, flows into European banks will likely drop dramatically. What’s more, a global recession and rolling financial crises mean that oil producers such as Russia and the Middle East states will have new calls to spend money at home, further diminishing the money available to grease the wheels of international banking.
Though it is impossible to track exactly, depositors from oil exporting states have long shown a preference for British and European banks over U.S. ones, some for political reasons, such as Venezuela, and some out of concern over the effects of post-Sept. 11 U.S. banking disclosure laws.
This, needless to say, is not a good time for these banks to lose an important source of inflows. It will worsen their position and make it tougher for their clients to secure loans.
Borrowers in emerging Europe, such as in Hungary, may be particularly hard hit having gorged on credit during the boom.
Deposits abroad from oil producing countries hit more than $1.2 trillion at the end of 2007, according to the Bank for International Settlements, up from less than half a trillion in the third quarter of 2003. More than $150 billion flowed into international accounts in 2007 alone, according to the BIS. Those flows will have continued to be strong in the first half of this year as oil soared, but would seem very likely to now be slowing and to diminish further so long as oil and the global economy struggle.
Certainly the oil-producing states have new calls on their funds. The Gulf particularly is suffering from crashing confidence and tight liquidity, and has its own housing boom that is turning to dust. The United Arab Emirates poured $6.8 billion into the financial system in October as part of a $19.1 billion rescue facility while Saudi Arabia injected $3 billion in long-term deposits into its banks, echoing other similar moves elsewhere.
Russian central bank reserves are down about $120 billion since their August peak, sapped in part by massive interventions to support the rouble.
WHO WILL SUFFER?
The Eurodollar market, for dollar denominated deposits outside the United States, began in the 1950s when Soviet Russia wanted a home for dollars that could not possibly be seized by the U.S. government.
Huge amounts of petrodollars flowed into U.S. banks during the oil price spike of the 1970s, much of which was recycled into ill-fated floating rate loans into Latin America. That ended with the Latin American crises of the 1980s, causing a series of problems that now seem familiar, not least bank capital woes and the need for official intervention.
“This time around, petrodollars may have been deposited with European banks, which in turn lent aggressively to emerging market economies in all three time zones,” Stephen Jen, currency strategist at Morgan Stanley in London wrote in a note to clients.
“Assuming this thesis is correct, sharply lower oil prices will constrain the recycling of petrodollars, and constrained risk-taking appetite of European banks could choke off loan flows into emerging Europe.”
Jen also notes that European and British banks are five times more exposed to emerging markets through bank debt that their U.S. and Japanese peers.
For some countries that have benefited from petrodollar banking flows there is another problem that their diminution will make worse; the banking sector is just really huge in relation to the size and wherewithal of the host economy.
Whereas bank liabilities in the United States were equal to about 20 percent of gross domestic product (GDP) in 2006 the last time BIS data was published, for Britain it was 285 percent and for Switzerland 317 percent.
That certainly gives things a piquancy when bank rescues are in the air.
High oil prices were a huge tax on oil consumers, and you can argue that as usual when faced with a surfeit of cash banks and went and blew it on trinkets and speculative loans. But having that flow of deposits cut back now is really one of the last things the banks or their overburdened regulators must want to see.
— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund —