The $5 trillion rollover

By J Saft
June 29, 2010

Banks around the world must refinance more than $5 trillion of debts in the coming three years, a massive rollover that poses threats to financial stability and growth.

The need to replace these debts, which are medium and long term, will place pressure on bank profit spreads and in turn may either prompt deleveraging, where banks sell assets that they can no longer economically finance, or simply lead to a bout of credit rationing, where borrowers must pay more to borrow, thus crimping investment and economic growth.

For banks in the UK, according to the Bank of England Financial Stability Report, the refinancings amount to about $1.2 trillion by the end of 2012.

If banks in Britain raise funds at the same pace they have been this year, they will only collect half of their needs in time. This is even before the fact that the banks need desperately to turn some of their riskier short-term funding into more reliable funding with a longer maturity.

“If funding costs increase dramatically, which is perfectly possible in what could be pretty febrile market conditions, that will hit profitability (and the banks ability to raise capital organically) until they are able to re-price loans and facilities,” according to Richard Barwell, an economist at the Royal Bank of Scotland in London.

“And to the extent that banks are unwilling or unable to roll over funds that would trigger forced deleveraging. Both outcomes imply a sharp contraction in credit conditions for those within and outside financial markets, putting considerable downward pressure on activity and asset prices.”

Banks outside of Britain are perhaps doing marginally better in meeting their needs, but still face an uphill struggle.

U.S. banks have issued $230 billion of debts in the first five months of the year, about 60 percent of the rate they need to achieve over the three year period. Euro zone banks have issued $133 billion, or about 70 percent of their needed run rate.

One easy to see consequence is that, all things being equal, the cost for banks to issue debt should rise, as should competition among banks for consumer deposits. It is possible that a global desire to save more helps to blunt this effect, but even so the macroeconomic effect and the effect on asset prices will both be strongly downward.

BANKS WILL HAVE THEIR FUNDS

The track record of the past three years tells us one thing is likely: the banks will get their money, courtesy of government support if needed.

Unless there is a profound sovereign debt crisis, we can count on governments taking the needed steps to see that the banking system does not fall over for lack of funding. So, if liquidity or support schemes need to be extended or invented anew, they will be.

But a banking system that has not fallen over, while a precondition for strong economic growth, is not in and of it self sufficient to cause strong economic growth. Expensive funding and a rising term premium will stunt growth and they will impose a haircut on risk asset prices.

Viewed another way, however, higher funding costs for banks is really nothing other than the market demanding a different capital structure from banks.

It is not simply that a lot of money needs raising all at the same time, but rather that the people who have in the past supplied the money have a new appreciation of the risks in lending to banks, or should that simply be of the risks of lending.

The Financial Stability Report also looks at the costs and benefits of higher amounts of capital in banking. The benefits are straightforward: a reduced chance of systemic crises. Costs are thornier, but also quite high. The BOE used an assumption that for every 7 basis points of additional lending spread charged by banks should create a 0.1 percent permanent reduction of GDP.  On their estimates upping capital in banking by one percent then equates to present value cost of about 4.0 percent of UK GDP.

This puts into perspective not just how challenging it will be to create growth going forward, but just how artificially growth during the boom was goosed by very loose and easy lending.
For the UK and for Europe, this will be happening at the same time that fiscal austerity programmes will be dampening growth.

Something has to give, and it will probably be monetary policy. Look for extraordinarily low rates for a very long time, and for new and bigger quantitative easing programmes.

7 comments

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I love the idea of a bank tax. Congress also should implement the UK’s tax rate of 50% on banker bonuses

Posted by STORYBURNcool | Report as abusive

Through all this you can be sure the CEO’s and other bank officers will make their money. Even if the common folk are broke and starving!

Posted by Sonnyjc9 | Report as abusive

What a useless comment by Sonnyjc9, it’s like a mad lib.

Through all this you can be sure the lobbyists and other professional rodeo riders will make their money. Even if the common folk are broke and starving!
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Does tthe BOE assumption have any historical precedent, aka, can you apply this assumption to past economic policies and it’ll hold true?

It’s scary to think that after the next funding crisis,
their might be a monetary one with devaluation being used
to make loan repayments. It’s time for me to diversify
my monetary holdings for sure.

Posted by Windtell | Report as abusive

Banks should not be operating for profit. They need to refinance 5 trillion in debt, that they themselves created by taking profit from risky deals and leaving others to hold the bag. Because of this refinance, legitimate businesses that work to solve real problems and provide real value, will be crushed by the burdens that will be placed on their finances.

Businesses are already purely profit focused in part, because they need to pay billions in interest to finance projects that really make a difference. Banking is supposed to be the means by which businesses can average the risk of failure down by drawing from a pool of money. That pool serves to help prop them up while they get operations under way and become commercially viable.

If a business owner only had to pay back the money that was borrowed with no interest, that owner would have incentive to expand operations and create jobs. Banks don’t do anything but shuffle paper and agree on a price for that shuffling. The banking system is not being used in a way that benefits society. No one is suggesting that banks should work for free. But they only need enough money to pay employees and do their work. Aside from that they need nothing.

Release real business from the strangle hold of the banking industry, and you will see real innovation and productivity. As it stands now, the banking industry can and often does, bleed a business dry before it even hits the market. And I’m not saying anything that is demonstrable simply by looking at the markets and the banks.

Posted by Benny_Acosta | Report as abusive

[...] wereldwijde banksysteem moet in de komende drie jaar $5.000 miljard aan financiering vinden. Om deze bedragen te vinden, zal men op zijn minst hogere interesten moeten betalen. En dat zet dan [...]

The debate over sovereign risk has focused on the government debt. Sovereign risk is a much more complex subject than that of which the another important component is the private sector and from the above article we can see that this is currently moribund. In fact I suspect that much of the angst over sovereign debt has been over the fear that the public sector will squeeze out the private sector and of course the latter is where people make money.
Secondly, securitization was the key to redistributing debt away from the banking sector.This mechanism is defunct. The market tries to revive itself, but the fundamental issue is that the mathematical constructs underpinning securitizations are inadequate. Not until this modelling issue is addressed will we see a revival of the market. To be quite honest politicians have been derelict in their duty in not explaining this to the public.

Posted by osymandius | Report as abusive

I’m shocked to read the 10:50Am comment by Benny_Acosta. It is even more frightening because it is well written rather than some easy to ignore rant.

A sound banking system is a fundemental pillar of a functioning economy. If you step back and look at human history there has never been a time with such widespread prosperity as has existed from 1950-present day.

If you want to tax bankers bonuses at 50% go ahead.
If you want to tax bank profits at 50% go ahead.
If you want to raise capital requirements go ahead.
If you want to implement a trading tax go ahead.

All of those changes will have positive and negitive effects but none of them would destroy our system of rewarding work and savings.

If you want banks to operate without profit or charging interest on loans than I assume that banks would no longer pay interest on deposits in that insane system. How would people plan and save for their retirement or the education of their children?

Even in this horrible rate enviroment my bank offers a 5 year CD for 3%. A very low rate by historical standards but better than zero!

The system of paying interest on deposits and charging interest on loans has served society amazingly well for over 1000 years. Start messing with that and I promise you that the quality of life will drop sharply.

Posted by y2kurtus | Report as abusive

[...] The $5 Trillion Rollover, Debt Deflation And The 666 Credit System By theyenguy I … Reuters provides the article The $5 Trillion Rollover: [...]

Yes indeed the massive rollover poses threats to financial stability and growth.

Banks will de-leverage, that is sell assets where they can but the market for the assets may be limited; therefore the assets may have to be written off, eventually causing the banks to go out of business; that is why credit default swaps on banks have been rising in value. Definitely there will be a bout of credit rationing, where borrowers must pay more to borrow, thus crimping investment and economic growth. The borrowers most at risk are the small companies which are reliant upon a well-functioning lending system with low rates. This group of companies includes the Russell 2000, IWM, whose value swings widely with the value of regional banks, KBE, and the too-big-too-fail-banks, RWW.

The problem with longer out funding is that as the yield curve rises, $TYX:$TNX as the economy slows then the funding becomes prohibitively expensive, limiting the amount of lending and raising the risk of failure on the loan.

First with the subprime crash and more recently with the sell off of currencies on the rise of the European Sovereign Debt Crisis on April 26, 2010, we entered into the age of the end of entitlements: the track record of the past three years of the banks getting their money, courtesy of government support, has ended in the US with the termination of the Federal Reserve QE and is ending in Europe as the ECB terminated the one year repo facility and put a three-month repo facility in its place.

Day by day, the European sovereign debt crisis is getting larger as investors have sought the so-called safe haven in US Treasuries, TLT and IEF and as the lending system has frozen as Spanish banks must be financialized by the ECB to continue in operations and as European financial organizations, EUFN, have stopped lending to each other and put their overnight money on hold at the ECB at low-interest.

The banking system problem has gone from one of liquidity to one of solvency: many banks are simply insolvent; they are zombie financial institutions waiting to be shut down.

The market demanding a different capital structure from banks will result in ever decreasing credit and an ever decreasing GDP; this is a vicious cycle that commenced April 26, 2010 as the currency traders sold the world currencies against the US Dollar; this is known as Debt Deflation.

Debt deflation is consequence of credit expansion. One of the most famous quotations of Austrian economist Ludwig von Mises is that “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

Bible prophecy foretells that when currencies collapse, a new worldwide credit system will be installed. The Sovereign, that is the world leader, Revelation 13:5-10, will be complemented by the Seignior, meaning top dog banker who takes a cut, Revelation 13:11-18, will direct the 666 credit system, Revelation 13:17-18, which is the seigniorage system whereby one will be given the charagma, or mark, necessary to conduct commercial activity.

Posted by theyenguy | Report as abusive