Quis custodiet ipsos custodes?

June 25, 2013

Who guards the guards? In the case of Europe’s banks, the answer is still a work in progress given the faltering efforts to create a banking union.

Today, we interview Jaime Caruana, head of the Bank for International Settlements which said on Sunday that its central bank constituents should not be deterred by fears of market volatility when the time came to start turning off the money-printing machines. That moment was fast approaching, it said.

The big question is why it would not be safer to wait until the world economy is on a sounder footing before turning the money printing presses off, particularly since there is a notable absence of any inflationary threat.

Just before he takes the helm at the Bank of England, Mark Carney will hold a briefing wearing his other hat – head of the Financial Stability Board, the body charged with coordinating international banking regulation. Both he and Caruana could have interesting things to say about the Federal Reserve’s warning that the era of QE is drawing to a close. Both could also have some trenchant things to say about Europe’s banking plans.

Having failed to agree how the bill for future bank failures should be paid, EU finance ministers are scrambling to alight upon a plan and will meet again on Wednesday in an attempt to have something for their leaders to approve at a Thursday/Friday summit.
This was supposed to be in the bag. The more profound elements of banking union are shelved for now. It has been apparent for some time that a bank “resolution fund” with pooled risk has not got a cat in hell’s chance of being created in the foreseeable future, so the “doom loop” of weak banks and sovereigns weighing on each other will not be broken. Berlin will certainly not budge before German elections in September.

The European Central Bank must be both nervous and furious at the prospect of taking over bank regulation next year without the parallel structures which were promised last year. ECB chief Mario Draghi is speaking in Berlin and his colleague, Benoit Coeure, speaks in London. They may well express alarm at what is, or more to the point what is not, happening.
Without further progress, the only part of banking union left standing will be the ECB’s regulatory role, which will be a toothless tiger in isolation. We will also seek the views of the commercial bankers – who presumably at least want clarity and certainty – at the Institute of International Finance’s two-day conference in Paris.

If further steps on banking union – originally conceived of as a three-step process involving a single supervisor, a single resolution mechanism to deal with failing banks and a single bank deposit-guarantee scheme – is put off until after the German election, the chances are that nothing will happen until mid-2014 or later, given it will take some time to form a German coalition and early 2014 will be dominated by campaigning for the European Parliament elections.

That might not be a disaster but this is playing out against a backdrop of rising euro zone borrowing costs again and other problems beginning to mount in the currency bloc – the Greek coalition government is down to a wafer-thin majority after one of its partners walked out and will almost inevitably need a further debt writedown in future. Neighbouring Cyprus is saying it needs to alter its bailout terms and Portugal’s premier said yesterday that he may have to ask the EU and IMF for a further easing of budget deficit goals. Spain remains deep in recession and Italy … well Italy is Italy.

Portugal bears particularly close scrutiny. It aims to get back to funding itself on the markets next year but that must now be in doubt, particularly if its yields continue to rise. The history of this crisis shows that it is market pressure that has forced the issue time and again.

Cypriot president Anastasiades will hold his first news conference since taking office in February. We will be watching for signs of resolve to move forward on privatisations, and attempts to change terms of the initial bailout, something he is already written to Brussels requesting.

Italy sells a range of debt during the week, starting today with an auction of zero coupon and inflation-linked bonds, at a rather tricky time although both it and Spain have frontloaded their funding for this year. Madrid sells up to three billion euros of short-term treasury bills, the Netherlands is offering up five-year bonds and Britain is launching the longest gilt it has tried in living memory – a 55-year bond. The UK’s debt management chief is speaking at the same conference as Coeure.

With markets on a helter-skelter ride after the Federal Reserve made doubly clear that it might not be printing any more money by this time next year, signs of a Chinese liquidity crunch have added to the sense of alarm. The central bank moved to ease that today but it has also made clear the era of cash glut was over – so both it and the Fed are moving to take the proverbial punch bowl away from the party — and Chinese bank stocks tumbled further.

Hungary’s central bank, filled with government appointees, has cut interest rates for 10 months in a row but will have to have a serious think at Tuesday’s policy meeting. Following the Fed’s intervention, emerging markets are in turmoil and a government that has hitherto got away with some decidedly unorthodox policies will have to be wary of the forint taking a hit. A rate cut could increase that threat.

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