An SMS from Ernst (20): Short Messages Service

After the extremely tense last days where the problems surrounding the Euro-zone reached a new climax, there is some relaxation on the financial markets. The new prime-ministers of Greece and Italy, Lukas Papademos and Mario Monti received for the time being the benefit of the doubt of the ever alert financial markets, thus diminishing the fear for an immediate Euro-zone meltdown.

Still the word of the day remains ´banks´: these are not only the pivots of the sovereign bond crisis as holders of enormous amounts of sovereign bonds from the PIIGS countries, but suffer also from the ubiquitous distrust in the banking world currently.

Therefore the emphasis of today’s SMS remains on the banks and the EFSF.

Het Financieele dagblad (www.fd.nl)  writes on the extra capital demands for the local system banks in The Netherlands.

Extra charge for Dutch system banks (link in Dutch)

Rabobank, ING, ABN Amro and SNS Reaal presumably must keep extra core tier one capital, as these banks can disrupt the Dutch financial system when they default.

The system banks must keep 1% - 3% of their risk-weighed assets in additional equity. This can be concluded from the latest quarterly report of the Dutch National Bank (DNB). The DNB speaks of a ´small group´ of system-relevant banks and wants to publish the name and segmentation later this year.

Last week the fact was published that ING was added to a list of 29 Global system banks by the Financial Stability Board (FSB): the so-called G-SIFI´s or Global Systemically Important Financial Institutions. These banks needed to keep up to 3,5% of their risk-weighed assets in equity, due to their importance for the global financial system.

When necessary, local supervisors may declare the measures for these G-SIFI´s also applicable for institutions that play an equally important role on a national scale. The criterion for the DNB is that the aforementioned banks are responsible for the greater part of business and private lending in The Netherlands

CEO Ronald Latenstein of SNS Reaal assumes ‘that SNS is a national SIFI’,  he stated in an analyst call on the quarterly results. Latenstein expects the expanded national capital ratio to be more substantial for the global system bank (ING) than for ´local heroes´, like SNS. I expect the percentage to be close to 1% for the national system banks and close to 3% for the global system bank. This added equity comes on top of the 7% core tier one rate, that is established by the Basel III treaty.

In itself, the added core tier one capital for system banks is a step in the right direction. However, when distrust is high among customers and other banks, a core tier one capital of even 9% is absolutely insufficient to withstand a serious bankrun when it occurs. This makes the extra capital demand more a token measure, than a measure with sharp teeth: while the solvability of a bank is important in the long run, a lack of liquidity can kill a bank in hours in the internet age.

The firepower of the EFSF

From financial firepower on a national level to firepower on a European level: the EFSF. This now leveraged emergency fund with its 20% ´not good, money back´ guarantee on sovereign bonds from the peripheral countries, is suffering from what you could call a lack of popularity.

Russia and China, while chuckling that ´they would help the EU when it is really necessary´ refused politely, but firmly to invest their money in it, after the EU countries initially refused to do so. And also the private and corporate investors passed the buck until now.

Instead of being a leveraged fund with a €1000 bln bazooka, the EFSF has now the firepower of a lady´s gun, loaded with blank cartridges. The Financial Times writes on this story:

Market volatility limits EFSF firepower

This week’s market upheaval in Europe has made it difficult to increase the firepower of the eurozone’s €440bn rescue fund to the €1,000bn that the bloc’s leaders had hoped for, the fund’s chief executive said on Thursday.

Investors have fled from bonds issued by highly indebted countries. Luring them back by offering insurance on losses – the centrepiece of a plan agreed in Brussels on October 26 – would now probably use up more of the fund’s resources, Klaus Regling, head of the European financial stability facility, said.

His concerns underline Europe’s difficulties in putting in place mechanisms to contain the sovereign debt crisis and, if necessary, help Italy cope with soaring refinancing costs.

“The political turmoil that we saw in the last 10 days probably reduces the potential for leverage,” Mr Regling told reporters. “It was always ambitious to have that number, but I’m not ruling it out.”

The European Commission sharply downgraded its forecast for eurozone growth next year from 1.8 per cent to 0.5 per cent. The global ramifications of Europe’s economic woes became clearer with the growth in China’s exports to the EU slowing in October and a sell-off in Asian equities markets.

The loss-guarantee programme aims to leverage the €250bn ($340bn) remaining in the EFSF to cover more than four to five times the value of bonds than if the fund purchased the bonds outright.

But Mr Regling said heightened investor skittishness meant the guarantees would now have to be bigger in order to convince investors to participate, meaning the fund was likely to have only three to four times the firepower.

Officials had hoped new investors could be enticed by a guarantee against a 20 per cent loss but those investors may now be seeking up to 30 per cent – which would limit the expanded firepower of the fund to about €800bn.

This whole story is a must-read, so please click the link.

Martin Visser, the excellent FD (www.fd.nl) correspondent for Brussels, had a very clear conclusion (Dutch) on the leverage problems and the lack of firepower for the EFSF. 

I quote: ´[…] but when do you need a big emergency fund? Right then, when there is massive turbulence on the financial markets. Regling shows with this very simple analysis that leveraging an emergency fund without additional capital from the euro-countries, is a very shaky solution´.

Martin is totally right here: An EFSF with little real money in it, is like a gun with blanks. It says ´bang´, but it doesn´t kill the problems.

And the signal that Europe transmits is: `hey, we don´t want to pay much for saving the euro-zone, but we sincerely hope you do, do you?´ I hate to say it, but it´s quite pathetic.

SNS Bank and the salaries

Het Financieele Dagblad (www.fd.nl) writes again on the smallest Dutch system bank SNS Reaal. During the presentation of the Q3-results, the aforementioned CEO Ronald Latenstein of SNS Reaal dropped a brick on a very painful subject: the salaries and fringe benefits of bank employees. He stated that those salaries were much too high, compared to other industries and could be reduced by 10-15%:

SNS employees earn too much money (link in Dutch)

SNS Reaal opens fire at the employment conditions of bank and insurance employees. CEO Ronald Latenstein calls the employment conditions for personnel much too abundant.

The salary and fringe benefits of a bank employee, when totaled, lie 10%-15% higher than in other industries: service as well as manufacturing.

Latenstein thinks that more austere employment condtions are inevitable, as yields in the financial sector will be structurally lower. SNS is still busy restructuring, which will cost about 1200 full time jobs. Already 900 jobs have disappeared.

But abolishing jobs can’t go on forever. ‘These cutbacks can not only come from reducing personnel’. Earlier, the CEO mentioned already that not only shareholders and consumers, but also personnel have to foot the bill for the deteriorated situation on the financial markets.

I personally agree with Latenstein that the salaries and fringe benefits in the financial sector are indeed very high, compared to other industries. But even inquiring readers that disagree with me on this subject, must see the enormous deflationary impact of this.

If SNS Reaal runs the gauntlet with the subject of wage reduction, you can be certain that ABN AMRO, Rabobank and ING Group have this also on their radar for the CAO (Collective Employment condition Agreement) negotiations with the labor unions.  In the ‘number one cartel country in the world’, The Netherlands, this subject is undoubtedly discussed within the banker’s old boys’ network and it can be considered a done deal for all banks.

I guess that banking personnel will be in for a ‘hot winter’ of employment condition negotiations. And you can bet that banking personnel is not the only group that will be asked to abolish some of their abundant salary and fringe benefits.