G20 to institutionalize Bank Bail-Ins?

As I have been saying and predicting here, governments have been in a mission creep to institutionalize "deposit haircuts ", which eventually culminates into a Cyprus style bail-IN. This has been part of the deepening of use of financial repression.

Negative deposit rates signify a slippery slope towards wealth confiscation as I recently noted: Negative rates will serve as a precursor to the widespread adaption of deposit confiscation via haircuts or wealth taxes especially when the global crisis emerges.

Analyst Russell Napier warns (published at the Zero Hedge which he calls “the day the money dies”) that the G-20 has reached an accord for member nations to standardize Bail INs by legislating a downgrade on the treatment of bank deposits. (bold mine)

The G20 announcement in Brisbane on November 16th will formalize a "bail in" for large-scale depositors raising the spectre that their deposits are, as many were in 1932, worth less than banknotes. It will be very clear that the value of bank deposits can fall in nominal terms.

On Sunday in Brisbane the G20 will announce that bank deposits are just part of commercial banks’ capital structure, and also that they are far from the most senior portion of that structure. With deposits then subjected to a decline in nominal value following a bank failure, it is self-evident that a bank deposit is no longer money in the way a banknote is. If a banknote cannot be subjected to a decline in nominal value, we need to ask whether banknotes can act as a superior store of value than bank deposits? If that is the case, will some investors prefer banknotes to bank deposits as a form of savings? Such a change in preference is known as a "bank run." 

Each country will introduce its own legislation to effect the ‘ bail-in’ agreed by the G20 this coming weekend. The consultation document from the UK’s Treasury lists the following bank creditors who will rank ABOVE depositors in a ‘failing’ financial institution: 

-Liabilities representing protected deposits (in the UK the government guarantee protects 100% of deposits up to the value of GBP85,000) any liability, so far as it is secured

-Liabilities that the bank has by virtue of holding client assets

-Liabilities arising with an original maturity of less than 7 days owed by the banks to a credit institution or investment firm

-Liabilities arising from participation in designated settlement systems

-Liabilities owed to central counterparties recognized by the European Securities and Markets Authorities… on OTC derivatives, central counterparties and trade depositaries

-Liabilities owed to an employee or former employee in relation to salary or other remuneration, except variable remuneration

-Liabilities owed to an employee or former employee in relation to rights under a pension scheme, except rights to discretionary benefits

-Liabilities owed to creditors arising from the provision to the bank of goods or service (other than financial services) that are critical to the daily functioning of its operations

The above list makes it clear that deposits larger than GBP85,000 will rank ahead of the bond holders of banks, but they will rank above little else. Importantly, both borrowings of the banks of less than 7 days maturity from other financial institutions and sums owed by banks in their role as counterparties to OTC derivatives will rank above large deposits. 

Large deposits at banks are no longer money, as this legislation will formally push them down through the capital structure to a position of material capital risk in any "failing" institution. In our last financial crisis, deposits were de facto guaranteed by the state, but from November 16th holders of large-scale deposits will be, both de facto and de jure, just another creditor squabbling over their share of the assets of a failed bank. 

Interestingly, HM Treasury uses the word ‘failing’ rather than "failed" in its consultation document and investors could find their large deposits frozen for a prolonged period in any "failing" institution while the courts unpick the capital structure and decide exactly where any losses should fall. 

If we have another Lehman Brothers collapse, large-scale depositors could find themselves in the courts for years before final adjudication on the scale of their losses could be established. During this period would this illiquid asset, formerly called a deposit and now subject to an unknown capital loss, be considered money? Clearly it would not, as its illiquidity and likely decline in nominal value would make it unacceptable as a medium of exchange. 

From November 16th 2014 the large-scale deposit at a commercial bank is, at best, a lesser form of money, and to many it will cease to be money at all as its nominal value can fall and it could cease to be accepted as a medium of exchange.

Fortunately, the developed world’s commercial banks are flush with central bank reserves and these are instantly convertible into the banknotes which they may need to meet demand from depositors. While the huge level of reserves on the balance sheet is a buffer, the funding of fractional reserve banks is still very negatively impacted by a shift from deposits to bank notes. With deflationary forces gathering momentum, this further impediment to the extension of commercial bank credit would be another factor preventing central bank monetary largesse translating into growth and inflation.

As the world’s smartest lawyer Charlie Munger is fond of saying, "Show me the incentive and I will show you the outcome." Some simple mathematics reveals that the November 16th announcement will create a very major incentive for investors to change deposits into banknotes.

In short, the formalization of the G20 accord on the downgrade of bank deposits implies greater risks of bank runs.  Yet the institutionalization of bail INs will not likely to be limited to G20s but should spread even on Emerging-Frontier markets. 

Governments around the world have been in a state of panic. They are desperately manipulating stock markets in the hope that these may produce “wealth effect”, a miracle intended to save their skin or the  status quo (the welfare-warfare, banking system and central bank troika), as well as, camouflage current economic weakness and or kick the debt time bomb down the road.

Yet the same political institutions recognize that inflating stocks are unsustainable. So during this current low volatile tranquil phase, they have been implementing foundations for massive wealth confiscation. 

What better way to confiscate than do it directly. Yet the more the confiscations, the greater risks of runs on banks and on money.

McKinsey's Outlook On Global Banks: Asian And Emerging Markets To Outperform

Here is an interesting outlook on global banks from the McKinsey Quarterly team.

From McKinsey (all bold highlights mine)

One key finding is that the capital shortage triggered by the crisis and recently addressed through several rounds of massive capital raising will endure and get worse. Our scenarios model both the demand for capital (the amount needed to finance projected asset growth and meet regulatory requirements) and the supply (earnings, less the amount likely to be paid out as dividends). In every case, demand exceeds supply. Capital needs will range from small (investment banks, which have already raised significant amounts and are holding substantial buffers, anticipating regulatory change) to vast (emerging-market giants, which will need to finance their growth). In between are the universal banks, which will have modestly challenging capital needs in the midpoint scenario and a very challenging problem in the extreme one.

A second factor weighing on returns will be the high and rising cost of long-term funding.

Several factors are at work here, beginning with a shift in demand. As part of balance sheet restructuring, many banks are cutting back on short-term, unsecured funding (such as commercial paper) and seeking instead to issue longer-dated debt. Demand will also rise as the longer-dated funding currently on banks’ books expires and is renewed. On the supply side, government asset-purchase programs—quantitative easing—are already being retired. Finally, the market will see greater competition for funds, not least from governments that must finance their deficits. All this implies that prices for long-term funding will inexorably rise, shaving as much as several percentage points off ROE, depending on the scenario.

Given these drags on performance, returns will be weak by the standards of the past decade. Worse, they will be highly uncertain—our third finding. In the midpoint case, industry revenues would grow by 5 percent annually through 2014; in the extreme case, the industry would eke out much less attractive annual growth of 1 percent. Under either scenario, the emerging-markets giants come out on top. The story for the other groups of banks is mixed. In the midpoint case, the European and US universals and the investment banks would generate middling ROEs well below their pre-crisis levels. The Japaneseuniversals’ returns would suffer from a poor macroeconomic environment. In the extreme scenario, all but the emerging-market giants will find it extraordinarily difficult to return even their cost of equity. In other words, these banks will face a challenging period reminiscent of the early 1980s.

Our estimates may be cautious. We did not include, for example, the effects of a liability levy such as the one the Obama administration recently proposed. Instead we modeled this proposal separately and found that if such a tax were adopted globally and imposed on the banks in our model, the effect would be to reduce their ROEs by 0.7 to 1.2 percentage points.

A fourth finding confirms the economic evidence of the past several months: the crisis affected emerging markets, especially Asia, less severely than Western ones. Parts of Asia were the last areas to enter into recession and the first to emerge from it—indeed, China’s economy never stopped growing. Asian banks had less trouble with toxic assets and excess leverage than their counterparts elsewhere did. The crisis served to demonstrate that the balance of power shifts abruptly and powerfully rather than gradually; many Asian banks have vaulted to the top of league tables in one go.

Our research confirms that for the next several years, Asia’s economic might will continue to grow, as will the influence and power of its banks. Indeed, in these markets, banking is likely to grow much faster even than the broader economy, because so much of the population is “unbanked.” In both scenarios, all the emerging markets will grow substantially faster than the more mature markets of Europe and North America.

Our last finding stands apart from the rest—and offers a ray of light to many banks. The archetypes constitute a form of destiny: emerging-market giants, riding the back of faster GDP growth, will outperform developed-market universals. In many ways, banking is a leveraged bet on the underlying economy. Yet despite that destiny, banks can do a lot about their performance. The model suggests that within archetypes, differences in performance will be even greater in the future than they are today. The crisis has considerably ratcheted up economic volatility, putting an end to the period some have dubbed “The Great Moderation.” This volatility will amplify the existing differences in performance. Even banks that have been dealt a challenging hand can do much to outperform their peers and reward stakeholders.

Bottom line: global banking is likely to be faced with higher interest rates and an outperformance of Asia and Emerging Markets relative to their OECD peers.

A Tectonic Shift In The Global Banking Industry!

It is said that a picture is worth a thousand words.

Well below are some stirring graphs that highlights on the unexpected changes arising from the recent global financial crisis.

As the old saw goes, in every crisis there are opportunities. In the present case, we seem to witnessing an evolving transition to a new order in the global financial industry.

All graphs from Financial Times...

At the topmost window, the market cap of banks as % of the GDP of key developed nations depicts of a "leveling"-where the pecking order of market cap erosion have been heaviest in UK, followed by Europe, the US and Japan. This has led to nearly a congruous distribution of market cap as a ratio to GDP as the crisis evolved.

The next chart ("What difference a decade makes") is THE revelation: China has snatched the banking industry's leadership (lowest chart) from what used to be a stranglehold of the West (upper pane)!

And for a better visual, FT.com provides a great comparative breakdown of the top financial companies of the world in 1999 and in 2009...

The above had been the ranking of top global financial institutions based on market capitalization in 1999...

And the radical transformation seen in the present ranking.

As Peter Thal Larsen and Simon Briscoe wrote at the Financial Times, (bold highlight mine) ``New names have meanwhile arrived as if from nowhere. This is partly a reflection of shifting economic power: China’s three big banks dominate the rankings after joining the stock market in 2006 and 2007. Australian and Brazilian banks have also risen to prominence. But the shifting composition also offers evidence of how well different countries have managed their financial systems. Canada, for example, has been praised for its risk-averse approach to regulation. A decade ago, no Canadian bank made the list. Now there are five in the top 50."

So aside from China we have major commodity producers sharing the honors or a wider distribution of financial leadership.

But where will the next best growth area be?

Based on Boston Consulting Group's investment banking model, we will likely see a shift in the leveraged based business model to one of stabilizing profitability through a return to a simpler smaller model, smaller profit pools, greater client demand for simpler financial solutions and specialized capabilities of individual investment banks in an environment of increased regulatory and governmental influence.

And the region, as illustrated above, which has the least increase in government intervention could likely benefit most.

Combined with many other fundamental factors as high savings, growing middle class, demographic trends, urbanization and etc..., Asia looks likely a winner!