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Global banks sliding share prices signify financial stress

 As the world’s three largest central banks take turns this week to show how they propose to remove the emergency support from asset markets, markets are already behaving as though financial risk has grown much higher.

Post-crisis, financial regulators decided to nominate a select few GSifis (global systemically important financial institutions). Because these groups were so systemically important, at least within their own markets, they would need to be regulated more tightly, or required to keep a bigger capital cushion, than other banks or insurers. 

This tends to reduce their profitability, which is why executives resist the status but should drastically reduce the risk that they crash. In the phrase everyone learned 10 years ago, they were too big to fail. The GSifi status makes them more attractive as bond investments, but less attractive to equity investors.

    There are any number of arguments over exactly which institutions should make the list, and some crafty lobbying has gone into ensuring that a few names are not labelled GSifis. But as it stands, there are 40 GSifis. And if this list were turned into its own stock market index, it would be doing very poorly, even as tech stocks hit new records and main indices enjoy steady recoveries from February’s sudden sell-off.

If we weight the 40 GSifis by market cap (so as not to overstate the impact of some sharp recent falls for relatively small European institutions), then London’s Absolute Strategy Research shows that from the market top on January 26 until May 31, they lost $800bn in market capital, or about 18 per cent. That is virtually a bear market. Some 16 of them remain more than 20 per cent down from their 12-month highs.

These numbers are slightly worse than for the banking system as a whole, and suggest nerves that systemic risks are returning. Tightening monetary policy may already be having an effect.

The US yield curve — the excess of 10-year over two-year Treasury yields — is now its flattest since 2007. This hurts the profitability of banks who make money by borrowing at short-term rates and lending at longer rates. The flat yield curve also implies that the Fed will tighten too much in the short run, and then have to ease policy in the longer run.

But the problem is primarily outside the US, where Prudential Financial is the only GSifi still down as much as 20 per cent from its peak. Most of the worst affected are in the eurozone, where the problems of the banking system have long been well known. The imbroglio over the new Italian government, even if it has calmed somewhat since the new finance minister ruled out any attempt to leave the euro, has made things worse. Certain specific banks, notably UniCredit and Deutsche, have their own idiosyncratic problems.

Twenty years ago, before both banks made a number of huge acquisitions, Deutsche’s market cap was slightly higher than JPMorgan’s. The US bank is now roughly 10 times larger.

But this cannot be dismissed as a group of idiosyncratic problems. Banks in China, where the authorities are hoping to deal with the debt overhang, and even Japan, whose central bank is still stimulating with full force, have also seen big falls in their share price.

However, ASR points out that the loss of confidence in the GSifis overlaps closely with a decline in the global real money supply. In other words, it could reflect a shortage of dollars. Even if US banks are not much affected, the GSifi problem could emanate from the US.

A shortage of dollars has shown up in rising short-term dollar Libor rates. It could be an artefact of quantitative tightening, as the Fed removes money from the market by selling bonds from its portfolio. Last year’s tax reform to encourage US multinationals to repatriate their cash could also be a factor; dollar balances previously held in non-US banks have shifted, making it harder for foreign banks to access dollars.

Alternatively, the move away from the equity of GSifis could reflect concern over widening US credit spreads, which have risen from a very low level. Eurozone asset managers are particularly heavily exposed to US credit at present, arguably because the European Central Bank has given them little choice but to look abroad to take risks. 

This is hard for central banks. They have lived in fear for 10 years of misjudging, pulling off support too quickly, and provoking another crisis once more. Problems for the GSifis could yet prompt them to slow down or reverse their tightening of monetary policy.