Wild west banking

With a certain degree of imagination, today’s situation in Europe makes me think about banks in the Wild West of America (with related romance, of course).

Initially, the only reason to put money at a bank could be to keep it in a ‘safe’ place, rather than earning a return. Basically, money had no other value than its physical value, and savers were just paying to keep their money safe.

In our XX century mind (unless you are a teenager), earning interest on money is – or was – obvious. Time value of money was clear to all of us.

Now, the persistent negative yields environment has turned everything upside down. It has also pulled prudent savers – who are any risk adverse (i.e. not investors) – back to the situation where they have no interest to put their money at a bank, but to keep it somewhere.

It is even worse. They pay both fees and interest, and the inflation is low but not negative. Deterioration of their wealth therefore goes fast.

Meanwhile, the digitization of money (and the AML and ATA regulations) makes the possibility of keeping it under the pillow unrealistic, while in the past it was a popular option (questionable, but an option).

Being a saver in our modern wild west may be painful then (if we ignore all other alternatives, of course).

I must admit, this analysis on individual savings is exacerbated. To emphasize the situation and make it more tangible, I used as example pure savers who prefer to see a slight constant decrease in their wealth, rather than facing any kind of risk and volatility. It is a quite extreme assumption and, moreover, banks that actually apply negative interest on individuals are indeed not many. However, nil interest on cash deposits is very common at the moment.

From a banking and business perspective, it is a real issue. European banks are suffering deeply from the persistent negative yields. While the ‘higher’ macroeconomic objectives to protect sovereign economies is indeed a priority, the banking system has serious difficulties to play its role of engine in those economies.

Margins are very thin and interbank deposits are expensive. Together with the CRD regulation and the post-crisis rules on NPLs and credit risk assessment, it puts banks under extreme pressure.

In other words, banks never really recovered from the 2008 crisis and the negative interests surely do not help. Lending activities and financial income remain weak and, in line with the EU economy in general, the banking sector is stuck at a very modest altitude, were the risk of hitting again the ground remains real. This is for Europe. Elsewhere (e.g. US) is different. However the risk of recession is more or less global and not only European banks may suffer from it.

Some corporates are also suffering, being obliged to hold deposits for liquidity risk management and paying negative (or nil) rate on it.

So, why this situation? The ECB squeezed the interest rates for two reasons: a) protect highly indebted European countries from the risk of default during and after the last crisis and b) stimulate the economic growth and the inflation in the EU.

Picture: 20-years chart on European official interest rates on deposit facility. Source: ECB website.

While the first objective was more or less achieved, the second is still far away. The temporary economic growth in some European countries between 2015 and 2018 was a kind of dead-cat bounce.

In 2019, the main European economies are stuck and the risk of recession is global (see trade war). Best performers are smaller economies (e.g. Ireland, Malta and Poland) that cannot balance the slowdown of the bigger players (e.g. Italy, Germany and France).

Picture: 2018 GDP growth rate by EU countries. Source: Eurostat website.

On the other hand, for some investors this situation is very juicy. Especially for those playing with leverage. For instance, when I did some RE investments in the last years, I kept insisting on floating rates for mortgage loans. Even when (2015) economists and asset managers were screaming out that the situation was unsustainable, that rates were going to increase soon, etc.. etc.. And even when (2018) the fixed rates where sometimes offered at a lower level than the floating (because of the difference between the short-term and the long-term curves). This is surely not a usual situation and can be a great opportunity for long-term investments.

Finally, not only those previsions were wrong, but now we are even talking about a “lower-for-long” scenario.

If a global recession materializes, also the investors (including myself) who enjoyed the low rates will eventually suffer, as one of the consequences of a recession is a decrease in assets value.

All this, highlights that there is a general stalemate in this situation and the way out from our wild west is neither easy nor close.

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