Liquidity v Solvency again

One man's assistance is another man's bailout...

In the world of bank recapitalisations little is clear and labels are important as substance.  Of the many banks which imploded or suffered from the ongoing implosion in Europe, a vast number had been given a clean bill of health by the European Banking Agency during post-2007 stress tests.  In fairness the tests were focussed on liquidity management (liquidity strain being identified as the immediate cause of failures of banks like Bear Stearns and Lehman which kicked off the crisis), while as many now know (except it seems the heads of the EU and the ECB, the crisis has morphed into one of solvency - banks just don't have enough capital in general (as opposed to immediate funds to hand and agreed credit lines to see off a sharp rise in demand for return of funds).

And so it is that the same debate is playing out in Australia in respect of its new bank liquidity facility.  As noted several times in this blog, this has been characterised as a backstop, a safety measure which should not have to be used, or if used, only to cover temporary liquidity demands.  Taking this at face value there are fair questions to answer, but interestingly Michael West had an article out where he disputes the purpose - that the facility is in fact, simply a bailout fund from the RBA - with the suggestion being that Australia's banks are much weaker than they represent.

Over to Michael:

...Glenn Stevens doesn't think it's a bailout fund. It's a Committed Liquidity Facility - the $380 billion in Reserve Bank rescue money, sorry ''liquidity'' that is, which the banks can access should they find themselves in strife....Under this thingamajig, one must select one's words with care, if you are a bank and you are about to bite the dust then you can forget about a bailout. If you are even tempted to whisper the word bailout, snap out of it!...

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...If, however, you encounter ''an acute stress scenario'', why not shimmy on down to Martin Place - but only if you need a little something to facilitate your liquidity in a committed kind of way - flop out the old paw for a spot of lazy taxpayer liquidity, say $20 billion, and Bob's your uncle. Or rather Glenn's your lender. This is no freebie. You will pay dearly - a heinous 40 basis points over the official cash rate....

...Yes, you can only access this exciting opportunity if you are a bank and you are ''illiquid'', but not ''insolvent''. It is beyond this mere chronicler to explore the fathomless schism between a bank that finds itself illiquid and one that finds itself insolvent....(here)

This is not too different from some schemes tried elsewhere and the main message from the crisis in other jurisdictions is that early recognition and writedown of bad banks is necessary (this is the difference between the US and EU response).  Given that thanks to the EU, we are now in a world of depositor bail-ins (with New Zealand and Canada indicating they are considering such contributions so that bondholders, depositors and all sorts of creditors likely to be hit if a bank fails), the strong suspicion is that, notwithstanding the arrangements discussed beforehand, any stress at a major Australian bank will be messy.

More on the RBA backstop

Excellent piece from Chris Joyce on the RBA Backstop.  Question is does it show the full extent of the weakness of the Australian banks in their descent into crisis or is this the pre-emptive strike to hit out at the markets?  Yes Aussie banks are vulnerable coming off good times due to their reliance on wholesale funding, but will the RBA's actions be enough?

...In a globally unique policy, the Reserve Bank of Australia will supply banks with a permanent bailout facility worth up to $380 billion by 2015....The policy has been designed by the RBA to help banks satisfy stringent new liquidity tests which simulate “acute stress scenarios” that deny banks funding for 30 days under the post-GFC rules, Basel III....Local regulators argue that insufficient liquid assets such as government bonds meant they had no choice but to give the banks a new taxpayer-backed “line of credit” that could be tapped at a cost just above the RBA’s cash rate. Smaller building societies and credit unions are not subject to the liquidity tests and will not, therefore, have access to the bail-out fund....

...The Australian Financial Review has been told that the Swiss-based Basel Committee, which is the supra-national regulator of bank regulators, was initially opposed to what is known as the “Australian solution”. Only one other country, South Africa, has emulated it, although Singa­pore is evaluating it....

...With actual leverage of roughly 26.5 times, a 4 per cent fall in asset values would, on average, wipe out the major banks’ capital. While the banks are regarded as being durable institutions, it does not take much duress to invoke solvency threats. The Basel Committee’s second finding was that banks should hold more liquidity in the form of high-quality liquid assets to pay out depositors and wholesale bond holders during times of stress....(here)

A splintered backstop for Oz banks

Great piece in AFR analysing the nature of the RBA's commitment to backstop Australia's large banks in case of emergency.  As has been so problematic in Europe, it seems the central bank is on the hook, and early.

...The Reserve Bank of Australia’s unique Committed Liquidity Facility – a little-known, taxpayer-backed “line of credit” to help banks overcome solvency crises – creates as many problems as it is intended to address. And it is not clear officials have thought these through....

...The Australian Prudential Regulation Authority appears to understand this nuance [of solvency]. Officials acknowledge that if a bank needed to draw on the CLF, it would be trading insolvent under the Banking Act in the absence of the taxpayer support, irrespective of whether it had “positive net worth”....The Committed Liquidity Facility opens a Pandora’s box of problems. The most obvious concern is that it inverts the logic of the Basel Committee’s post-GFC policy remedies by entrenching taxpayer loans as a first, rather than last, line of defence against bank collapses. (here)