The FT presents some good work from ML on Banking crises. We have been talking about the link between banking and currency crises and the US problem will be no different from other banking crises. Taxpayers will not get a windfall. The economy will be affected for years. The cost will be higher than anticipated and the currency should fall as investors walk away from the dollar.
27 things you may not have known about banking crises
Brought to you by Merrill Lynch economist Alex Patelis and the IMF Working Paper, “Systemic Banking Crises: A New
Database.”
The paper tallies 124 banking crises over the past 27 years. These are ML’s key points:
1. In 55 per cent of cases, the banking crisis coincides with a currency crisis.
2. Bank runs feature in 62 per cent of the crises.
3. Banking crises are often preceded by credit booms, in 30 per cent of the cases.
4. Non-performing loans average about 25 per cent of loans at the onset of the crisis.
5. Macroeconomic conditions are often weak prior to a banking crisis.
6. Extensive liquidity support is used in 71 per cent of crises.
7. Peak liquidity support tends to be sizeable and averages about 28 per cent of total deposits.
8. Blanket guarantees are used in 29 per cent of crises, often introduced to restore confidence even when previous explicit deposit insurance arrangements are already in place, lasting for an average of 53 months.
9. Prolonged regulatory forbearance - where banks, for example, are allowed to overstate their equity capital in order to avoid the costs of contractions in loan supply - occurs in 67 per cent of crises.
10. In 35 per cent of cases, forbearance takes the form of banks not being intervened despite being technically insolvent, and in 73 per cent of cases prudential regulations are suspended or not fully applied. Existing literature on forbearance shows it is counterproductive, with banks taking on additional risks at the future expense of the government.
11. In 86 per cent of cases, government intervention takes place in the form of bank closures, nationalizations, or assisted mergers.
12. 51 per cent of crisis episodes have experienced sales of banks to foreigners.
13. The more bank closures there are, the higher the fiscal costs.
14. A blanket guarantee, however, reduces the instances of bank closures.
15. Bank restructuring agencies are set up in 48 per cent of crises.
16. Asset management companies are set up in 60 per cent of cases to manage distressed assets.
17. In 76 per cent of episodes, banks were recapitalised by the government, mostly with cash, government bonds or subordinated debt.
18. Recapitalisation programs are usually accompanied with some conditionality.
19. To the extent that debt relief schemes are discretionary, they run the risk of moral hazard as debtors stop trying to repay in the hope of being added to the list of scheme beneficiaries.
20. Average net recapitalisation costs to the government amounts to 6 per cent of GDP.
21.On the bright side, recapitalisations tend to be associated with lower output losses.
22. Monetary policy tends to be neutral during crisis episodes, while fiscal policy tends to be expansive.
23. Average fiscal costs, net of recoveries, associated with crisis management average 13.3 per cent of GDP.
24. The average recovery rate is just 18 per cent of gross fiscal costs.
25. Real GDP losses average 20 per cent relative to trend during the first four years of the crisis.
26. There is a negative correlation between output losses and fiscal costs: the higher the fiscal costs, the smaller the loss of output
27. Inflation and currency devaluation help reduce the budgetary burden and thus have been a feature of the resolution of many crises in the past.
And here are ML’s conclusions:
Implications: Past banking crises suggest that fiscal costs are likely to be substantial and the government is highly unlikely to make a profit on any recapitalization program. Fiscal packages do positively help the economy. Blanket government guarantees are sometimes necessary when previous liquidity provisions have failed.
What is different about this crisis: So far the US and the UK have not suffered from a sudden stop of capital inflows which has been the feature of many episodes in the past. We continue to remain concerned of the risk of a current account financing crisis. Note overnight an article in the South China Morning Post suggested that China’s regulators had told mainland banks to stop lending to US financial institutions. The article was later vehemently denied by the regulators.
The role of the international investor:
The international investor remains a significant holder and continued buyer of US assets. These have primarily been in recent years in the form of fixed income securities, particularly by foreign official institutions. Foreigners own 47 per cent of the Treasurys market; foreign official institutions have accounted for 91 per cent of flows into the agencies market. In order for foreigners to change their US fixed income reserve accumulation policies, they would have to substantially revise their existing exchange rate policies, acquiescing to currency strength. In our view, investors should start preparing themselves for the eventual shift in existing central bank reserve accumulation policies.
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