It is now apparent that we are facing the likelihood of a major global credit squeeze, which will hit Europe harder than any other region. But its effects will be felt around the globe, including in Australia. In times of credit squeezes, asset values are put under pressure. To some extent global share and commodity markets are beginning to adjust for the looming squeeze. Other assets, like property, may follow if the squeeze intensifies.
Two events in the last 24 hours have locked in my view of a looming credit squeeze. The first was a cable from the Financial Times in London saying that European bankers are worried about how a wall of corporate debt, that is set to mature in 2012, will be refinanced. The wall was credited by the so-called collateralised loan obligations – structured investment vehicles that buy loans made to private equity firms to finance acquisitions. These CLOs are about to go into run-down mode.
The FT says the CLO problem is going to become acute in the next 12-18 months because there are billions of euros worth of leveraged loans coming due. The crunch will be particularly acute for the smaller companies.
In all there are about €250 billion worth of leveraged loans maturing in Europe between now and 2017 and the banking system is in no position to refinance them. Not only does this remove a source of credit to the wider economy but it will really hit the businesses which borrowed. European credit markets are bracing for more defaults.
Then came the second event. The Boston Consulting Group last night released a survey about the effect of Basel III on global banks and the sums are scary. BCG says that Basel III will require global banks to raise €354 billion in extra capital, including €221 billion by European banks. The Europeans expect to have completed their capital adjustment by the end of 2013.
The capital ratio improvement will be achieved partly by extra capital but partly by contracting balance sheets. If banks can find someone to buy their loans that will be good, but often the reduction in balance sheet size will be achieved by not making more loans and pressing companies to repay. In other words, a credit squeeze.
This is happening at the same time as the European problems which have caused many European banks to lose their existing capital if they had to write down their sovereign debt assets to market. But they do not admit to this disaster.
So we have the absurd situation of European banks that in reality have no capital being assumed to have capital and being required to raise €221 billion more than their existing inflated capital figure. In reality, the amounts that are required are beyond any ability to raise the money.
These comments are mine. BCG does not link the banks' current capital plight with Basel III. However, BCG does point out that corporations are going to be most affected by the need for more bank capital and that in the scramble for money bank margins will be reduced.
Australia, of course, is not immune because we are one of the biggest wholesale borrowers in the world, funding about 40 per cent of our banking system that way. That 40 per cent figure is set to shrink dramatically over the next three years because the money may not be there. The reduction will be achieved by banks being tougher in granting loans and raising deposits in Australia. In addition, European banks will want to offload their Australian assets, so we will have our own version of the European CLO problem.
It all adds up to quite a credit squeeze and it's hard to see a way out unless Europe goes into massive money-printing mode.