Is the Euro Crisis Over?

Hyun Song Shin Princeton University Bendheim Center for Finance Spring Alumni Event New York City, April 18, 2012

BCF Spring Event, NYC: “Is the Euro Crisis Over?”

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Three (Interlocking) Features of the Euro Crisis
• Sovereign debt crisis • Banking crisis • Balance of payments crisis — Cross-border capital flow reversal — “Sudden Stop” Common thread is the bank leveraging/deleveraging cycle

BCF Spring Event, NYC: “Is the Euro Crisis Over?”

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Trillion pounds

1.4

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1.0 Equity 0.8 Other Liabilities 0.6 Total MMF funding Customer Deposits

0.4

0.2

0.0

Figure 1. Total Liabilities of Barclays (1992 - 2007) (Source: Bankscope)

1992

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1994

1995

1996

1997

1998

1999

2000

2001

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2007

risk-weighted assets and total assets (Source: Bankscope) 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 .0 Total Assets 0.0 Figure 2. Barclays.2 1. NYC: “Is the Euro Crisis Over?” 3 Trillion pounds 1.4 1.4 0.2 0.6 0.8 Risk-Weighted Assets 0.BCF Spring Event.

NYC: “Is the Euro Crisis Over?” 4 Trillion Euros 1.2010 (Source: Bankscope) ee e e 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 .2 1.2 0.BCF Spring Event.0 Figure 3.4 Total Customer Deposits 0.6 Other Liabilities 0. Soci´t´ G´n´rale liabilities 1999 .8 Equity 0.0 0.

Soci´t´ G´n´rale risk-weighted assets and total assets (1999 .2 0.8 0.0 0.4 RiskWeighted Assets 0.2 1.6 Total Assets 0.2010) (Source: Bankscope) ee e e 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 .BCF Spring Event. NYC: “Is the Euro Crisis Over?” 5 Trillion Euros 1.0 Figure 4.

BCF Spring Event. NYC: “Is the Euro Crisis Over?” 6 Corporate Finance of Banking A L Equity Assets Debt .

NYC: “Is the Euro Crisis Over?” 7 A L Equity A L Equity Assets Debt Assets Debt .BCF Spring Event.

BCF Spring Event. NYC: “Is the Euro Crisis Over?” 8 A L Equity A L Equity Assets Debt Assets Debt .

BCF Spring Event.000 Equity Change y = 0.000 y = 0.2.9998 Annual change in equity.000 Annual change in assets (billion pounds) Figure 5. NYC: “Is the Euro Crisis Over?” 9 Barclays: annual changes in assets. Barclays: annual change in assets.9957x .81 R2 = 0.81 Debt Change -500 0 500 1. equity and debt (1992-2010) (Source: Bankscope) . debt and risk-weighted assets (1992 -2010) 1.0043x + 2. equity. debt and risk-weighted assets (billion pounds) 800 600 400 200 0 -200 -400 -600 -800 -1.

NYC: “Is the Euro Crisis Over?” 10 BNP Paribas: annual change in assets.0051x .6. BNP Paribas: annual change in assets. equity and debt of (1999-2010) (Source: Bankscope) .BCF Spring Event.2010) 500 400 Change in equity and debt (billion euros) 300 200 100 0 -100 -200 -200 Debt Change y = 1. equity and debt (1999 .9987 Equity Change -100 0 100 200 300 400 500 Asset change (billion euros) Figure 6.2 R2 = 0.

996x .15 R2 = 0. NYC: “Is the Euro Crisis Over?” 11 Societe Generale: annual changes in assets.BCF Spring Event.2010) 300 Annual change in equity and debt (billion euros) 250 200 150 100 50 0 -50 -100 -150 -200 Equity change y = 0.9985 Debt change -100 0 100 200 300 Annual asset change (billion euros) Figure 7.3. Societe Generale: annual change in assets. equity and debt (1999 . equity and debt of (1999-2010) (Source: Bankscope) .

NYC: “Is the Euro Crisis Over?” 12 Barclays: 2 year change in assets. Barclays: 2 year change in assets. debt and risk-weighted assets (1992 -2010) 1. equity and debt (1992-2010) (Source: Bankscope) .9998 2 year change in equity.0. equity.BCF Spring Event.000 800 600 400 200 0 -200 -400 -600 -800 -1.175 R2 = 0.000 y = 0.9974x . debt and risk-weighted assets (billion pounds) 2yr RWA Change 2yr Equity Change 2yr Debt Change -500 0 500 1.000 -1.000 2 year asset change (billion pounds) Figure 8.

65 R2 = 0.0014x + 6.2010) 400 2 year change in risk-weighted assets.9986x .65 y = 0. equity and debt of (1999-2010) (Source: Bankscope) . NYC: “Is the Euro Crisis Over?” 13 Societe Generale: 2 year changes in assets. equity and debt (1999 . risk-weighted assets.BCF Spring Event. equity and debt (billion euros) 350 300 250 200 150 100 50 0 -50 -100 -100 y = 0.9988 2yr debt change 2yr equity change 2yr RWA change 0 100 200 300 400 2 year asset change (billion euros) Figure 9.6. Societe Generale: 2 year change in assets.

impending Basel II and EU Capital Adequacy Directive (CAD) • Advent of Euro opened up cross-border banking market within the eurozone . NYC: “Is the Euro Crisis Over?” 14 Why did European banks expand so much? Two candidate hypotheses: • Regulatory environment: circumvention of Basel I.BCF Spring Event.

0 Figure 10. Table 5A) .0 4. Cross-border euro-denominated claims and liabilities of eurozone banks (Source: BIS Locational Statistics.0 1.0 5.0 6.BCF Spring Event.0 Crossborder claims in domestic currency of eurozone banks Crossborder liabilities in domestic currency of eurozone banks 1999-Q1 1999-Q4 2000-Q3 2001-Q2 2002-Q1 2002-Q4 2003-Q3 2004-Q2 2005-Q1 2005-Q4 2006-Q3 2007-Q2 2008-Q1 2008-Q4 2009-Q3 2010-Q2 2011-Q1 3. NYC: “Is the Euro Crisis Over?” 15 Trillion Euros 7.0 2.

NYC: “Is the Euro Crisis Over?” 16 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% 2000-Q1 2000-Q3 2001-Q1 2001-Q3 2002-Q1 2002-Q3 2003-Q1 2003-Q3 2004-Q1 2004-Q3 2005-Q1 2005-Q3 2006-Q1 2006-Q3 2007-Q1 2007-Q3 2008-Q1 2008-Q3 2009-Q1 2009-Q3 2010-Q1 2010-Q3 2011-Q1 Figure 11. Four quarter growth rate of cross-border euro-denominated liabilities of eurozone banks (Source: BIS Locational Banking Statistics Table 5A) .BCF Spring Event.

8 0.0 Germany 2005-Q2 2005-Q4 2006-Q2 2006-Q4 2007-Q2 2007-Q4 2008-Q2 2008-Q4 2009-Q2 2009-Q4 2010-Q2 2010-Q4 Figure 12.2 0.BCF Spring Event.6 United Kingdom Other European BIS reporting countries Switzerland 0.2 1. Table 9D) BIS .0 0.4 France 0. Foreign claims of European BIS-reporting banks on counterparties in Spain (Source: consolidated banking statistics. NYC: “Is the Euro Crisis Over?” 17 Claims of European Banks on Counterparties in Spain Trillion Dollars 1.

9 0.BCF Spring Event.0 2005-Q2 2005-Q4 2006-Q2 2006-Q4 2007-Q2 2007-Q4 2008-Q2 2008-Q4 2009-Q2 2009-Q4 2010-Q2 2010-Q4 Germany Figure 13.6 0.2 0. Foreign claims of European BIS-reporting banks on counterparties in Ireland (Source: consolidated banking statistics.1 0.3 France United Kingdom Other European BIS reporting countries Switzerland 0. Table 9D) BIS . NYC: “Is the Euro Crisis Over?” 18 Claims of European banks on Counterparties in Ireland Trillion Dollars 0.5 0.7 0.8 0.4 0.

0 -10% Spain Figure 14. Current account of Ireland and Spain (Source: IMF International Financial Statistics) .0 -9.0 Current Account Balance as % of GDP 1.0 -3.0 -11.0 -7.0 Ireland -5.BCF Spring Event.0 -1. NYC: “Is the Euro Crisis Over?” 19 Current Account Balance as % of GDP 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3.

BCF Spring Event. NYC: “Is the Euro Crisis Over?” 20 .

BCF Spring Event. NYC: “Is the Euro Crisis Over?” 21 ECB .

BCF Spring Event. NYC: “Is the Euro Crisis Over?” 22 ECB .

Nov 2011) (Source: “Sudden stops in the Eurozone” Silvia Merler and Jean Pisani-Ferry (2012). data from European Central Bank) . NYC: “Is the Euro Crisis Over?” 23 Figure 15. Share of Eurosystem Main and Long-term Refinancing Operations (Jan 2003 .BCF Spring Event.

TARGET 2 net balances in the Eurosystem (Source: “Sudden stops in the Eurozone” Silvia Merler and Jean Pisani-Ferry (2012). NYC: “Is the Euro Crisis Over?” 24 Figure 16. data from Eurosystem central banks) .BCF Spring Event.

NYC: “Is the Euro Crisis Over?” 25 Some Historical Parallels • US mortgage crisis 2007 ∼ • Japan’s bursting bubble 1990 ∼ 2003 Slow deleveraging eventually results in bad assets and public recapitalization of banks How much? How soon? How? Some lessons from Japan .BCF Spring Event.

0 2.0 Figure 17.0 7.0 1.0 3.0 5.0 6. Japan: Loans and discounts of major and regional banks (in red) and M2 money stock (in blue) (Source: Flow of Funds. NYC: “Is the Euro Crisis Over?” 26 M2 Loans and Discounts 100 Trillion Yen 9. Bank of Japan) 1980/01 1981/05 1982/09 1984/01 1985/05 1986/09 1988/01 1989/05 1990/09 1992/01 1993/05 1994/09 1996/01 1997/05 1998/09 2000/01 2001/05 2002/09 2004/01 2005/05 2006/09 2008/01 2009/05 2010/09 2012/01 .0 8.0 4.BCF Spring Event.

BCF Spring Event. NYC: “Is the Euro Crisis Over?” 27 Some Characteristic Features of Boom and Bust • Boom phase — Rapid increase in lending — Increase in loan to deposit ratio — Increasing incidence of “non-core” liabilities • Bust phase — Loans and loan-to-deposit ratio decline — Liquidity support by central bank cushion (or delay) the process — Zombie banks and zombie firms .

0 9.BCF Spring Event.0 5. Eurozone: Loans to non-MFIs (monetary and financial institutions).0 6.0 Jan-95 Mar-96 May-97 Jul-98 Sep-99 Nov-00 Jan-02 Mar-03 May-04 Jul-05 Sep-06 Nov-07 Jan-09 Mar-10 May-11 Loans to nongovernment borrowers Deposits due to non-banks Figure 18.0 8.0 10.0 7.0 3.0 4. excluding general government (in red) and deposit liabilities to non-MFIs excluding central government (Source: European Central Bank) .0 Trillion Euros 11. NYC: “Is the Euro Crisis Over?” 28 12.

95 0.BCF Spring Event.20 1. NYC: “Is the Euro Crisis Over?” 29 Loan to deposit ratio 1. Eurozone: Loan to deposit ratio. excluding general government.10 1. Numerator is loans to non-MFIs (monetary and financial institutions).05 1.00 0.15 1.90 Figure 19. Denominator is deposit liabilities to non-MFIs excluding central government (Source: European Central Bank) Sep-97 Dec-98 Mar-00 Jun-01 Sep-02 Dec-03 Mar-05 Jun-06 Sep-07 Dec-08 Mar-10 Jun-11 .

8 0. Crisis date for Japan is January 1991 (between stock market peak and real estate peak) 252 240 228 216 204 192 180 168 156 144 132 120 108 96 84 72 60 48 36 24 12 0 -12 -24 -36 -48 -60 -72 -84 Months from crisis date . NYC: “Is the Euro Crisis Over?” 30 Normalized loans (Japan) Normalized loans 1.7 0.5 0.6 0. Eurozone and Japan: Loans in Euro area (in red) and in Japan (in blue) normalized to 1.1 1.2 1. and measured in months from the crisis date. Eurozone crisis date is September 2008.9 0.4 Crisis date Japan (Jan 1991) Eurozone (Sept 2008) Normalized Loans (Euro area) Feb 2012 Figure 20.BCF Spring Event.0 at crisis date.0 0.

NYC: “Is the Euro Crisis Over?” 31 Lessons for Eurozone from Japan • Liquidity versus solvency — Comparing Eurozone LTRO with Bank of Japan’s monetary policy in early 1990s — But loans granted during the bubble phase almost always go bad.BCF Spring Event. and must be written off eventually • Pre-condition for restructuring is political will. which is an added complication in Eurozone Question: How well can the institutions and governance structure of the Eurozone cope with strains of the restructuring process? . which needs shared diagnosis of crisis — Japan’s deleveraging started 7 years after crisis date (see figue) — Restructuring entails fiscal costs.

NYC: “Is the Euro Crisis Over?” 32 What Implications for Rest of the World? • Implications for the US economy • Emerging economies .BCF Spring Event.

0 9. Table 5A) 2007Q4 2009Q1 2010Q2 . Federal Reserve and BIS locational banking statistics.BCF Spring Event.0 5.0 7.0 3.0 2. US dollar foreign currency claims of BIS banks and US commercial bank total assets (Source: Flow of Funds.0 4.0 1999Q1 2000Q2 2001Q3 2002Q4 2004Q1 2005Q2 2006Q3 2008Q1 US chartered commercial banks' total financial assets US dollar assets of banks outside US Figure 21. NYC: “Is the Euro Crisis Over?” 33 Trillion Dollars 11.0 8.0 10.0 6.

BCF Spring Event. NYC: “Is the Euro Crisis Over?” 34 European Global Banks Shadow banking system Wholesale funding market US Borrowers US Banking Sector US Households border Figure 22. European global banks add intermediation capacity for connecting US savers and borrowers .

BCF Spring Event. p. June 2011. NYC: “Is the Euro Crisis Over?” 35 Figure 23. US Dollar-denominated assets and liabilities of euro area banks (Source: ECB Financial Stability Review. 102) .

0 France Non-European BIS reporting countries Other European BIS reporting countries Switzerland United Kingdom 1.0 5. Foreign claims of BIS reporting banks on US counterparties (Source: BIS consolidated banking statistics.0 4. Table 9D) 2005-Q2 2005-Q4 2006-Q2 2006-Q4 2007-Q2 2007-Q4 2008-Q2 2008-Q4 2009-Q2 2009-Q4 2010-Q2 2010-Q4 .0 Germany 0.0 6.0 3. NYC: “Is the Euro Crisis Over?” 36 Trillion Dollars 7.0 Figure 24.0 2.BCF Spring Event.

representing $755 bn of $1. NYC: “Is the Euro Crisis Over?” 37 (%)  90 80 70 60 50 40 30 20 10 0 Belgium. Greece 2009 H1 2009 H2 2010 H1 2010 H2 2011 H1 2006 H2 2007 H1 2007 H2 2008 H1 2008 H2 Other euro area Other Europe Asia United States Figure 25. Amount owed by banks to US prime money market funds (% of total). Portugal. Ireland. Italy. data from Fitch).66 trn total prime MMF assets (Source: IMF GFSR Sept 2011.BCF Spring Event. Spain. . based on top 10 prime MMFs.

NYC: “Is the Euro Crisis Over?” 38 Emerging Economies • Emerging Europe • Rebalancing in China • Asia ex China and Latin America .BCF Spring Event.

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