05 December 2011

The end of Europe’s liquidity crisis? (Dec 2011)

Well, many people already bored with the on-going Europe debt crisis, and subsequently liquidity crisis. This is like what we have seen in 2008 when Lehman Brothers collapses, which drags down the whole financial systems globally through liquidity crisis. The different is between company and country. Maybe some of us doesn't know how this chain effects rattles the global markets. So, let us start here.

The European Organisation chart of Debts
The root of the problem plaguing the market right now is Europe debt crisis, where Greece and few other European countries were highly in debts. They just simply cannot generate enough revenue (taxes) to support the economy itself. So, they resorted to seek for funding via borrowing by issuing sovereign bonds to finance their day to day operations. However, the debt is piling up intensively after 2008 global financial crisis until recently. Because the government does not have money, their bonds may go into default. So, they were forced to borrow some more, but with higher interest this round.

For them, this kind of measures are simply to prolong the problems and those debts were still there charging higher and higher interest. They are buying time, hoping their economies will survive and growing in the future to repay back whatever they borrow now. What a pretty picture?

Who is the main borrower?
Congratulations, the winners go to French banks. They are the main source of funding for these troubled ladden countries. As long as these banks charges those countries interests, everything is good for banks but bad for countries. What if those countries really go bankrupt? French banks may follow suits too.

So, the pretty solution is to write-off from the book of borrowers (French banks). Why French banks still need to accept the offer? Depending on the % of write-off, banks at least got something better than nothing. Right?


How the liquidity problem set in?
Debt writing-down means that the assets of French banks were being slashed. Last month, there is a 50% hair-cut for Greek debts and the amount will reflects in the books of these banks in the next few quarters. Now, you know why rating agencies are cutting 15 European banks' rating last week?

Sigh... But, not yet ends?
After the hair-cut, banks may having liquidity issues next. They doesn't have enough capital to borrow and this may dampened the whole financial system, thus, businesses and public facing difficulties to finance their expansion or consumption. Don't worry, angels were always by our side.

Angels (not Santa) come before Xmas...
Last week, 6 central banks globally take an important step toward dealing with the problems in Europe by pledging to continue provide funding to global banks (especially European banks). These angels are US Federal Reserve, the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. They would lower the pricing on US dollar liquidity swap arrangements effectively easing the liquidity problems faced by European banks.


This action dissolves one of the stumbling blocks in global financial system. Risk plays a role when one bank lends to another. In the current environment, banks likely don't believe that they are being compensated enough for the risks they face by lending out. With the dollar swap lines, banks can instead go to their central banks for short-term loans, provided that they have good collateral. Win-win situations? Yup. I think so because one can solve the liquidity problem, while US successfully creates a huge demand for its sliding currency.

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