Friday, 25 November 2011

London and the Doomsday Machine

When the UK's FSA takes to warning UK banks to think about the structure of their balance sheets, and how they might stand up to a systemic implosion in the Eurozone financial system, you know it is well past time to take cover. This body, after all, was happy to OK Northern Rock as its loan/deposit ratio soared past mere percentages and into actual multiples. The FSA and regulation? I'm reminded of Gandhi's reply to a journalist's questioning what he thought of Western civilization: 'It would be a good idea'.

Nonetheless, it's worth a trip over to the Bank of England to have a look at the balance sheets of EU financial institutions operating in the UK, and see what they might tell us about Britain's first-round exposure to the Doomsday Machine. And the news isn't all bad: Europe's banks in London have squared themselves off to a marginal net asset position in Sterling, have shorted the Euro, and built up a reasonable non-sterling, non-Euro long FX position. As defensive crouches go, it's quite compact. 

That's reasonable, because whatever else the history books will say about this crisis, no-one will be able to say it struck out of the blue. 

We've previously charted the way in which international banks in New York have this year changed from being net takers of liquidity from US interbank markets, to being net suppliers (here). And the same thing, albeit on a much smaller scale, has happened in London. We have the data to the end of September, at which date, EU banks had a very small marginal net asset position in sterling, with sterling assets of £670 billion (down £22.3 billion on the year), and sterling liabilities of £668 billion, (down £56.7 billion on the year). That's the good news.  

But, of course, if the Doomsday Machine really blows, it'll be about liquidity at least as much as balance sheet. And here the news is less good: unlike in New York, very little of the sterling assets are held in cash or deposits. Rather, just over 50% of the assets are held in the form of loans to UK residents, and a further 25% (ie £170 billion) is in the form of intergroup loans (uh-oh) and loans/advances to non-residents (yup). Meanwhile, 92% of these banks' sterling liabilities is in the form of deposits. Chances of a maturity mismatch? Extremely high.

What about the foreign currency element? Here again, the news is perhaps better than expected, with foreign currency assets and liabilities almost exactly matched, at 58% of the balance sheet. (In fact, there's a £1.7 billion net foreign currency liability). This represents an almost complete eradication of net FX exposure during the previous 12 months, since in September 2010 these banks had net FX assets worth £32.7 billion.

And mark how the currency positioning has changed! These European banks have over the last year switched from a net long position in Euro assets of £54 billion in September 2010 to a net short position of £23.7 billion in September 2011. Meanwhile, all other fx positions (ie, excluding both Euro and Sterling) have gone from a net short of £21.3 billion to a net long of £22 billion.
Conclusion: In truth, these are better results than I had expected. For all the brave talk of bold solutions to the Eurozone's problems, and for all that it (just about) remains heresy to publicly accept where this is likely to end, Europe's banks operating in London have prepared for the worst, just as they have in New York. 

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