INTERNATIONAL SECURITIES AND EQUITIES COMMISSION WARNS ABOUT LACK OF TRANSPARENCY IN EUROPEAN BANKING SYSTEM.
We believe that banks in Europe should be required to provide more transparency in the information that is given to investors about their collateralized borrowing activity.
Many banks are seeking secured funding but there have not been many sources recently. Covered bonds or even private deals for lending have been more available even though they are expensive. International Securities and Equities Commission believes that the rise in use of this type of financing is worrying.
It is normal that banks do not need to disclose this type of information on a regular basis and it can be difficult to make an estimate of the information using less direct sources.
It is certainly important that banks provide more information when it comes to finance that is secured against their assets. Surveys have shown that the majority of investors are concerned about the effects of secured funding on the assets of the institutions which of course would mean that less of the debt is unsecured.
Different banks have a different tolerance for secured debt depending on many different financial variables including assets and type of business.
The current financial situation in Europe has meant that banks have had to resort to this type of lending more and more in the past months but one of the main concerns is the migration to more complex and controversial instruments including “extendable repo” trades or “liquidity swaps” arranged with insurance companies or pension funds.
Our concern is that the increase in this type of borrowing is likely to adversely affect unsecured funding which in the past has been the way that banks have been financed.
For every asset that is secured against a loan or bond, the bank has less in the way of assets left over when it comes to the unsecured creditor’s rights in a bankruptcy situation. The direct affect of this is that banks will find it harder and harder to sell their unsecured debt if secured debt continues to increase.
Recently the banking institutions in Europe have issued the largest amount of covered bonds, a total of almost $330 billion. In effect this has brought the gap between secured and unsecured debt closer and closer.
Our belief is that banks are likely to use more covered bonds and similar products as we move forward into 2012. Other types of similar debt including liquidity swaps and repo trades already have our attention as potentially risky to the bank’s security.
Repo agreements involve investors agreeing to purchase a portion of a bank’s assets, although with the caveat that the bank will buy back the securities at a predetermined date. In reality this enables the bank to finance securities on their balance sheets.
An extendable repo enables both parties to renew the agreement therefore effectively allowing the bank a source of funding for a longer period.
It further concerns us that almost all banks are using these sorts of structures and are very likely to continue to in the near future.
In addition to the encumbrance on a bank’s balance sheet, one of the main concerns to International Securities and Equities Commission is that the funding obtained using these types of vehicles can be withdrawn rapidly during volatile markets at just the time that such funding is needed.
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