The IMF has raised concerns relating to the expectation that European Banks will drastically reduce their balance sheets. The fear in short is that banks are expected to tighten credit facilities and off load securities, thereby reducing their balance sheets and thus bolster their capital position- Although good news from the view of the banks, this is certainly the last thing that the economy needs right now. This extreme deleveraging will extert pressures on already struggling EU economy.
Oliver Blanchard, has suggested that rather than risking a painful deleveraging process, taxpayers should inject further capital into the major European Banks. Mr Blanchard’s rationale is very simple, saving the banks from deleveraging will ultimately save the EU from an extended economic contraction. Unfortunately, very few people will be able to grasp Mr. Blanchards rationale. The appetite for further capital injections via tax payers money has reached its saturation point and the general European population will be unable to comprehend public policy favouring the injection of further money into the banks, while announcing deep austerity re-forms the next. Such a political choice, although economically rationale, would certainly lead to mass protests.
Another challenge facing Mr. Blanchards solution comes down to the mere ability, or rather the inability, of sovereigns to inject any additional capital. Most sovereigns entities are already facing sever funding concerns, and are up against difficult forces to reduce their budget deficits and calm capital markets- and so a debt trend in the wrong direction would certainly lead to a sea of sovereign funding complexities.
Perhaps the real problem and thereby the solution, lies with the regulators. Perhaps in their search for financial stability the Regulators did not consider the timing of their new and improved capital ratio requirements. I will be the first to admit that the regulators have accomplished more in the last 5 years than in the previous 50. Perhaps their ultimate success is the ultimate cause for the balance sheet reductions we are experiencing. My opinion is that banks have taken the regulatory conditions and have over-exerted their attempts to reach these capital targets quicker and more extreme than the regulators had envisaged.
If only the banks could go back to their leveraged ways and ludicrous balance sheets…
