3rd European lender comes under scrutiny in less than a week

It's been quite a week for the European banking community who've faced years of shallow earnings due to the low rate of interest offered by the ECB in order to perk up economic growth but more importantly halt the slide in prices away from the unwanted presence of deflation that could make policymakers lives just that much harder.

The European Central Bank's desire to spur on growth with easy money at below zero interest rate means the banking sector in Europe are having a tougher time generating income from conventional means, putting stockholders out of pocket in terms of dividends and sending the industry into a downward spiral in attempts to find alternate forms of return that aren't appropriate risks.

We saw speculation around the continuity of Deutsche Bank's existence enter the fray at the beginning of the week with many investors not seeing much hope for the German lender who has its back up against the wall with a litany of legal cases to deal notwithstanding a whopping $14 billion fine imposed on it by the US Department of Justice relating to the mis-selling of mortgage backed securities at the climax of the Financial Crisis bubble.

Besides this inconvenience, management has to deal further with the bleak outlook of oil prices having made considerable investment into alternate energy resources, most notably in the United States with regards to shale gas extraction. Lower oil prices has seen US producers battling to eradicate losses let alone break even translating into a scenario of a house of cards for the European lender.    

Largest Dutch Bank To Fire Thousands https://t.co/4b3wbEhLdt

— zerohedge (@zerohedge) September 30, 2016

Since then we heard from the second largest lender in Germany and main competitor to Deutsche Bank, Commerzbank announcing a restructuring program that'll see 9600 jobs shed by 2020 and dividends cut to fund it. Deutsche Bank has a similar program in place so it was only a matter of time before the others joined the party.

Today we've heard unconfirmed reports that the Netherland's biggest lender, ING Group, might effect the same when it hosts its stockholders early next week leaving many wondering if these measures will become commonplace amongst Europe's top lenders.

The crux of the matter is these actions should send alarm bells ringing in the headquarters of the ECB who have insistently delved deeper into the experimentation of low interest rates for extended periods on end without fully realising the wider consequences of their own actions.

We shouldn't forget that one of Europe's greatest value producing sectors is the financial industry, providing thousands of jobs for highly skilled people who spend a high amount of their incomes in other sectors of the economy. If the proposed job losses are to go ahead all the good the ECB believes it can do in helping economic growth tick up will fall in a heap.

It again comes down to what I've said earlier in the week, the decision by the ECB will not be taken on which action produces the best outcome but rather the one with the least consequences.

Why is the European financial system is getting shakier by the day?

The pressure inside the European financial system doesn't seem likely to lower anytime soon with the latest development coming out of Deutsche Bank who received a demand from the US Department of Justice ordering the corporation to settle a $14 billion fine related to mortgage-backed securities that were mis-sold to the public during the build up to the 2008 Financial Crisis.

However top management responded quickly to dispel speculation over the mammoth amount it could potentially have to pay over to US authorities by indicating that it expected to pay the penalty but confidently said it would be able to negotiate a lower charge as US banks had done prior to settlement.

This comes on the heels of an impending Italian banking crisis that threatens to renew fresh calls for a breakup of the world's largest economic trade bloc, the EU. Currently Italian banks are holding a monumental €360 billion of soured debt on their balance sheets with little to help free up bankers ability to deal with it. Much of the focus has been turned on the world's oldest bank, Monte dei Paschi, who seemingly looks like the weakest link in a long line of exposed institutions.    

Deutsche Bank says to solve problems without help from Berlin https://t.co/4SzoXE9T3v pic.twitter.com/5OTWETYYkK

— Reuters Top News (@Reuters) September 26, 2016

Looking past the calamitous state of affairs, one aspect remains the chief detriment in the destruction of the European financial system which is the issue of low and negative interest rates, a sore topic for most banking institutions in Europe who have bemoaned it's place and suffered gravely as an inability to generate healthy income has been stunted by its protracted implementation.

In the case of Deutsche Bank, management had decided to offset the effects of a slim delivery of earnings through increased exposure in riskier assets, some of which included loans to the US energy sector. All it took was a collapse in oil prices for fear to be released amongst stockholders surrounding the capacity of Deutsche to absorb the losses incurred from non-performing loans when considering the little reserve's built up from bleak earnings.

With Italian banks it's a situation of institutions being in possession of inexpensive liquidity coupled with lowly sustained economic growth that caused government to use banks in averting a crisis. But as what we've seen evolving in the broader EU economy, increased monetary supply didn't lead to the deserved effect so many policymakers had wished for leaving many big name banks in a precarious position of holding onto debt that couldn't be paid for with the absolutely no prospect of growth in the future, only driving the fear of a mass default even closer.

The problem the world has now and more specifically the European Union is deciding what action will yield the least consequences because if we cast our minds on either objective we soon realise that there can be no relief from the pressure if the curtailment isn't dispensed in the other.The ECB is trying so desperately to get European consumers and manufacturers to produce value but in the same breathe pushing the stability of their financial system into jeopardy in reaching its goals.  

Central banks defiance of reality can't last forever

Yesterday's interest rate announcement by the European Central Bank didn't pull any surprises with an unchanged commitment to continue stimulus measures until it's expected expiry in March 2017 but ECB president Mario Draghi saying the central bank foresees interest rates remaining low for an extended period of time.

He also took a hardline stance on European governments implementation of structural reforms which he said were urgently needed in their respective economies but was reluctant to confirm the looseness of monetary policy was reaching it's limits and would be tightened whether or not reforms were in place, minimizing the seriousness of his tone.

We've encountered these undertones on a number of occasions involving central banks being unwilling to contemplate the thought of bringing monetary policy back into the sphere of normalisation by acting as a saviour for fiscal sluggards who fall short of finding long term solutions for their nations infected with epidemic economic discord.    

The European Central Bank has done about all it can do. https://t.co/tRIeuQS80N via @BV #ECB #Draghi

— Piotr Skolimowski (@Skolimowski) September 9, 2016

The longer we continue to see central bankers refusal to force the hand of governments to shape up, the higher the expectancy of market participants perennial thought of quantitative easing remaining indefinitely and with a greater propensity distort the overall picture.

Although the unequivocal endurance from central banks in their fidelity of the belief that more is better may show the characteristics of bravery in the face of adversity, the limitations of the market will eventually erode this might with is ever protruding flash of reality.
   

Why markets increasingly becoming correlated spells trouble?

Ahead of today's announcement from ECB president Mario Draghi relating to a decision whether to make the monetary environment in Europe more expansive than where it currently stands, we heard yesterday from Sweden's Riksbank who gave promising commentary regarding the country's economic outlook yet added that it's monetary toolbox remained opened and should further intervention take place on the part of the ECB it wouldn't shy away from continuing its extended run of stimulus.

I expressed concern over the matter by saying the ECB's partial contribution towards distorting asset markets along with other advanced nations enacting the same strategy with similar force, namely the Bank of Japan and Swiss National Bank, was overstating central bank's need to influence these markets closely but also directly competed against their smaller counterparts like Sweden who had no choice but to put up a brave defence in imitating what the bigger central banks were doing but were likely to be defeated due to comparative size.

New evidence shows that assets have become so distorted that the utilisation of diversification through the process of portfolio management won't mitigate the risk often associated with having a variety of distinct assets.

Asset contagion worse than 2008 as markets held hostage to rates https://t.co/44y6zYxZYX via @luwangnyc pic.twitter.com/so5w6ILsn3

— Bloomberg Markets (@markets) September 8, 2016 

The Credit Suisse Cross-Market Contagion Indicator measures the interconnectedness of different instruments price movements in relation with one another in finding the correlation amongst the basket of instruments that includes foreign exchange, commodities, bonds and equities. An optimal outcome for this indicator would be to suggest there's little correlation between instruments however the current reading says the risk of contagion is higher than it was pre-Financial Crisis.

Contagion would occur due to the direct relationship asset prices have taken on with one another and if a market crash were to happen the effects wouldn't be isolated to one asset class.

We've seen an extensive rally into bonds returning positive yield and in some extreme occasions investors being forced to accept longer term maturities in exchange for meagre coupon payments. The zero yield parade not only pushes the prospects of bond investors into jeopardy since the convexity (the rate of change in bond prices when rates increase/decrease) is alarmingly high, the tiniest of interest rate hikes could trigger a full blown financial market crisis it seems.

The responsibility falls squarely on central banks around the globe but as much as we can play the blame game perhaps we should give thought to the idea of a state in the global economy where monetary policy has exhausted it's options, government coffers are burdened with huge debt bills to pay with lenders insisting on reducing the load, effectively creating a situation where no interventionist policy is in place to guide the world economy forward. Absolute chaos but closer than what you think.

Are the markets as "resilient" as Draghi says?

ECB's president Mario Draghi struck a soft tone when talking about the impacts of Brexit yesterday saying the central bank was of the view that financial markets had acted "resilient" in the face of incredible headwinds created by it but conceded the bank could only tell of the real damage at its next meeting to be held in September. Draghi reiterated that he was ready and able to use all the instruments available to him to ward off disruptions created by the event.

The irony of this comes in the article I posted yesterday surrounding comments made by Bank of Japan governor Haruhiko Kuroda where he explicitly told a radio interviewer that the probabilities of floating the concept of "helicopter money" weren't possible and needed to revive Japan's sagging economy.

Inasmuch as I'm of the belief that measures such as these merely make a small problem even bigger, there's no hiding from the fact it's created the situation we deal with at the moment.

ECB in wait-and-see mode after Brexit vote, says Mario Draghi https://t.co/r3ZpvLhmpe

— Telegraph Business (@telebusiness) July 22, 2016

Markets didn't rally after Brexit because they thought the prospects of a separation between the United Kingdom and the European Union would bring about a stronger outcome, they did so based on the expectation of central banks natural inclination towards reverting to stimulus measures when the sad state of the global economy peeks through the cracks of policymakers rhetoric.

If this be the case then Draghi's comments regarding the "resilient" spirit of financial markets after Brexit cannot be taken at face value but in the context with the action that's driving valuation higher than they should be, the very policy he advocates as a measure to unshackle deflation that's arrested economic growth in the region but with little evidence to prove effectiveness.

A frighten trend of monetary policymakers following in the footstep of their bureacratic government counterparts of choosing to ignore the problem long enough to think it'll disappear only to be shaken awake when crisis hits is a reminder that those in charge don't necessarily possess the right solutions to the problem.