‘Gambler Banks’ Will Detonate: Are They Only in Europe?

The People’s Bank of China reminded the financial world today that trans-Atlantic and Japanese banks and stock markets just had their worst week of 2016, with all Chinese markets closed and no new data about the Chinese economy available.

It is not China, but the zero- and negative-interest policies of the Western central banks and the oil price collapse, which have triggered the crisis, Xinhua quoted central bank governor Zhou Xiaochuan.

The trans-Atlantic bank blowout is still only in early stages. The Feb. 14 Money Morning newsletter notes, “We Haven’t Seen the End of Bank Troubles,” with a subhead, “European ‘Gambler’ Banks Will Detonate.” “The carnage in European banks is much worse than U.S. banks,” it states, “but then again European banks have much more serious problems. They suffer from inadequate capital and enormous amounts of bad loans that could force them into insolvency without government support.” After discussing the great distress of Deutche Bank and Credit Suisse in particular, the newsletter concludes, “Europe’s banks are in big trouble and that poses a serious risk to the rest of the world, because these banks do business with every other financial institution in the world. The U.S. economy and U.S. markets cannot insulate themselves from their problems…. U.S. banks are well capitalized and should not pose a systemic risk -… unless their derivatives books blow up.”

A blizzard of financial media “commentary” over the weekend tried to argue, not so much the classic “This time is different,” but “This country [i.e., U.S. banks] is different.”

But oil and commodity debt continues to drag U.S. banks over the cliff. The Markit financial data firm has a report that 26% of all “high-yield” bonds held by U.S.-based banks are now classed as distressed debt: i.e., they have yields more than 10% higher than U.S. Treasuries. The “distressed” share was 7% a year ago. That is 26% of approximately $2 trillion, or about $500 billion in distressed debt. “Bad loans,” already non-performing, are approximately 11%, or about $225 billion.

An experienced Japanese source noted of this, that a safe regulatory standard for such a crisis, would be classifying all that “high-yield” debt as either “risk” or “high-risk” debt, requiring that banks hold loan-loss reserves of either 50% or 75% of their total high-yield debt assets.

But the major Wall Street banks each have $15-20 billion of such assets, except for Citibank, which has about $50 billion. And these banks’ loan-loss reserves against these investments are only in the hundreds of millions, between 5% and 7% of the assets, although 11% of the assets are already non-performing. The loan-loss reserves of the major Canadian banks, against oil/gas exposure, are typically only 0.5% to 1.5%.