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ЗмістSince the second quarter 2009 the measures taken both in Germany and the Ukraine to overcome the crisis seem to unfold first imp
2. Some basic framework for analyzing crisis situations
3. The financial crisis in the EU
3.1. „Liquidity“ and „Liquidity risk“
3.2. The vicious circle of market and funding liquidity
4. Measures to break the vicious circle in the EU
5. The situation in Germany
Guarantees (Billion Ђ)
6. The situation in the Ukraine
6.3. IMF support
Bordo, M./Eichengreen, Barry/Klingebiel, Dieter
The financial crisis in Germany and the Ukraine – Reasons, development and countermeasures
Thomas Dietz, Tetiana Protsyk1
Both the matured West European and the emerging East European countries are currently facing an economic recession, preceded by a financial crisis triggered through different channels of contagion. The measures taken by the respective Central banks and governments to fight the crisis in Western and Eastern Europe differ substantially, however, depending on how developed the respective financial markets are and what exchange rate regime has been implemented. In line with EU recommendations, Germany - a member of the European Union and the Euro area – has chosen a comprehensive approach of state guarantees, public bank recapitalisation and stimulus spending going hand in hand with measures by the European Central Bank to provide liquidity to the markets,reducing the ECB policy rate to historical lows.
In the Ukraine, however, Central bank measures have until recently rather aimed at defending the exchange rate of the local currency, public recapitalisation of the banks has been slow and stimulus spending is restricted by conditions imposed by the IMF, having granted a Stand-by-facility to the Ukraine. Moreover, financial intermediation outside the banking sector is not very much developed. Thus, up to now, in the Ukraine these measures have rather had an ad-hoc-character predominantly trying to strengthen the Ukrainian Hryvnia and depositors' confidence in the banking system.
If you want to escape long winter nights in Finland spending some of your leasure time being on an exciting cultural trip in continental Europe instead, a look at the timetable of most European airlines shows that a flight from Helsinki to Berlin takes approximately the same time as a flight from Helsinki to Kiev. If your flight is combined with business linked to financial markets, however, the direction you take makes a fundamental difference. In Germany, a member of the European Union and the Euro area with a stable political system, the capital markets – as an alternative to banking intermediation – are well developed. In the Ukraine, a country where it is still controversial with which country to cooperate closer – the EU or Russia – and a country with a de-facto peg of the local currency, the Hryvnia, to the US Dollar, intermediation is clearly dominated by banks, and financial markets are underdeveloped.
As we will see, these different institutional settings have advantages and disadvantages when it comes to prevent or later on to fight financial crises. For example, although both the countries of the European Union (Western matured countries) and the countries of East, central and southeastern Europe (CESEE countries) have been hit by a deep economic recession, the transmission mechanisms of the financial crisis preceding this economic crisis, and the measures to fight it are in general fundamentally different. This is also due to different financial intermediation channels.
Taking Germany and the Ukraine as an example for a developed Western and an emerging Eastern European country respectively, in the sections below we try to explain which factors triggered which crisis, by which mechanisms it got reinforced respectively and why the measures taken by the governments and the Central banks to stop the crisis are so different. In this respect we will also have a closer look at the implementation of the German and the Ukrainian ‘rescue package’.
At the beginning we start with a brief overview of possible classifications for financial and economic crises and their interaction.
Several authors have provided definitions of different types of crisis in order to classify them2. Below we will use the definition of Mishkin3, according to which a ‘financial crisis’ is characterized by a disruption to financial markets making them (by adverse selection and moral hazard problems) unable to efficiently channel funds to the most productive investment opportunities. Furthermore, we refer to the definitions of Bordo/Klingebiel4, who define a ‘banking crisis’ as a period of financial distress that is severe enough to result in the erosion of most or all of the capital in the banking system, and a ‘currency crisis’ as a forced change in parity, an abandonment of a pegged exchange rate or an international rescue. A twin crisis is a combination of a banking and a currency crisis.
Finally, when we talk about an economic crisis we distinguish between a stage and a cyclic crisis (also called economic recession). Each market based economy is subject to cyclic economic development creating economic recessions sooner or later5, but apart from these cyclic crises there are also stage crises, related to the transition of the economy and society in general from one stage to a higher level of development6.
Contagion effects of crises initially developing in one specific country or region have been facilitated over time by diminishing restrictions for cross-border capital flows and the increasing use of modern information technologies. On the other hand this free flow of capital can contribute significantly to raising the living standards of the local population, inducing also foreign direct investments (FDI). However, the higher the share of foreign capital in relation to the Gross Domestic Product the more vulnerable the local economy gets to a crisis (initially) only affecting only the home countries of the foreign investors.
The subprime crisis in the US has triggered a financial crisis in the EU, characterised by perturbances on the money market, the stock markets and the bond markets, in particular affecting banks' activities to get liquidity via wholesale funding. This financial crisis has caused a banking crisis now triggering an economic recession. That the crisis has affected the EU countries so hard is due to the unanticipated interaction between funding and market liquidity in crisis situations7. This interaction has triggered – as we shall see in the next section - a downward spiral of liquidity and bank equity.
„Funding liquidity“ can be defined as the possibility of a bank to fund itself by borrowing money at third parties, either secured or unsecured. It is low if funding for the amount and maturity required can only be obtained under unexpectedly unfavourable funding conditions (e.g. higher interbank rates or high haircuts or margins under secured funding) or cannot be obtained at all. Funding liquidity is high as long as it is possible to get the required amount of money with the right maturity under the required conditions8. „Funding liquidity risk“ defined in this sense is typically caused by maturity transformation9, and it is particularly relevant for institutions that rely on “wholesale” funding (volatile market based funding). These institutions get their liquidity predominantly from the capital or money markets by unsecured short-term funding or by issuing securities, like covered or uncovered bonds (including, for instance, Asset Backed Commercial Papers), and less from the rather stable retail deposits (retail funding).
„Market liquidity“ is the possibility to fund itself by selling assets in the market. It is low, if selling an asset (typically securities) is possible only under high haircuts or not possible at all, and it is high, if selling is possible at any time without significantly influencing the price of this asset in the market10.
Another helpful distinction in this respect refers to original and derived Liquidity risks. Derived liquidity risk occurs when an asset can only be sold at a price lower than expected (e.g. due to unfavourable developments in the stock market) or funding might only be obtained at higher costs because of an unexpected widening of the spread curve of the institution. Derived Liquidity risk is therefore linked to the profit and loss of the institution and is balance-sheet based11. Original liquidity risk refers to the possibility that a bank might not be able to meet its payment obligations at any time and is therefore cash-flow based. Original and derived Liquidity risks are both – ceteris paribus - higher under wholesale than under retail funding.
The interaction between funding and market liquidity in crisis situations has triggered a downward spiral of liquidity, where disturbances of market liquidity had negative repercussions on funding liquidity and on individual funding costs.
At the beginning the impacts of the subprime crisis were particularly painful for institutions
However, even if these problems were restricted to a limited number of institutions, and even if these problems were not really representing an international financial crisis at that time, they started a downward spiral (a vicious circle) of declining values of financial instruments, market disturbances and eroded equity (own funds), restricting the institutions’ access to funding liquidity in the end. Under the new IFRS rules, these declining values caused losses in the banks’ balance sheets which in return also decreased their equity (own funds)12.
The continuous reduction of capital cushions and the deterioration of confidence in former counterparties affected also the markets for interbank lending. The price for unsecured short term funding, the Euribor, was rising sharply (see figure 1), since the institutions started to hoard liquidity instead of lending it to their counterparties. As a result, the spread between Euribor and Eurepo (price for secured short term funding) widened significantly, putting institutions without sufficient collateral under additional liquidity pressure, both under the perspective of original and derived liquidity risk.
As a consequence of the equity problems of banks their funding spreads widened in the bond markets. Due to the unfavourable funding conditions caused by this the issuance of covered and uncovered bonds had declined sharply13. While at the beginning of the crisis it was predominantly original liquidity risk concerning the market participants (and the supervisory authorities) it was after a certain point of time derived liquidity risk starting to play a role at least as important.
Figure 1: Spread between Euribor und Eurepo
Source: Deutsche Bundesbank (2009), p.31
Up to now most banks obviously still had a sufficient liquidity buffer allowing for cheap collateralised short-term Central bank funding to avoid liquidity gaps. Without funding costs on capital markets returning to normal conditions, however, and without the unsecured interbank lending market being restored, it is uncertain for how long institutions relying on wholesale funding will renounce on deleveraging14. With deleveraging further losses at the institutions have to be expected since their business will be reduced. This means more problems with their equity, meaning less favourable funding conditions, and entering a further round in the vicious circle described in Figure 2.
In the end in the EU the prevailing financial crisis has effected the money market, the stock markets and the bond markets, in particular restricting banks’ possibilities for wholesale funding. Between the beginning of 2007 and the end of 2008 the Euro and US financial stocks lost on average about 60% of their value, single stocks (like Lehman Brothers or Washington Mutual) even up to 99.9%15.
Figure 2: The vicious circle between market and funding liquidity
Source: Huertas (2008), p.3
The EU countries also suffer from a banking crisis, since several (systemically relevant) banks have incurred large financial losses, reducing significantly their capital buffers. For example, the Royal Bank of Scotland lost 27 billion Euro in 2008 (the largest company loss in british history)16, and although the average percentage change of tier 1 capital of 15 large and complex banking groups in the Euro area between 2007 and 2008 is slightly positive, the total loss of supplementary (tier 2 and tier 3) capital was 28%17. As a result, according to the European Central Bank economic growth in the Euro area will decline by approximately 4.6% in 200918.
The measures taken by most national governments within the EU after Lehman insolvency aim at restoring market confidence and at reviving the dried-up liquidity markets, trying to break the vicious circle described above. Before Lehman insolvency it was primarily the ECB trying to compensate the lack of interbank lending by direct (collateralised) Central bank loans to the institutions. The ECB instruments to support the institutions were (in coordination with other Central banks outside the Euro area like the Bank of England) interest rate cuts, the extension of eligible collateral and available liquidity facilities (longer maturities, higher volumes, additional currencies)19. Finally, since May 2009 the ECB has also gone for ‘credit easing’ (purchase of securities of other issuers than the government like banks or corporates), starting with the purchase of covered bonds. However, due to the institutions’ problems not only with liquidity but also with equity the ECB could only alleviate the problem, but not really solve it20.
After the insolvency of Lehman ad-hoc measures like the bailing out of some systemically relevant institutions (e.g. Fortis und Dexia in October 2008) were replaced by a more systematic and comprehensive approach of state aid, aiming at
In total 18 EU member states have implemented these comprehensive rescue packages. They show similar features based upon experiences with recent financial market crises like in Sweden and are comprised of
Part of the rescue packages is also the temporary suspension of the IFRS rules, based upon a corresponding EU Directive adopted in October 200822. By this further writedowns can be avoided in many cases.
In June 2009 the institutions in the EU have used approximately 50% of the amount of government guarantees offered and about one third of the budget reserved for recapitalisation, which in total accounts for 3.7 billion Ђ or 30% of the annual GDP of the EU23.
As the stock, the money and the bond markets show first signs of recovery since the beginning of the second quarter 2009 the rescue packages seem to have reached their aim (at least partly). Indicators for this are (i.a.):
The banking sector in Germany is basically comprised of three pillars, the savings banks, the cooperative banks and the commercial banks, including the large German cross-border groups like Deutsche Bank and Commerzbank. In total, at the end of 2008 there were approximately 2200 banks operating in Germany, about 450 from the savings banks sector, around 1250 cooperative banks and 500 commercial banks, with the private banks representing a market share of approximately 42% (savings banks about 45 and cooperative banks about 13%).. Whereas the savings and cooperative banks as well as the smaller private banks predominantly rely on retail funding, wholesale funding is most important for the large private banks.
Due to the well developed German financial markets the wholesale funding business model worked well until Germany was hit by the crisis in summer 2007. At that time the ABCP Conduit ‘Rhineland-funding’ of the German bank IKB drew the IKB liquidity facility which the bank actually couldn’t provide. Bankruptcy could only be prevented then by public subsidies. Being in a similar situation with its own conduit („Ormond Quay“) the state bank (‘Landesbank’) SachsenLB could only be saved from bankruptcy by the state bank of Baden-Wьrttemberg taking it over.
IKB and SachsenLB being a good example for this, also in Germany the institutions most affected by the crisis are the ones having invested largely in subprime exposure (like other state banks), having gone for extensive maturity transformation, and following poorly diversified wholesale funding. Besides increasing the original liquidity risk, such a business model also makes the institutions vulnerable to derived liquidity risks, since rising risk premia and money market rates directly affect the funding costs.
Another institution pursuing this business model was Hypo Real Estate25, for which the German state has provided public guarantees of 102 Billion Euro until end of April 2009 (not only coming from the SOFFIN – see below)26. The situation at Hypo Real Estate, which is systemically relevant for the German covered bonds market, has also triggered a discussion about possible expropriations, shouldn’t it be possible for the state to gain influence on the operational or strategic business of a bank in another way.
Savings banks and cooperative banks in Germany and their business model (retail banking) are commonly seen as the winners of the financial crisis27. In 2007 retail deposits accounted for almost 70% of their funding, whereas the issuance of debt obligations and interbank deposits contributed about 30% (aggregated figure for cooperative and savings banks). In contrast to this, retail deposits accounted for 35% of commercial banks’ funding and the issuance of debt obligations and interbank deposits for almost 60%28.
After IKB, SachsenLB and Hypo Real Estate, the financial crisis did not hit another German institution in particular, but affected the money, the stock and the corporate bond markets in general. The situation aggravated, however, after Lehman insolvency in September 2008. As a consequence, the German government and the German parliament adopted in record time (only 10 days) a comprehensive public rescue package for the banks with the following features:
A Financial markets stabilisation fund (SOFFIN), managed by a public authority, the “Finanzmarktstabilisierungsanstalt”, which is supervised by the Federal Ministry of Finance can – for a limited period of time - provide
In total, in mid-April 2009 the SOFFIN had granted 152 Billion Euro of support measures (133 Billion for state guarantees and approximately 19 billion for recapitalisation30):
As table 1 shows, the SOFFIN has not granted support measures with respect to “toxic waste”. This is due to a lack of interest of the institutions so far since these papers would have to be taken back by them from SOFFIN after 36 months the latest. This would apparently (in the point of view of auditors) be equivalent to the situation that the papers had never left the bank at all31. This started a discussion on the possible founding of one or several „Bad Banks“ in Germany in order to really enable the banks to take these papers off the balance sheet. Although the government has presented a corresponding proposal in May, the discussion on this topic was still on-going in mid-June 2009.
Table 1: SOFFIN support measures (mid-April 2009)32
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