Beware – this banking crisis could last for years: Gottliebsen

Last night European stock markets were too concerned about Greece to worry about a tsunami that looks to be headed their way in two or three years. And, at least at the opening, Wall Street was more worried about the immediate US economic outlook.

But in the days ahead, analysts will begin studying an alarming document from Boston Consulting Group which effectively warns the developed world that there are actions in the pipeline that could sustain the downturn for the next two or three years. I emphasis that this is my conclusion based on their research, although Boston Consulting itself uses the word ‘tsunami’ to describe what could happen.

The Basel Committee on Banking Supervision has announced a series of proposals to improve the stability of the banking system which they are testing this year with the view to implementing them by the end of 2012. That sounds innocuous, but Boston Consulting have modelled the potential effects of these proposals on 32 large banks across 12 countries and found that the changes would cut their tier-1 capital ratios by about half.

While the proposals will improve the stability of the banking system, they will lead to smaller balance sheets and lower profits.

To keep their tier-1 ratios in the range of 6 to 8%, the 32 banks would need to increase their core capital by 15 to 40%, or between $US280 billion to $US650 billion.

In other words, banks will need to raise more capital or, says the report, “limit the scope of their activities”.

There will be big differences between countries and individual banks but on average, if banks raise this capital it will dilute the value of existing shares by about 12 to 25 per cent, according to Boston Consulting.

On the basis that global banks were capitalised at $US6.4 trillion at the end of 2009 and that the projected loss is 20%, we are looking at a global market fall of about $US1.3 trillion. While that sounds a lot, bank market capitalisation peaked at $US8.9 trillion at the end of 2007 and had fallen to $3.1 trillion at the start of 2009, so we have already experienced big changes.

But what alarmed me more was Boston’s second ‘tsunami’ – that global banks would “limit the scope of their activities”. While this will reduce revenues and profits, banks could also increase margins to help build up capital.

In my opinion, we are facing the danger of a massive global bank credit squeeze where the leading banks in the developed world are forced to either raise capital at a time of depressed share-prices or curtail their lending (they will do both) and then in the process lift their margins.

We need to add in the effect of looming haircuts from foolish loans to bankrupt countries like Greece and we will see that bank loans could be much harder to arrange. That means a fall in global asset values. Larger companies will move outside the banking system and raise their own money, but smaller enterprises cannot do that.

All this is set to happen just as the world should be looking at sustained recovery. Boston Consulting says that Australian banks are among the best placed in the world to handle this problem, which is good news. Nevertheless, a large number of Australian companies proudly point out that their borrowings are not due until 2011 or 2012, when everyone assumes the world will be a safer place. What Boston Consulting is warning is that we are currently in a situation where the water has left the beaches and it looks safe. But by 2012 the tsunami could roll in and damage vast areas of business.

What are the chances that The Basel Committee on Banking Supervision changes will come in? That committee is looking at bank solvency, so as to protect the world from bank failures. They may take heed of the Boston Consulting warnings, but once global bank regulators head in a direction they are very hard to change.

This article first appeared on Business Spectator.