Jul 30, 2008
The fixed currency model of bank collapse: Baltics on target
Panic has started.
Discussed by John Hempton in Bronte Capital, Baltic banks are insolvent. The reasoning is the following:
Well if the Lati devalues (as would seem inevitable) then Hansa Bank has to pay Euro to Swedbank – and as its assets are in Lati it would be insolvent.
If the Lati doesn’t devalue its only because people (ie Swedbank) are prepared to continue to fund it. This is not pretty at all. All in Hansa owes Swedbank over 30 billion Swedish Kroner – all denominated in Euro and which can’t be paid. The equity capital of Hansa (roughly 7 billion Swedish Kroner) is also going to default.
To protect Baltic economies, firstly, central banks should have enough willingness and reserves to long Baltic currency and short Euro with gold. While the rest of the world is doing vice a versa. Any thoughts who is able to spend more capital: hedge funds or Baltic central banks?
Secondly, people must inject more Euros to Hansabank, SEB and other banks to diminish their loan-to-deposit ratios and make shareholders of Swedbank calm. Any one is willing to buy litas or kronas from the bank and give them all your Euro savings?
Yes, we do! Banks have been clever enough to hedge their currency risks by lending in Euro to residents of Baltic States. And we have been borrowing in Euro, protecting banks and exposing our own assets. The great scheme that has been working until recently, when borrowing capacity was more or less sustainable.
Today, it’s not true. Banks’ credit risks are topping due to bad loans coming from the Baltics. Inflation does not allow to reduce interest on domestic currency denominated loans and decrease demand for Euro. People do not funds banks anymore. Contracting GDP growth is pushing away foreign investors. Consequently, to make their shareholders calm, both Swedbank and SEB should closed down their Baltic branches. Until they will be forced to.
Rate opinion
Hi Guys,
Nice post …
Interesting to see economic analysis from within inside the Baltics. I liked the whole “looking in mall commercials” to gauge the “official” CPI level in Lithuania
.
Anyway … this is of course a quite serious topic and one which I (and my colleague Edward Hugh) have been writing about several times. With respect to Hempton’s piece I have a note up here …
http://clausvistesen.squarespace.com/alphasources-blog/2008/7/30/the-baltics-lithuania-and-eastern-europe-redux.html
But in general, the following blogs should be interesting for you.
http://easterneuropeeconomy.blogspot.com/
http://balticeconomy.blogspot.com/
My own impression is that the pegs WILL fall but not because some kind of Soros like figure moves in. It is more likely I think that the currency board will fall once it becomes clear that deflation is the only way out of the current mess. Then of course, Hansbank may well and truly be cooked since all those loans will need to be written off in which case the balance sheet WILL fall apart.
Cheers and keep up the good work. I will be looking forward to hear more.
Claus Vistesen
Claus,
People here are not always even allowed to understand the consequences of excessive borrowing especially in a foreign currency.
For instance, I have recently purchased a new car through a financial leasing provided by another foreign bank branch DnB Nord. They were heavily convincing me about benefits of a Euro loan and were enormously surprised when I chose Litas. Moreover, they claimed I was the first person in their operating history to buy a car for Litas, but not Euro.
Ironically, one of Baltic central banks’ reasons for sustaining the peg is a high proportion of Euro loans to total loans. The last thing before devaluation they can do is to keep the panic away from general people. Even using illogical arguments.
BR,
Aleksej
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