'Short-term attitude leaves Europe vulnerable'

Euromoney Skew

December 07, 2011

Citi experts debate whether short-term attitude towards liquidity and liabilities has left Europe vulnerable in an illiquid market

Short-term liquidity is at a premium.

Floundering countries and institutions are fond of protesting that they have liquidity, rather than solvency, issues, but while illiquidity might not be as bad as insolvency, it is far from ideal.

Europe is suffering from a banking culture that has traditionally focused more on short-term funding than banks in other regions – a sudden lack of liquidity is a bigger stumbling block for European banks than their American counterparts.

Experts at Citi’s recent European credit conference said there were several reasons for Europe’s short-termist culture towards liquidity:

“A short-term stance towards liquidity has important customer facilitation benefits, and has traditionally been a vibrant part of managing margins,” says Patrick Buxton, head of capital management strategy at Citi. “It also reflects regional differences within Europe. French banks don’t have the same deposit penetration as institutions in some countries, and so have had to look to other forms of funding.”

However, Greg Markouizos, managing director of Citi’s London finance desk, seemed unconvinced by Buxton’s argument.

Markouizos suggests the focus on short-term liquidity is a result of differing regulatory attitudes between Europe and other regions:

“European regulators appear to be more comfortable with banks' reliance on short-term funding than their US or Asian counterparts,” he says.

However, there are concerns about the lack of appetite among investors for the provision of short-term liquidity for the banks. Financial turmoil is making the providers of liquidity cagey.

“It’s driven by the fear of contagion from peripheral countries,” says Richard Smethurst, ECP trader at Citi. "Until there’s a resolution to the crisis, this will continue."

As more banks look to secure their short-term funding in an environment that is proving less amenable to such provision, banks are struggling to keep their short-term liabilities in check.

“The liability side of our balance sheet is increasing faster than the asset side can,” says Markouzios.

One suggestion is that the ECB should cut interest rates to break down bank-funding costs. This thesis is supported by the strong performance of French and Spanish bonds in last Thursday’s auctions, a sign of hope that the ECB may lower interest rates at its next meeting.

“It would not surprise me if you see a rate cut from the ECB next week,” says Markouzios.

- Euromoney Skew Blog