Banks have raised $250 billion (Rs12.5 trillion) of capital on their own this year already. Billions more from governments has been or is being injected too. But is it enough? Hopefully, yes—but maybe not.
When considering new tier 1 capital ratios, financial institutions and their regulators tried to anticipate the reserves necessary to cushion against all sorts of horrible scenarios involving interest rates, inflation and economic growth. But it’s not clear those stress tests factored in a range of other late-breaking horrors. That could mean second helpings of capital will be in the offing.
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First, there’s the meltdown in Iceland. The country’s collapsed banking system owes $46 billion to lenders in 26 countries, it emerged on Thursday. German banks alone held $21 billion of that debt. Iceland’s central bank chief reckons creditors will be paid just 10 cents in the dollar. Next, there are emerging markets fast becoming submerging markets. Take eastern Europe, where currencies and growth are tumbling. Banks from Austria, France, Germany and Italy dominate the region, after they flooded in for the post-communist boom. As the news worsens, bank subsidiaries there are likely to need recapitalizing, putting further pressure on parent groups. All of Asia isn’t immune, either.
Then there’s the hedge funds getting dramatically pruned. What started the year as a $1.9 trillion industry could be just a $1.3 trillion industry by the year-end after poor performance and investor withdrawals, Morgan Stanley reckons. That could chop bank revenue from hedge funds by 45%. Some of this may have been anticipated, but the pessimism seems to deepen by the day.
Lifeline? A file photo of people protesting the Icelandic government’s handling of the financial crisis in Reykjavik. The IMF has agreed to lend Iceland $2 billion to bail out its banking system.
Finally, the default lines are being redrawn. Credit rating agencies keep expecting more and more companies will be unable to repay their debts. Standard & Poor’s now says there could be as many as 353 defaults by non-investment-grade, non-financial US borrowers from 2008-10. That would put the three-year cumulative default rate at 23%, the worst since 1981. There are likely to be savage defaults in Europe, too.
This combination of calamitous events would easily tot up to at least another $100 billion of losses for banks. Those that raised capital early could need more still. For the banks still mulling or resisting their first helpings, they’d better get their skates on.