Transcript Kazimierz Dolny konferencja

The impact of global crisis on banking system.
Ph.D. Renata Karkowska
Banking and Financial Markets Department
FACULTY of MANAGEMENT
WARSAW UNIVERSITY
Universita' di Urbino "Carlo Bo", November 2009
Course schedule
sub-prime crisis
European Financial Market
crisis banking in emerging markets
future face of Europe’s Financial System
2
What was the reason of the subprime crisis?
The early part of this decade saw a long period of
unusually easy macroeconomic conditions, with low
or negative real interest rates in the major
economies.
It encouraged a build-up in leverage and risk-taking,
among both regulated and unregulated entities.
3
FED interest rates in USA
4
CPI in USA
5
What was the reason of the subprime crisis?
Easy credit, combined with the assumption that housing prices
would continue to appreciate, encouraged many subprime
borrowers to obtain loans. Some homeowners were unable to
re-finance their loans and began to default.
The reasons for this crisis are very complex (both in the housing
and credit markets). Some of these include:
• the inability of homeowners to make their mortgage
payments;
• poor credit judgment by the borrower and/or the lender;
• risky mortgage products (CDO);
• high personal and corporate debt levels;
• central bank policies; and regulation (or lack of there).
6
What was the reason of the subprime crisis?
Sub-prime lending
Growth of the housing bubble
7
Causes of the crisis
Source Data: US Department of the Treasury, Financial Crimes Enforcement Network
8
Causes of the crisis
Role of securitization
Securitization is a structured finance process in which credit
assets are extract from the balance sheet and classified into
pools, and offered as collateral for investors.
Due to securitization:
• investors appetite for mortgage-backed securities (MBS),
• the tendency of rating agencies to assign investment-grade
ratings to MBS,
• loans with a high risk of default could be originated, packaged
and transferred to others.
Asset securitization began in the 1970s.
9
Causes of the crisis
10
Causes of the crisis
11
Causes of the crisis
Role of housing investors and speculators
Speculation in real estate was a contributing factor. During 2006,
22% of homes purchased (1.65 million units) were for investment
purposes, with an additional 14% (1.07 million units) purchased as
vacation homes. During 2005, these figures were 28% and 12%,
respectively. In other words, nearly 40% of home purchases
(record levels) were not primary residences.
13
Causes of the crisis
Role of financial institutions
The lenders offered an increasing higher-risk loans to higher-risk
borrowers. The share of subprime mortgages to total originations
was 5% ($35 billion) in 1994 , 9% in 1996, 13% ($160 billion) in
1999, and 20% ($600 billion) in 2006. A study by the Federal
Reserve indicated that the average difference in mortgage interest
rates between subprime and prime mortgages (the "risk premium")
declined from 2.8 percentage points in 2001, to 1.3 percentage
points in 2007. In other words, the risk premium required by
lenders to offer a subprime loan declined. In addition to
considering higher-risk borrowers, lenders have offered increasingly
high-risk loan. These high risk loans included the "No Income, No
Job and no Assets" loans, sometimes referred to as Ninja loans.
14
Causes of the crisis
Financial innovation and complexity.
Development of financial products designed to achieve particular client
objectives, such as offsetting a particular risk exposure (such as the default of
a borrower):
- Credit Default Swaps,
- Mortgage-Backed Securities (MBS),
- Securitization.
CDS (protection)
buyer
Risk transfer
& fee
compensation
CDS (protection)
seller
reference
asset
15
Causes of the crisis
Role of credit rating agencies
Credit rating agencies gave investment-grade ratings to securitization
transactions (CDOs and MBSs) based on subprime mortgage loans.
Rating agencies are paid by the firms that organize and sell the debt to
investors, such as investment banks.
16
Causes of the crisis
Role of central banks
Central banks are primarily concerned with managing the rate of
inflation and avoiding recessions. They are also the "lenders of
last resort" to ensure liquidity.
They are less concerned with avoiding asset bubbles, such as the
housing bubble.
Central banks have generally chosen to react after such bubbles
to minimize impact on the economy, rather than trying to avoid
the bubble itself.
There is significant debate among economists regarding whether
this is the optimal strategy.
17
Causes of the crisis
During the years preceding the crisis, U.S. financial institutions became
increasingly indebted or overleveraged. This increased tend to the collapse of
the housing bubble.
18
Effects of Crisis
Effect on world economy
The collapse of Lehman Brothers
was a symbol of the Crash of 2008
When the crisis first came to light,
many analysts called it a domestic
problem — one that would only affect
US housing markets.
However, the crisis quickly spread
throughout the world.
People started to withdraw their
savings due to fallout from the
subprime crisis.
19
Effects of the crisis
Effects on stock markets
The crisis has caused panic in financial markets and encouraged
investors to take their money out of risky mortgage bonds and
put it into commodities.
Financial speculation in commodity futures following the collapse
of the financial derivatives markets and it has contributed to the
world food price crisis and oil price increases.
Financial speculators seeking quick returns have removed trillions
of dollars from equities and mortgage bonds.
20
Effects of the crisis
Effects on financial institions
During 2007 and 2008, over 100 mortgage lenders went
bankrupt.
In March 2008 ivestment bank Bear Stearns collapsed.
Several major institutions failed or were subject to government
takeover. These included Lehman Brothers, Merrill Lynch, Fannie
Mae, Freddie Mac, and AIG.
21
Effects of the Subprime Crisis
Many banks, real estate investment trusts (REIT), and
hedge funds suffered significant losses as a result
of mortgage payment defaults or mortgage asset
devaluation.
Profits at the 8 533 USA banks declined from
$35.2 billion to $646 million (90 percent) during
the fourth quarter of 2007 versus the prior year.
22
Course schedule
sub-prime crisis
European Financial Market
crisis banking in emerging markets
future face of Europe’s Financial System
23
Effects on the global economy
The crisis rapidly developed and spread into a global economic
shock, resulting in a number of European bank failures, declines
in various stock indexes and commodities.
OMX Iceland 15 closing prices during the five trading weeks from September
29, 2008 to October 31, 2008.
24
Characterization of single European financial market
1/ EU financial markets are increasingly integrated, especially in the
wholesale markets.
2/ The banking and insurance markets are dominated by pan-European
groups, in which risk management functions are centralised in the
group's headquarters.
3/ There has been an increase in cross-border M&A transactions.
This trend was particularly strong in 2005, when several large-value
transactions were conducted, amounting to over 50% of the total M&A
value in the euro banking system.
4/ EU banks have become more international than ever, expanding into
foreign markets both in Europe and beyond.
5/ Currently around 70% of EU banking assets is in the hands of 43
banking groups with substantial crossborder activities. Especially in the
Central and Eastern European countries, the banking sectors are
dominated by foreign financial groups.
25
Characterization of single European financial market
26
Characterization of single European financial market
27
Impacts of crisis on financial institutions
One of the first victims was Northern Rock, a medium-sized British
bank. The highly leveraged nature of its business led the bank to
request security from the Bank of England. It led to investor panic
and a bank run in September 2007.
Initially the companies affected were those directly involved in home
construction and mortgage lending such as Northern Rock, as they
could no longer obtain financing through the credit markets.
28
Impacts on financial institutions
During September 2008, the crisis hits most critical stage. There was
the equivalent of a bank run on the money market mutual funds,
which frequently invest in commercial paper issued by corporations to
fund their operations.
The TED spread, an indicator of credit risk in the general economy, spiked even higher
in September 2008, reaching a record 4.65% on October 10, 2008.
29
European policy responses
1/ As the financial crisis began to seriously affect the economy, from
September 2008, many countries announced specific measures:
Germany, Spain, Italy, Netherlands, United Kingdom, Sweden.
2/ The European Commission proposed a EUR 200 billion stimulus
plan to be implemented at the European level by the countries.
3/ The European Central Bank injected $99.8 billion in a one-day
money-market auction.
4/ The Bank of England pumped in $36 billion. On September 2008
the Belgian, Luxembourg and Dutch authorities partially nationalized
Fortis bank. The German government bailed out Hypo Real Estate. On
October 2008 the British Government announced a bank rescue
package of around £500.
The plan consisted of three parts:
• increase banks liquidity scheme,
• increase the banks' market capitalization,
• temporarily underwrite any lending between banks.
30
European countries in economic recession or depression
Many countries experienced recession in 2008.
In the first quarter of 2008 Denmark went into recession.
Iceland fell into an economic depression in 2008 following the
collapse of its banking system.
In the second quarter of 2008, the following countries went into
recession : Estonia, Latvia, Ireland.
In the third quarter of 2008, the following countries went into
recession: Sweden, Turkey and Germany.
As a whole the fifteen nations in the European Union that use the
euro and the United Kingdom went into recession.
In addition, the European Union, the G7, and the OECD all
experienced negative growth in the third quarter.
31
Countries maintaining growth or technically avoiding recession
Poland is the only member of the European Union, which avoided a
decline in GDP, meaning that in 2009 Poland has created the most GDP
growth in the EU. As of September 2009 the Polish economy had not
entered recession.
China and India have experienced slowing growth, they have not entered
recession.
South Korea avoided technical recession in the the first quarter of 2009.
The International Energy Agency stated that South Korea could be the
only large OECD country to avoid recession for the whole of 2009.
However, as of the October, the Australian economy has managed to
avoid recession thanks to a strong mining sector. It was the only
developed economy to expand in the first half of 2009.
On October, Australia became the first G20 country to raise its main
interest rate, with the Reserve Bank of Australia deciding to move rates
up to 3.25% from 3.00%.
32
Course schedule
sub-prime crisis
European Financial Market
crisis banking in emerging markets
future face of Europe’s Financial System
33
Strong belief of emerging markets
At the beging of the Subprime crisis, everybody supposed
that Emerging Economies are stronger than they have been
during previous crises (the Asian crisis of the late 90s).
There was strong belief that the BRIC economies
(Brazil, Russia, Indian and Chinese) are so big, modern
and well-balanced to support demand for goods & services
in global economy, in spite of crisis in USA and Europe.
This phenomenon was named decoupling.
In EM economies there were not mortgage instruments
connecting with securitisation, CDS – Credit Default Swap).
34
Why the EM economies have looked stronger?
Many countries in the CEE region would be protected from the
global financial crisis, because:
- their banks' finance came not from markets but from the
multinational banks that have bought most local lenders.
- EM banks have not buy MBS in a huge quantities,
- little exposure to the subprime lending instruments,
- preparing to join the European Union in 2004, they also
strengthened their regulatory and supervisory processes.
- there is not investment banking in CEE, like in USA.
35
Banking crisis in patern-banks
In CEE countries between 60 and 80 percent of the banking
sector assets are controlled by foreign banks.
The presence of foreign banks in the EM banking system has
managed to:
- the lack of confidence between local banks, because of
insolvency of their patern-banks,
- and the liquidity crisis in the interbank markets.
In Poland there was a problem with lack of confidence of
Pekao Bank, which is Polish subsidiary of UniCredito
Italiano, when it facing with liquidity problems at home.
36
Effects of the capital outflows from EM
Interbank markets interest rates increased
dramatically. Local banks stopped lending money
one another.
37
What’s happened in 2007?
After the information about crisis in America there was the
strong belief about the strongness of EM economies.
It caused a very big capital inflow to emerging markets up
to $1 trillion. First of all, it was short term loans for EM
banks.
38
External loans and deposits of BIS-reporting banks in Eastern Europe
These loans were used to increased credit action in foreign
currency in EM countries. About the middle of 2007, external
loans have been growing deposits from the region.
39
What happened after the bankruptcy of Lehman Brothers (09/2008)
• In EM 52% of currency credits was lending in USD.
• In this case EM banking system much more depends on
foreign loans (American& European banks).
• After the bankruptcy of Lehman Brothers (09/2008) the
biggest world banks started to afraid about their own
liquidity and insolvency.
• This spectaculative bankruptcy caused the change of direction
of international capital flows.
• Parent banks (mainly in Western Europe) have become
progressively less able and/or less willing to finance their
subsidiaries in Central & Eastern Europe.
40
Effects of the capital outflows from EM
• The loss of large share of external loans in currency
developed the confidence crisis in EM banking systems.
• Local banks have been stopping lending one another.
• The reason of the confidence crisis in EM banking systems
was not MBS losses, but difficulty in currency finansing.
41
Effects of the capital outflows from EM
• The situation was so dramatic that CEE
countries have led the ECB to take the extramely
unusual step of making swap transactions
available to the central banks.
European
Central
Bank
Foreign
currency
CEE
central
banks
Local currency
42
Effects of the capital outflows from EM
The capital outflows from Central Europe gave
occasion to strong depreciation of EM
currencies and a lot of speculations in the FOREX
(currency markets)
The bankruptcy of Lehman
Brothers
48%
43
Effects of the capital outflows from EM
The zloty has dropped 33 % against the Euro. In the same
period, the Czech koruna decreased 14 % and the
Hungarian forint lost 24 %.
We can say about a speculative attacks made on Polish
zloty, HUF, made by hedge funds.
38%
44
Exotic derivatives in EM
Emerging markets firms entered into exotic
derivatives contracts that caused massive losses.
KIKO in Korea, TARN in Brazil and other
- this is the names of the exotic derivatives, sound
like toys or children’s stories.
45
Exotic derivatives in EM
The first reported losses were at private firms in the tradable goods
sector.
Most of the firms were exporters that appeared to be using the
derivatives to hedge against ill effects if their domestic currency
were to appreciate.
But when the currencies depreciated instead and the losses were
disclosed the firms had to sell local currency for euro to cover their
losses.
46
Exotic derivatives in EM
Transactions in these derivatives have resulted in massive
losses that fueled currency market panics and helped transmit
the financial crisis to emerging markets.
The very real consequences led the head of Poland’s
Business to call them a “product from hell.”
The direct losses have been deep and wide.
An estimated 50,000 firms in the emerging market world have
been affected. This includes 10 percent of Indonesia’s
exporters and 571 of Korea’s small and medium-size exporters.
Losses in Brazil are estimated at $28 billion, in Indonesia at $3
billion, and in Mexico and Poland at $5 billion each.
Sri Lanka’s publicly owned Ceylon Petroleum Company lost
$600 million, and China’s Citic Pacific suffered $2.4 billion
in losses.
47
Exotic derivatives in EM
There are two fundamental questions at the core of the problem:
1/ Did the firms intend to hedge — which, insulate
themselves from currency movements — or
speculate?
2/ And did banks, acting as derivatives dealers,
merely meet the needs of their clients or did they
engage in deceptive trading practices?
48
Exotic derivatives in EM
What were they?
• The derivative provided a long position, in which the investor
gains from an apreciotion in the value of the underlying
currency.
• The derivative generated monthly payments for a
period of one or sometimes two years. A KIKO structure
used long call options (giving the buyer the right to buy the
currency at a certain price over a certain period of time) and
short put options (granting the right to sell). That created the
economic equivalent of a futures or forward contract—the
investor gains from an upward movement in the underlying
price and losses from a downward movement.
BUT the losses was twice times bigger !!
49
Exotic derivatives in EM
What were they?
• Potential gains on the transaction were limited.
In some cases it was a so-called knock-out provision
that canceled the monthly payment if the foreign currency
appreciated beyond a specified exchange rate
• Potential losses were not limited.
• The initial cost or premium to enter into these transactions
was zero.
50
Exotic derivatives in EM
The rule was: 1 put + 2 call, barrier knock down&out
If the EUR/PLN rate will be below A, bank pays X,
But if the EUR/PLN rate will be above A client pays 2X
payoff
Risk-Return Function option structure
___ put option bought by client
___ call option sold by client
___ structure function
51
Hedged or speculated?
It is hard to know whether the nonfinancial firms intended
to hedge against further strengthening of their currency or
speculate.
It is also hard to know how they understood the risk-return profile
of these transactions.
Recomended literature:
Randall Dodd, Playing with Fire, Finance&Development, June 2009
52
Effects of the capital outflows from EM
Poland is a member of EM region basket. When
international investors see bad condition in one of the
countries from this region, they also go out from Polish
market. Then foreign investors sell Polish Treasury bonds,
stocks and Polish zloty making its depreciation.
So now there is a big problem with stability of our currency,
because of capital flows.
The solution of the problem could be the enter of
Poland to Eurozone.
53
Course schedule
sub-prime crisis
European Financial Market
crisis banking in emerging markets
future face of Europe’s Financial System
54
The lessons of the crisis for financial supervisory policy
A first lesson of the financial crisis is that it has been a consequence of:
the overall macro-financial environment
as well as the behaviour of individual institutions
and the functioning of specific market segments.
At a macroeconomic level: large global imbalances, rapid credit expansion
over a protacted period of time, in a environment of low inflation and high
growth, a huge increase in leverage, a significant underpricing of risk and a
consequent divergence of asset prices from fundamental values.
At a micro-economic level: financial innovations, the securitisation
process helped to better diversify and distribute risk, the creation of
complex products whose real value and risk was difficult to assess,
and the establishment of off-balance sheet investment vehicles.
55
The lessons of the crisis for financial supervisory policy
A second lesson of the crisis is that the nature of the systemic risk in the
financial sector is not related only to:
the potential illiquidity,
or insolvency of large banks or other big regulated financial institutions,
but it also depends on the degree of “interdependence” between financial
institutions and between markets
the size of some of the non-bank financial institutions and the activities of
the “non-bank, non regulated sector” have become significant and can pose
systemic risks.
This “interdependence” reflects a variety of direct and indirect links in the
financial system and it involves institutions and markets that are
regulated or not regulated.
This second category includes not only hedge funds but also off-balance
sheet financial entities, such as structured investment vehicles, as well as
the securitisation market, and the market for credit default swaps (CDS).
56
The lessons of the crisis for financial supervisory policy
A third lesson is that the increasing financial integration in
Europe and globally has important implications for the
cross-border distribution and propagation of systemic
risk.
The growing presence and significance of cross-border financial
institutions within the EU (the largest 43 cross-border banking groups in
the EU accounted for 76 % of total EU bank assets at the end of 2007)
requires the strengthening of the pan-European character of supervision.
57
The lessons of the crisis for financial supervisory policy
A fourth and final lesson that I want to stress is that
effective crisis prevention and management call for close
cooperation and efficient information exchange between
the supervisory authorities as well as between the central
banks
58
The lessons of the crisis for financial supervisory policy
What are conclusions can we draw from these lessons, and more
generally from the recent experience, for supervisory policy?
to strengthen both the macro-prudential and micro-prudential
supervision of the financial system
Somebody recommends set up a new body – called the European
Systemic Risk Council (ESRC)
59
The lessons of the crisis for financial supervisory policy
The main functions of the macro-prudential framework include:
the identification and assessment of risks and vulnerabilities in the
EU financial system (including all markets, institutions and
infrastructures);
the issuance of risk warnings; and
the adoption of related recommendations on macro-prudential
policies.
60
Course schedule
sub-prime crisis
European Financial Market
crisis banking in emerging markets
future face of Europe’s Financial System
capital market in Poland
61
Polish Capital Market
Poland started to change its economy from “100% banking
based system” into more flexible mixed “banking and
markets based system” in 1989.
One of awaiting effects of program implementation was
creation new segment in the Polish Economy – Capital
Market.
At the begining of the reform Poland have:
• weak currency,
• high inflation,
• strong budget deficit.
62
Evolution of Polish capital market 1989 -2007
Polish Capital Market
Problems
1989
2007
Proper legal solution
Lack, some regulations of
Commercial Code from
1930-ties
Solutions regarding capital
market in important part
compatible to EU solutions
Capital market institutions
Lack
Complete
institutional
infrastructure .
Domestic capital
Very limited
Permanently
growing
strength of institutional
investors (pension funds,
investment funds), still
relatively weak individual
investors
Foreign capital
Lack
due
to
low
creditability of the country –
high unpaid foreign debt
Creditability of the country
at the safe level of BBB+
(S&P),
also speculative
capital
Strong inflation process
Strong currency
Strength
currency
of
domestic
Source: author’s own research
63
The History of the Warsaw Stock Exchange
One of the oldest in Europe, the capital market in
Poland with its 190 years of history has an impressive
heritage. Paradoxically, the interruption in exchange
operations in Warsaw as a result of World War II and
then the transition to the communist economic system
enabled Poland to create a modern stock exchange.
The first stock exchange in Poland opened in Warsaw in May, 1817
under the name of the 'Mercantile Exchange'.
1991 12 April - Poland and France signed a co-operation
agreement to open a securities exchange in Warsaw
(The Warsaw Stock Exchange Company).
64
From a national bourse to regional leadership
During the seventeen years of its history, the WSE has
developed from a small national exchange into one of the
fastest growing bourses in the European Union and an
unquestionable leader in Central and Eastern Europe.
Number of listed companies
65
From a national bourse to regional leadership
When WSE began its operations in April 1991, it had five
companies listed. At the end of November 2007 there were as
many as 345, out of which 21 were foreign companies.
Additionally, NewConnect had 19 companies listed.
WSE is the leader among exchanges in Central and Eastern
Europe:
* first position in terms of the number of listed companies,
* first position in terms of the number of new companies
coming to the bourse,
* first position in trading in derivatives,
* second position in capitalisation of domestic companies,
* second position in value of equity trading.
66
NUMBER OF LISTED COMPANIES ON EXCHANGES
IN THE CEE REGION – DOMESTIC COMPANIES
(end of August 2008, source:WSE)
450
395
400
341
350
300
250
198
200
150
85
100
50
23
103
39
0
Prague
Stock
Exchange
Budapest
Stock
Exchange
Ljubljana
Stock
Exchange
Wiener
Börse
Bratislava
Stock
Exchange
Warsaw
Stock
Exchange
Bulgarian
Stock
Exchange
67
FOREIGN COMPANIES LISTED ON STOCK EXCHANGES IN THE REGION
(end of July 2008, source:WSE)
30
25
20
18
10
10
3
0
1
0
0
Bulgarian
Stock
Exchange
Ljubljana
Stock
Exchange
0
Bratislava
Stock
Exchange
Bucharest
Stock
Exchange
Budapest
Stock
Exchange
Prague
Stock
Exchange
Warsaw
Stock
Exchange
Wiener
Börse
68
WSE – CAPITALISATION AND LISTED COMPANIES
Capitalisation - domestic companies (Euro bn) - left scale
Capitalisation - foreign companies (Euro bn) - left scale
Number of listed companies - right scale
158
180
400
142
160
140
114
120
100
350
113
101
80
40
32
53
41
25
27
20
150
51
19
250
200
80
60
300
100
29
50
6
0
0
2000
2001
2002
2003
2004
2005
2006
2007
Aug
2008
Source: WSE
69
Polish capital market in Central Europe
The success of WSE results from a variety of factors:
* the country’s economic potential,
* favourable legislative framework,
* strength and resources of financial investors,
* IT infrastructure
70
WSE – INTERNATIONAL MARKET
REINHOLD
SILVANO
OLYMPIC
CEDC
BMP AG
ATLAS ESTATES
AMREST
CINEMA CITY
PLAZA CENTER
CEZ
ORCO GROUP
PEGAS
NWR
SKYEUROPE
BELVEDERE
WARIMPEX
IMMOEAST
ACE
ASTARTA
KERNEL
ASSECO
MOL
UNICREDIT
ITALIANO
ASBIS
RONSON
71
IPOS ON STOCK EXCHANGES IN EUROPE
Q2 2008, ALL MARKETS
No.
Exchange
No. of IPOs
Value of IPOs (EUR m.)
1
London
46
6 298
2
Warsaw
37
1 890
3
NYSE-Euronext
15
1 615
4
OMX
10
178
5
Deutsche Boerse
8
330
6
Oslo
6
28
7
Luxembourg
6
49
8
Switzerland
3
412
9
Borsa Italiana
2
14
10
Madrid (BME)
-
-
11
Wiener Boerse
-
-
12
Ireland (ISE)
-
-
13
Athens
-
-
Source: PricewaterhouseCoopers
72
Special facility for small issuers. Markets AIM type
British AIM, Polish NewConect are not regulatory
markets.
This markets join trading public and private issue.
NewConect has provided a platform for financing and
secondary trading for small and medium size
companies showing high growth potential.
73
MARKET CAPITALISATION AND NUMBER OF LISTED
COMPANIES
PLN mln.
Market capitalization
Number of listed companies
1500
70
1300
60
1100
50
900
40
700
-100
0
20
Ju
ly
00
e2
Ju
n
8
00
y2
Ma
00
il 2
Ap
r
rc h
Ma
Fe
br
ua
ry
2
00
8
08
20
ry
ua
Ja
n
r2
be
ce
m
be
ve
m
00
7
00
r2
20
be
r
No
De
7
be
tem
Se
p
Oc
to
r2
00
7
00
us
t2
Au
g
08
10
8
100
8
20
20
08
300
7
30
08
500
74
WIG - MARKET HISTORY 3Y
75
www.WSE.com.pl
76
www.NewConnect.eu
77
www.WSEInfoSpace.eu
78
Thank you for attention
[email protected]
79