The tensions continue to go out of the tight conditions in global banking, especially in the eurozone, which has been blamed by Australian banks and their mates in the investment community and the local media looking for doom-and-gloom stories and easy headlines.

In fact you get the feeling that some of the heavy hitters of the global economy don’t think much of the recent alarmist forecasts for world growth from the World Bank and IMF and their seeming ignorance of what has happened in the eurozone banking sector in the past month.

If the improvement in conditions (from fraught to serious concern, but not fear of collapse) continues into the rest of this year, don’t expect our banks and their local mates to tell us that the easing of tensions in eurozone banking and financial markets will help lower funding costs for our banks and take pressure off their profit margins.

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The World Bank got easy headlines in the past 10 days with its lurid forecast that the world faced a potential deep recession if a Lehman-type situation happened (three or four countries shut out of funding markets). The IMF and its head, Christine Lagarde, got easy headlines by suggesting the world faced the chance of a possible “1930s situation” if the eurozone crisis deepened.

Both groups warned of deeper falls in already weak levels of global growth to recession levels if the eurozone crisis worsened or some other unexpected event occurred.

But those doom-laden forecasts have been rejected by one of the heavy hitters of central banking: Mark Carney, who is head of the Bank of Canada and, more importantly, chairman of the Financial Stability Board, part of the Bank of International Settlements that oversees global banking policy, especially capital levels.

The FSB co-ordinates the work of national financial authorities and international standard-setting bodies, and develops and promotes the implementation of effective regulatory, supervisory and other financial sector policies.

Carney told Reuters TV in Davos this week in widely reported comments that the risk of a Lehman-style failure in Europe has been “dramatically reduced” by recent policy steps. Carney said the decisive action by the ECB to provide liquidity to the financial system has eased market pressure on Spain and Italy and boosted demand for their bonds:

“It is absolutely essential that the financial system, the banking system specifically in Europe, is able to finance itself on a reasonable basis, that we’re not worried about a Lehman event in Europe,” he said. “Our view is that given the measures that the ECB has taken and the heightened focus of the banking regulator in Europe on the health of these institutions that that tail risk has been dramatically reduced. That’s incredibly important.”

When asked whether that meant he was now optimistic about a positive outcome for the European debt crisis, Carney said he was merely “realistic”, which is a view far more appropriate than the headline-grabbing doom and gloom scenarios from the World Bank and IMF. Europe is not outside of the woods by any measurement, Greece still has to to do a deal, although that may be closer with reports that major banks have agreed to a interest rate on new Greek debt of 3.75%, below the 4% level rejected earlier this week by the EU and IMF

“Within that context, one is realistic because the judgment has to be made: have European authorities done enough to take away the more extreme possibilities?” Carney said. He defined “extreme possibilities” as serious debt financing troubles in a major European economy, which was the basis for the dire warnings from the World Bank and IMF.

And the improved outlook for European banks is slowly easing the tight conditions in credit markets. In fact the Financial Times and other media groups say US money market funds, which started the “mouse run” on eurozone banks by withdrawing tens of billions of dollars of deposits and short-term money from July onwards, have returned to eurozone banks (and French banks in particular) in the past 10 days, buying short-term debt. The catalyst was the €489 billion pumped into more than 500 banks by the European Central Bank.

That will see a slow easing in high interest rates for banks in eurozone markets, which will help Australian banks, which have been among the major beneficiaries from the eurozone woes.

A report from Fitch Ratings this week says US money market funds, lifted their investments in the debt of banks from Australia late last year (See, having a AAA rating means something). Canadian and Japanese banks have also been beneficiaries as well.

“US prime money market funds (MMFs) continued to reduce their exposure to eurozone banks. As of month-end December, exposure to eurozone banks was approximately 10% of total MMF holdings in Fitch Ratings’ sample, a 16% decline on a dollar basis since end-November. Aggregate MMF exposure to European banks outside of the euro zone remained stable at approximately 22% of MMF holdings. Exposure to banks in Australia, Canada, and Japan each increased relative to end November and represents more than 30% of MMF assets, up from 20% of MMF assets as of end-May 2011,” Fitch wrote.

The report reveals that the NAB, Westpac and Commonwealth are among the top 15 most favoured investments for these funds, but not the ANZ. The funds are major providers of finance for the banks. but in the case of the three Australian banks, the investments exclude so-called repurchase agreements, which means means the money market fund money is more stable.

Westpac is the bank most favoured by these funds: 3.2% of their assets are on loan to Westpac, and 4.8% of Westpac’s funding is from them. The NAB is second with 3.1% of fund assets in loans to the bank and 4.6% of the NAB’s borrowings from funds. The Commonwealth represents 2.4% of fund assets and 3.1% of the CBA’s funding is held by US money market funds. The funding include commercial paper, certificates of deposits, repurchase agreements and other securities.

This substantial increase in investment in Australian bank debt is a major reason the Australian dollar has stayed high in December and January, despite the strength of the US currency (which normally pushes our dollar lower). Foreign central banks and other big investors have also been big buyers of Australian government debt (which remains in very short supply). In fact 80% of government debt is now held by foreign investors chasing the high yield compared with record low rates in the US and Europe. These investors have also been diversifying their reserves out of euros and US dollars and including more Australian and Canadian dollars.

The dollar topped the $US1.06 mark this morning for the first time in three months as “risk on” investments return to the fore among offshore investors, especially in the US and Europe. The carry trade (borrowing US dollars and euros cheaply and buying Australian dollar assets) is helping the currency, but the surge in US money market fund investment, especially in December, has had a big impact here and will help ease tensions (and interest rates globally) if Carney’s view is accurate.


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Peter Fray
Peter Fray
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