“The euro zone is caught in the middle of two opposing forces,” said Alberto Gallo, head of European Macro Credit Research for Royal Bank of Scotland (RBS) and a featured speaker at the Global Association of Risk Professionals (GARP) webinar “The State of the Credit Markets” on November 15, 2012. He was referring to the forces both “positive” (European Central Bank liquidity and low interest rates) and “negative” (heavy debt and increasing fragmentation) in the euro-zone financial markets.
Gallo pointed out that, in the last 20 years, banking in Europe has grown tremendously. At €35 trillion, bank assets are now about triple the size of the European economy. “Europe is overbanked. Deleveraging is just beginning,” he said. “The funding costs for European banks are eroding profitability.”
Gallo compared Europe to Japan in the 1980s. With its ageing population, stagnant growth, and low interest rates, he said, “Europe looks like Japan [did then] but it is much more unstable,” referring to the mix of sociopolitical factors.
“I call this the Benjamin Button syndrome,” said Gallo, referring to his recent article. “Europe is growing younger and its financial markets are becoming more separate” as the crisis churns on. “After deleveraging the risk, Europe’s financial markets will face disintegration.”
Gallo divided Europe into “core” and “periphery” and showed graphs on how the financial markets and the real economies of “core Europe” and “peripheral Europe” are diverging. He said that a euro is perceived to be safer in the core, and thus, there is a net deposit outflow from Greece and Portugal. The risk of capital flight from Spain and Italy still remains high.
In response to a question from the audience, Gallo described the effect the euro zone is having on Latin American markets. There is “aggressive deleveraging” by Spanish banks, but South America is not heavily dependent on foreign banks so the credit crunch is not so severe.
Gallo showed a remarkable figure of the cross-linked holdings among the European banks (slide 20, for those who download the slide from the URL given below). The cross-holdings could produce an adverse feedback loop, he remarked.
All is not bad, however. Gallo was quick to point out that “yield and diversification opportunities can be found on the edges of the market.”
The solution Alberto Gallo advocates is a strong deposit insurance fund, along the lines of the Federal Deposit Insurance Corporation (FDIC). Europeans hope to get the framework in place by December 2012. “But it’s in the hands of the politicians,” said Gallo, “and the danger is they may change their minds.”
The webinar presentation slides can be found at: http://event.on24.com/r.htm?e=533739&s=1&k=2D77B52DE83507E0F9FC37553BBA1BBD
There is extensive commentary on market events provided by Alberto Gallo at: www.albertogallo.com
The movie poster for the 2008 movie The Curious Case of Benjamin Button was borrowed from: https://www.impawards.com/2008/curious_case_of_benjamin_button_ver12.html