Connect with us


Why central banks will double down on lending schemes 



The writer is chair of the sustainable finance committee at UBS

Of all the innovations in central banking this year, few are as intriguing as Bank of Japan’s special bonus interest rate to regional banks that cut costs, merge or lend for sustainable development.

The underlying issue is one that worries all central banks. Will banks will be strong enough to fund the recovery, particularly for small and midsized businesses, when government guaranteed loans expire? 

How policymakers answer this question has major implications for bank dividends, financial regulation and the shape of quantitative easing programmes. This makes the next salvo of measures from the European Central Bank all the more interesting.

Last month, the Japanese central bank took the unprecedented step of paying Japan’s smaller regional banks an extra 0.1 per cent of interest “to enhance the resilience of the regional financial system”. It warned that if profitability were to keep falling, financial intermediation could stop functioning smoothly.

Guaranteed lending has represented almost all small business loans this year across the eurozone, UK and US. Little wonder central banks are being creative to try to improve monetary policy transmission to refresh parts of the economy that other QE programmes cannot reach. New Zealand just introduced a funding-for-lending scheme to help banks lend to small business. And this week the Federal Reserve extended the scheme helping banks fund loans under the payment-protection programme.

So far in the pandemic crisis, banks have been the dog that did not bark. In the main, they have been resilient, not amplified risks across the system, and worked with policymakers to disburse emergency lending or offer forbearance.

But zero and negative interest rates have hit their profitability hard by squeezing profit margins. The longer these are in place, the greater the side-effects. A recent study by the San Francisco Fed persuasively demonstrated this.

Japanese regional banks were already the least profitable globally, on return on assets. Now, an increasing number of small to midsized banks around the world are starting to struggle to cover their fixed costs, especially if you exclude the gains on sovereign bond holdings.

There is a new dimension. The pandemic has accelerated banks’ need for technology investment by three to five years, according to Mohit Joshi, president of Infosys. This requires far greater investment and bigger firms can cover their costs better and invest more in innovation. Simply put, the winner-takes-most dynamic we see in most digital markets is coming to banking — and fast.

This means an uphill battle for subscale regional banks. Hence the prompt by the Japanese central bank to merge or take out costs. In Europe, Andrea Enria, chair of the ECB’s supervisory arm, has also been leading the calls for mergers.

An alternative is for banks to piggy back on another’s scale through far greater use of utilities or outsourcing their entire back end to a cloud provider, as I argued in the Future of Finance report for the Bank of England. This can take years, so schemes would be needed as bridges.

The market implications of central bank policy shifts are fourfold. Any changes that shield banks more effectively from the corrosive impact of negative rates are net positive for bank securities and, in turn, financial stability. Eurozone bank earnings could benefit more than 5 per cent on UBS estimates, should the ECB extend their scheme or improve its terms. But the spread of winners and losers is likely to widen over time as the winner-takes-most dynamic plays out. 

Second, the more the special lending schemes, such as the ECB’s targeted long-term refinancing operations (or TLTROs), are extended, the greater will be the pressure to make them support the transition to a lower carbon economy.

Third, expanded special lending schemes will have spillovers into sovereign bond markets. Given that the ECB’s TLTROs are disproportionately taken by southern European banks, this will keep bids on peripheral eurozone bonds strong.

Fourth, the more workarounds there are for banks, the longer policy rates could stay at zero or negative rates. The pressure on pension funds and insurers to optimise their asset allocation in the face of ultra low rates will be intense.

Milton Friedman used to say nothing was as permanent as a temporary government programme. Funding-for-lending schemes look likely to follow his maxim.


Source link

Continue Reading
Click to comment

Leave a Reply

Your email address will not be published. Required fields are marked *


European stocks stabilise ahead of US inflation data




European equities stabilised on Wednesday after a US central banker soothed concerns about inflation and an eventual tightening of monetary policy that had driven global stock markets lower in the previous session.

The Stoxx 600 index gained 0.4 per cent and the UK’s FTSE 100 rose 0.6 per cent. Asian bourses mostly dropped, with Japan’s Nikkei 225 and South Korea’s Kospi 200 each losing more than 1.5 per cent for the second consecutive session.

The yield on the 10-year US Treasury bond, which has dropped in price this year as traders anticipated higher inflation that erodes the returns from the fixed interest securities, added 0.01 percentage points to 1.613 per cent.

Global markets had ended Tuesday in the red as concerns mounted that US inflation data released later on Wednesday could pressure the Federal Reserve to start reducing its $120bn of monthly bond purchases that have boosted asset prices throughout the Covid-19 pandemic.

Analysts expect headline consumer prices in the US to have risen 3.6 per cent in April over the same month last year, which would be the biggest increase since 2011. Core CPI is expected to advance 2.3 per cent. Data on Tuesday also showed Chinese factory gate prices rose at their strongest level in three years last month.

Late on Tuesday, however, Fed governor Lael Brainard stepped in to urge a “patient” approach that looks through price rises as economies emerge from lockdown restrictions.

The world’s most powerful central bank has regularly repeated that it will wait for several months or more of persistent inflation before withdrawing its monetary support programmes, which have been followed by most other major global rate setters since last March. Investors are increasingly speculating about when the Fed will step on the brake pedal.

“Markets are intensely focused on inflation because if it really does accelerate into this time near year, that will force central banks into removing accommodation,” said David Stubbs, global head of market strategy at JPMorgan Private Bank.

Stubbs added that investors should look more closely at the month-by-month inflation figure instead of the comparison with April last year, which was “distorted” by pandemic effects such as the price of international oil benchmark Brent crude falling briefly below zero. Brent on Wednesday gained 0.5 per cent to $69.06 a barrel.

“If you get two or three back-to-back inflation reports that are very high and above expectations” that would show “we are later into the economic recovery cycle,” said Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management.

He added that the pandemic had sped up deflationary forces that would moderate cost pressures over time, such as the growth of online shopping that economists believe constrains retailers’ abilities to raise prices. Widespread working from home would also encourage more parents and carers into full-time work, he said, “increasing the labour supply” and keeping a lid on wage growth.

In currency markets on Wednesday, sterling was flat against the dollar, purchasing $1.141. The euro was also steady at $1.214. The dollar index, which measures the greenback against a group of trading partners’ currencies, dipped 0.1 per cent to stay around its lowest since late February.

Source link

Continue Reading


Potash/grains: prices out of sync with fundamentals




The rising tide of commodity prices is lifting the ricketiest of boats. High prices for fertiliser mean that heavily indebted potash producer K+S was able to report an unusually strong first quarter on Tuesday. Some €60m has been added to the German group’s full year ebitda expectations to reach €600m. Its share price has gone back above pre-pandemic levels.

Demand for agricultural commodities has pushed prices for corn and soyabeans from decade lows to near decade highs in less than a year. Chinese grain consumption is at a record as the country rebuilds its pork herd. Meanwhile, the slowest Brazilian soyabean harvest in a decade, according to S&P Global, has led to supply disruptions. Fertiliser prices have risen sharply as a result.

But commodity traders have positioned themselves for the rally to continue for some time to come. Record speculative positions in agricultural commodities appear out of sync even with a bullish supply and demand outlook. US commodity traders have not held so much corn since at least 1994. There are $48bn worth of net speculative long positions in agricultural commodities, according to Saxo Bank.

Agricultural suppliers may continue to benefit in the short term but fundamentals for fertiliser producers suggest high product prices cannot last long. The debt overhang at K+S, almost eight times forward ebitda, has swelled in recent years after hefty capacity additions in 2017. Meanwhile, utilisation rates for potash producers are expected to fall towards 75 per cent over the next five years as new supply arrives, partly from Russia. 

Yet K+S’s debt swollen enterprise value is still nine times the most bullish analyst’s ebitda estimate, and 12 times consensus, this year. Both are a substantial premium to its North American rivals Mosaic and Nutrien, and OCI of the Netherlands, even after their own share prices have rallied.

Any further price rises in agricultural commodities will depend on the success of harvests being planted in the US and Europe. Beyond restocking there is little that supports sustained demand.

Our popular newsletter for premium subscribers Best of Lex is published twice weekly. Please sign up here.

Source link

Continue Reading


Amazon sets records in $18.5bn bond issue




Amazon set a record in the corporate bond market on Monday, getting closer to the level of interest paid by the US government than any US company has previously managed in a fundraising. 

The ecommerce group raised $18.5bn of debt across bonds of eight different maturities, ranging from two to 40 years, according to people familiar with the deal. On its $1bn two-year bond, it paid just 0.1 percentage points more than the yield on equivalent US Treasury debt, a record according to data from Refinitiv.

The additional yield above Treasuries paid by companies, or spread, is an indication of investors’ perception of the risk of lending to a company versus the supposedly risk-free rate on US government debt.

Amazon, one of the pandemic’s runaway winners, last week posted its second consecutive quarter of $100bn-plus revenue and said its net income tripled in the first quarter from the same period a year ago, to $8.1bn.

The company had $33.8bn in cash and cash equivalents on hand at the end of March, according to a recent filing, a high for the period.

“They don’t need the cash but money is cheap,” said Monica Erickson, head of the investment-grade corporate team at DoubleLine Capital in Los Angeles.

Spreads have fallen dramatically since the Federal Reserve stepped in to shore up the corporate bond market in the face of a severe sell-off caused by the pandemic, and now average levels below those from before coronavirus struck.

That means it is a very attractive time for companies to borrow cash from investors, even if they do not have an urgent need to.

Amazon also set a record for the lowest spread on a 20-year corporate bond, 0.7 percentage points, breaking through Alphabet’s borrowing cost record from last year, according to Refinitiv data. It also matched the 0.2 percentage point spread first paid by Apple for a three-year bond in 2013 and fell just shy of the 0.47 percentage points paid by Procter & Gamble for a 10-year bond last year.

Investor orders for Amazon’s fundraising fell just short of $50bn, according to the people, in a sign of the rampant demand from investors for US corporate debt, even as rising interest rates have eroded the value of higher-quality fixed-rate bonds.

Highly rated US corporate bonds still offer interest rates above much of the rest of the world.

Amazon’s two-year bond also carried a sustainability label that has become increasingly attractive to investors. The company said the money would be used to fund projects in five areas, including renewable energy, clean transport and sustainable housing. 

It listed a number of other potential uses for the rest of the debt including buying back stock, acquisitions and capital expenditure. 

In a recent investor call, Brian Olsavsky, chief financial officer, said the company would be “investing heavily” in the “middle mile” of delivery, which includes air cargo and road haulage, on top of expanding its “last mile” network of vans and home delivery drivers.

Source link

Continue Reading