IMF Managing Director Dominique Strauss-Kahn.BENOIT TESSIER
Global banks are facing a $4-trillion reckoning over the next two years as precrisis financing strategy comes back to haunt them.
Over the past decade of cutthroat competition in international finance, banks sought to lower their funding costs by selling debt of shorter duration.
This meant more frequent trips to the debt market, but the tradeoff was worth it - significant savings on the cost of raising money because investors accept lower yields on debt that will mature relatively quickly.
The financial crisis short-circuited this approach. Yet despite warnings dating back to the end of 2009, banks in some of the biggest economies have been slow to come to grips with this new reality, the International Monetary Fund warned Tuesday.
As a result, these institutions must refinance more than $4-trillion (U.S.) in debt over the next 24 months. With uncertainty high, investors will be looking for higher returns to offset greater risk. At the same time, governments will be issuing massive amounts of debt to pay their bills from the financial crisis, meaning financial institutions might have to offer higher yields to attract buyers. The bottom line: Financing costs for banks are almost certainly set to rise, putting a significant strain on the global financial system and representing a risk to the economic recovery.
"Funding is perhaps the major challenge confronting banks everywhere," Jose Vinals, director of the IMF's monetary and capital markets department, said at a press conference in Washington where he presented the fund's latest bi-annual Global Financial Stability Report.
The warnings aren't new. Almost a year ago, Moody's Investors Service Inc. issued a report that expressed concern about bank funding, noting that average maturities of new debt rated by Moody's had fallen to 4.7 years from 7.2 years over the preceding five years. In April, the IMF joined in, using its previous financial stability review to second Moody's concerns.
"As foreshadowed in the April, 2010, GFSR, banks now face the greatest vulnerabilities on the liabilities side of their balance sheet," the IMF said in its new report. "There has been little progress in lengthening maturity of their funding."
This is primarily an issue for continental Europe, Britain and the United States. Moody's ranked Canada among a handful of countries, including Japan and China, where banks have managed their financing requirements to keep the average maturity at more than five years. Rod Giles, a spokesman for the Office of the Superintendent for Financial Institutions, said from Ottawa that Canada's banking regulator has no worries over the banks' financing plans or their ability to tap markets.
Jean-Francois Tremblay, a vice-president and senior analyst at Moody's and the author of the New York-based rating agency's November, 2009, report on banks' looming financing crunch, echoed the IMF's concern, saying that little has changed in the past year to give him more comfort.
Banks managed to refinance more than $1.7-trillion worth of debt in 2009 without incident, according to Moody's figures. But that had almost everything to do with the significant support programs governments put in place to nurse financial institutions through the crisis. Central banks have kept interest rates at record levels and provided emergency funding when financial institutions couldn't find it elsewhere. Finance ministries guaranteed wholesale issuance and, in the U.S. and Europe, recapitalized failing institutions.
Governments are now talking about ending their support programs for banks, if they haven't already done so. The financing crunch argues against that. The costs of borrowing are set to increase, either for good reasons - stronger economic growth that demands higher benchmark interest rates - or bad ones, such as the sovereign debt crisis that gripped Europe in the spring.
The risk, according to the IMF and Mr. Tremblay, is that too few banks are ready for it, demanding a government safety net for a while longer. "We're concerned about a change in investor perception," he said. "Those banks that are viewed as financially weak and are at risk of losing government support could be challenged in refinancing what is coming to maturity on their balance sheets."