takeover

Bank Scandals: Is This Just The Tip Of The Iceberg?

From accusations of interest rate manipulation, to charges of illegally hiding transactions with Iran, the spotlight is well and truly on the banking industry. Institutions appear to have been operating right at the edge of what’s reasonable where the line between right and wrong can become blurred. Crucially, it highlights how issues can occur outside ‘investment banking’, and therefore attempts to classify one part of the industry as bad and one part good is flawed. Nevertheless, public opinion is against the banks and it’s up to them to earn back respect. We’re entering a tough new paradigm of tighter regulation, greater demands for transparency and less incentive to lend. Vindication, conviction and takeovers are all possible but one thing we can be more certain of, the regulator is watching closely and further turmoil is likely.

Working On The Border Between What’s Right And Wrong

Standard Chartered has been accused of illegally hiding transactions with Iran. The aggressive attack of money laundering charges came as a shock to investors, who punished the bank’s shares with a sell-off of more than 16%, wiping $6bn from its market value. So what can we take away from this latest scandal? Is this a one-off or an indication of an industry wide shortfall?

The complication seems to arise from the claim that the bank was already working openly with US agencies and 99.9% of this business complied with legislation.

However therein lies the shortfall, the opaqueness. Investors maintain these discussions should have been better highlighted in their last annual results. The confusion surrounding whether they did or did not do wrong may signal that they could have been operating right at the edge of what’s reasonable.

With a focus on profits and market share, the line between right and wrong can become blurred. Indeed previous fines have merely moved not mitigated risk. As other banks closed their doors on these types of transactions, Standard Chartered, it has been argued, may have instead welcomed the new business. Changing this culture may prove prudent.

Issues Aren’t Black & White But Murkier ‘Shades Of Grey’

An interesting aspect of this investigation is the type of bank business it is targeting. This is not an investment banking scandal. Instead commercial banking dealings are under attack. Could this have been avoided by having investment banking and retail banking separated? Arguably no.  It is not as binary as one part good, one part bad and not all banks overall are the same as each other either.

Indeed, investment banking can help subsidise the cost for running other banking operations and although transgressions may have been made, not all who work in the industry can be tarred with the same brush.

A New Paradigm

There is huge political capital in ‘bank bashing’, finding a common ‘enemy’ to engender sympathy and support.  But the pressure is on the banks to earn back trust. Likewise, whilst banks have to get used to tougher regulation, we must accept that fines could erode their reserves and reduce their incentive to lend. A tougher ‘new paradigm’. Furthermore, whilst financial institutions must accept greater demand for transparency, both banks and regulators must improve the way they communicate with the public to avoid unnecessary panic.

What’s Next?

Vindication? Conviction? Takeover? Next Wednesday we’ll hear Standard Charter’s response to these accusations. Analysts admit that at this stage it’s hard to know which way the case will go. An unintended consequence could be a potential takeover, with JP Morgan already mentioned as a possible buyer (source: John Kirk at Redburn). As some hope to split banks up so they are easier to control, this would not be a welcomed outcome. Meanwhile the LIBOR scandal continues as additional institutions are investigated. Further turmoil is likely. And the regulator is watching…

Europe and a New Form of ‘Decoupling’ – How to React

The problem with international meetings is politicians are often “more interested in their next job than the next generation” – Anonymous source via Anthony Hilton, Evening Standard

Political turmoil has hit the three largest European economies in recent days. Portugal’s Prime Minister resigned, Merkel’s party was ousted from the most prosperous state in Germany after an almost 58 year uninterrupted rule and at France’s recent election, abstention reached a new high at 54% of the population. What are the main issues to be watching, how are they affecting investments and why is the term ‘decoupling’ now being used to describe countries within the EU?

Headline of Germany's biggest newspaper, Bild, 12 May 2010. Source: http://read.bi/cZa0of

Berlusconi ‘Flirting’ With Protectionism

In reaction to recent French takeovers of Italian companies, Italy is threatening to draft a bill to curtail the trend. France maintains the bill will go beyond measures conceived by Paris and tensions look to worsen as the French EDF, the largest shareholder of Italian energy company Edison prepares to replace the Italian CEO with a French counterpart.  Indeed with David Cameron concerned about maintaining an open and competitive continent, the issue is one to watch. Nevertheless, with a high savings rate and exposure to German and Emerging Market economies, the outlook for Italy remains strong. In a recent auction, the maximum amount of index-linked bonds targeted was sold on Tuesday, €6bn year to date. Domestic demand remains strong.

Spanish Growth Downgraded

Another European country with issues of its own and yet resilient market reaction is Spain. The Central Bank sees a growth outlook of 0.8% for this year, lower than the government’s expectation of 1.3% growth. Unemployment is still among the highest in Europe at ~20% and they are implementing some of the deepest austerity measures to bring their deficit inline with that of France. Nevertheless, markets are forward looking and are reacting well to the aggressive policy implementation. Spreads on Spanish bonds over the equivalent German versions continue to narrow.

Even more worrying is the 43% youth unemployment (as quoted in The Guardian), higher than both Egypt and Tunisia - leading Gregory White at The Business Insider to call Spain "The Next Egypt" http://read.bi/i7fKOu. Source of chart: Miguel Navascues, an economist who spent 30years for the Bank of Spain following a posting for the US http://bit.ly/fDGb6k

Germany Facing a ‘Blocking Majority’

After another disappointing election result, the governing party of Germany could face a ‘blocking majority’ if they lose one more state in the September elections. Inner-party opposition is looking likely to intensify and after abstaining in the UN’s vote on the ‘no fly zone’ over Libya, fears of a return to isolationism have returned. Together this could compound the indecision that has dogged Merkel’s leadership so far. Nevertheless, the country’s deficit is set to fall as low as 2.5% of GDP.

 

Equally applicable for France with their 54% abstention rate as to Germany's indecision - The once opinionated cocktail hour has gone quiet! Source: http://www.zundelsite.org/cartoons/german_party.html

A New ‘Decoupling’

Therefore, the markets are starting to differentiate between countries. Spanish and Italian equity markets are almost 9% higher than they were at the start of the year while others are still struggling.  Most interesting is the lacklustre return of Germany’s equity market despite stronger fundamentals. Although this can be explained by the idea that markets move not by information on an absolute basis but relative to past performance and most crucially – expectations. With this in mind, Italian and Spanish economies are seen to be improving and doing well versus investor-set benchmarks.

The Investment Insight

There are many more hurdles along the way. The yield on Portugal’s 5-year notes surpassed 9% for the first time since Bloomberg records began (1997). The average yield across maturities lies at 4%, but the trend is upwards and once a 6% level is reached, it is argued it will become near impossible to reduce the countries debt-to-GDP ratio. In the immediate future, today’s results of Ireland’s banking stress tests will reveal the additional capital required for adequate solvency. As always, it is wise to maintain context, exploit contagion to your benefit and focus on quality for the longer-term.