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World's Banking Sector Still Faces Major Challenges

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Alex Carrick

Positions:
Alex Carrick is Chief Economist for CanaData, Reed Construction Data’s Canadian economic forecasting and statistical service.

Economists

The banking sector worldwide is still facing serious challenges. In Europe, the problems relate to sovereign debt issues, particularly in Greece. In China, it’s all about lending at the local level to finance infrastructure work. Social housing is the latest hot-button topic. In America, it’s going to be costs associated with improper foreclosure practices, new capital requirements that will see the largest banks saddled with holding more capital in reserve and Washington’s questionable resolve when it comes to straightening out public finances.

The banking sector worldwide is still facing serious challenges. In Europe, the problems relate to sovereign debt issues, particularly in Greece. In China, it’s all about lending at the local level to finance infrastructure work. Social housing is the latest hot-button topic. In America, it’s going to be costs associated with improper foreclosure practices, new capital requirements that will see the largest banks saddled with holding more capital in reserve and Washington’s questionable resolve when it comes to straightening out public finances. Greece Greece is stuck with the biggest red pin on Europe’s crisis map. Its economy is expected to contract by nearly 4% this year. Governments count on economic growth to fund their spending through higher tax revenue. The prospect of a growing tax base also facilitates public sector borrowing. Greece has stopped issuing new debt. The interest rate on resales of its existing 10-year notes is 16%. The country is getting by on borrowings from major international financial institutions. The answers to Greece’s deficit and debt problems lie in three areas. First, there will be continuing austerity measures, unpopular as they may be. These will consist of more government spending cuts, tax increases and pension reform on top of state payroll reductions. Second, existing creditors will be asked to roll over their debt holdings as they come due. They will likely be provided with an incentive in the form of preferred status or collateral. If “suasion” in this form is effective, it will be a means to avoid the term default. Third will be asset sales. Athens owns a great deal of land and other property that can be sold for a nice return. However, a problem for Greece is that its infrastructure lags much of the rest of Europe. There are ambitious plans to improve roads, highways, railways and ports. These initiatives will be essential if the country is to pull itself out of its economic funk. But to do so will require money the government doesn’t have. China In China, Premier Went Jerboa is proposing to build 10 million low-cost homes over the next year. Out to 2015, the increase to the social housing stock will be 36 million units. This homebuilding action plan will serve several purposes. By increasing the supply, it will help deflate the bubble in property prices that has developed. In turn, there will be less incentive for social unrest by those at the lower end of the economic scale. Furthermore, it will provide fiscal stimulus for the economy as a whole. There are implications for international raw material prices. Copper, cement and aluminum will all be in greater demand. Analysts are becoming more vocal in expressing their concern over the Chinese lending model. Local governments (municipal and provincial) are not allowed to issue bonds or borrow money directly. Therefore, they’ve set up financing vehicles to accomplish the task on their behalf. There are estimated to be some 8,000 such entities. The financing vehicles gain access to loans based partly on collateral, but mainly thanks to the backing of government revenue. When it comes to social housing, however, for which prices and rents are specifically designed to be below market rates, the potential for significant defaults is high. It was U.S. efforts to place low-income wage earners into homes that brought on the sub-prime mortgage disaster. The centralized Chinese government does have some advantages. The debt-to-GDP ratio in China is only 19%. Therefore, there is considerable room to handle local banking defaults before Beijing’s debt-to-GDP ratio approaches the U.S. (93%) or Japan (225%). United States As for the U.S. banking sector, a final package on how to deal with homeowners who were too-hastily, or without proper scrutiny, ousted from their properties is close to being finalized. A number of possibilities are being offered, including modest principle re-evaluations, paying for costs incurred by faulty foreclosures and some fines payable to state regulatory agencies. This will no doubt cost the banks, but not to the point where their viability will be put in any doubt. Measures that are likely to hamper the industry to a greater degree are proposed capital requirement revisions under Basel III international financing standards. The amount of capital banks will need to hold in reserve will be raised significantly. For most banks, common equity to risk-weighted assets will move up to at least 7% from a much lower level. But for the largest banks, the ones requiring taxpayer-bailouts in the latest recession, a further increase to 10% or higher is being considered. The largest banks, of which the U.S. has several, are termed the SIFIs – the systemically important financial institutions. This will have three impacts. It will lower the total volume of loans the banking industry will be able to float. It’s likely to raise costs for consumers in the form of higher rates. And it will set up competitive differences between SIFI and non-SIFI institutions. In the meantime, the U.S. government has problems of its own. A $1.6 trillion revenues-to-expenditures shortfall in funding this fiscal year ending September 30, will result in a deficit-to-GDP ratio of 11%. By comparison, Portugal – the third of the three bailed-out nations in Europe, along with Greece and Ireland – recently recorded a 9% deficit-to-GDP ratio. Nevertheless, 10-year U.S. treasuries continue to be acquired by all manner of investors at only 3.00%. There is a great deal of inertia in this market. Problems tend to lie dormant until there is an outcry all at once. A turning point can often occur when unexpected debt comes to the fore. Such was the case in Greece, when it became clear debt was three times greater than had previously been reported. Greater transparency in U.S. capital markets is a significant plus. Canada Canadian banks are not expected to have any problems meeting new international capital requirements. At the moment, several major Canadian banks are pre-occupied with an effort to best the London Stock Exchange in a bid to become owner of the Toronto Stock Exchange. Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News. Mr. Carrick also has a lifestyle blog that can be reached by clicking here.

by Alex Carrick

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