Adam Smith Institute

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EU banks – The LIBOR forward indicator

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Recently, LIBOR (the London Interbank Offered Rate) has spiked again – though less seriously than pre the crash of Lehmann Brothers in 2008. Given that LIBOR is seen as a lead indicator, there is real concern about the financial health of many EU banks. The hasty banning of some short-selling in Germany has actually created further alarm rather than promoting confidence.

Central to the deep-seated problems in Europe is the euro, which operates in countries with vastly different economies. The strain exerted by the Greek crisis, and the real risk of contagion that may well reach a major player, such as Spain, continues to spook the market.

Seemingly, as more money is set aside to defend the euro, the more nervous the markets become.

Whether eurozone countries separate into two groups or some countries simply drop out is not clear. Germany could eventually go it alone with a strong currency whilst its banks take a major haircut. Or the ClubMed group could decide it simply cannot hack it in the eurozone.

Given all the political confusion and the massive financial deficits that many EU countries have piled up, renewed fears about the banking sector are no surprise. However, following the effective collapse of such UK banks as Royal Bank of Scotland and Lloyds, notwithstanding the carnage less than two years ago on Wall Street, everyone is now better prepared.

But real risks remain, both in terms of sovereign debt and the viability of banks. Even after the injection of £45.5 billion of taxpayers’ money, RBS is currently worth just £26 billion. And in Spain, many small Caja banks are in desperate straits.

Undoubtedly, banks are now hoarding cash as the recent LIBOR data indicates. Sovereign debt concerns in the EU deepen as unprecedented efforts are made to save the euro. Where will it all end?