Tuesday, 24 April 2012

Brics Banks Better

Perhaps nowhere is Shifting Wealth more visible today than in the banking world, according to an excellent article in the twice-weekly (Swiss) Finanz und Wirtschaft. Western banks are still the biggest when measured by the assets they hold on their balance sheets (with Deutsche Bank in the lead). But the ongoing Eurozone crisis has shown that much of the underlying value is shaky and in particular European banks have to deleverage strongly as they are utterly undercapitalised. The OECD’s excellent Adrian Blundell-Wignall does not tire to raise the alarm clocks on the fragile state of OECD commercial banks.
One of the wonderful ironies of contemporary journalism is that the alarm clocks have been belling since decades on the imminent implosion of Chinese banks. Unlike Lehman & Co, that implosion has not materialised; nor are Chinese banks on LTRO lifeblood support, as most European banks are. 

Ranking Banks Market Capitalisation (end 2011)
Market cap, bn$
China Construction Bank
Wells Fargo
Agricultural bank of China
JP Morgan Chase
Bank of China
Ita├║ Unibanco
Source: Finanz und Wirtschaft, 7.3.2012

The investors (who have just been burned by Western bank share declines) think that BRIC banks hold more value (see the table for current market capitalisation). Only in 2005, the ranking of top bank market capitalisations held just Western banks. The high market capitalisation of Bric banks compared their assets may be justified, for three reasons: high profit growth, high margins, low default risk. The graph on bank capital returns does indeed suggest that emerging market banks are safer and generate a higher return on equity than do G7-based banks.

Return on Bank Capital

Source: Finanz und Wirtschaft, 7.3.2012

There are plenty of reasons for that. Public debt dynamics are much more favourable in emerging countries than in OECD countries, which translates into lower default risk on bank claims on public entities. The rising middle class generates rising savings, which provide low-cost funding to banks even if financial liberalisation will raise the interest rates on private savings. And emerging market banks are safer and more transparent than many Western banks (Deutsche Bank shares, anyone?) as the share of investment banking is much lower.
A final observation. While Europe and the US had to nationalise banks notwithstanding their ideological priors, emerging-country banks have traditionally been either in public ownership or strongly directed by the public authorities. China’s government is majority owner of China’s four biggest banks, in India two out of four of the biggest banks are public; in Russia, the central bank is the majority owner of big banks such as Sberbank.  The linkage between state and banking is very close in emerging countries, for industrial and other structural policies; that can generate losses, to be sure. But it can support growth, helping a safer asset base, while prudent bank risk management is a necessary collorary to industrial policy.

Monday, 16 April 2012

PBoC sets the RMB free and it ... falls

 People’s Bank of China (PBoC) announced over the weekend that, effective on April 16, 2012, the RMB daily trading band would be widened to ±1% from current 0.5%. That is, the RMB against the USD can be traded in the interbank market within a 1% band around the daily opening fixing price. Meanwhile the allowable maximum daily bid-ask spread for client trades is also widened, from 1% to 2%. This is the first time the PboC has announced a new trading band since May 21, 2007, when PBoC widened the daily trading band from 0.3% to 0.5%.

For many mainstream economists, the US Treasury and for the French Presidential candidates the RMB is strongly undervalued. So there was mainstream welcome to the flexibilisation announced over the weekend. The expectation, to be sure,  was that the Chinese currency would now appreciate faster than it did in the past and hence help improve competitiveness elsewhere.

Widening the RMB daily trading band will help deter “hot money” inflows because it will introduce higher volatility. I think a flexible RMB will make one-way bets more difficult, so that's a good thing, as the currency will find its equilibrium value more easily. I actually reckon that the RMB is now quite close to that equilibrium value, based on our recent estimates (1) and the subsequent real effective appreciation of the RMB.

The RMB displayed greater volatility this morning but steered clear of testing a newly expanded trading band, suggesting investors were comfortable with the current range as Beijing tries to guide the economy through a controlled cooldown. At its weakest point early this morning, the currency traded at 6.3250 per dollar - 0.46 percent weaker than the midpoint and 0.3 percent weaker from Friday's close - just within the previous 0.5 percent limit and well shy of the new 1 percent band that went into effect Monday.

(1) Garroway, C., B. Hacibedel, H. Reisen and E. Turkisch (2012), "The renminbi and poor-country growth", The World Economy, Vo.35.3, pp. 273 - 294, March.