Friday, October 07, 2011

Dexia Bank Collapse: What it means for Europe, Belgium and the World

Dexia Bank is among the Top 50 financial institutions in the world. It is not just some small, unknown bank. It is different from other banks because it, and with it, Belgium, are caught in an uncomfortable spot. How? Let me attempt an explanation.
  1. Belgium has external debt to GDP ratio of close to 100% already. The Government thus does not have room for manouevre to fund losses of Dexia. That's already been done once - in 2008, the Belgian Government took control of Dexia. Various arms of Belgian and French Government now hold over 50% in Dexia. This closes off one source of succour. Worse, there is a political standoff in Belgium because of which there is no functioning Government at all at present in Belgium! Worst time for such problems to hit.
  2. Dexia's leverage at present is estimated to be almost 60:1 – double that of Lehman Brothers when its collapse was triggered. So Dexia is not in pretty shape at all. Worse, of its over €500Bn of assets, €20Bn are debts of Portugal, Italy and Greece, all of whom are in need of bailouts.
  3. After the 2008 takeover by the Government, instead of getting better, things got worse, because Dexia was a source of funds for the various parts of Belgium's Government. When they took it over, instead of stopping loans to Government which were the major part of its NPAs, they stepped up lending to Government, which enabled the Government to reduce its fiscal deficit somewhat. Now, if the Government were to bear even a small part of the losses of Dexia, its external debt to GDP ratio will shoot up to almost the level that Italy is at currently (which is 134%). So PIIGS will no longer be a sufficiently comprehensive acronym of European states in deep fiscal trouble. We have to find some way of adding a “B” to it. Just for comparison, US, Australia and India are at 99%, 94% and 22% respectively. France, one of the co-owners of Dexia, is at 208%.
  4. The only time-tested solution for banks or financial institutions in such a mess as Dexia finds itself in is to break up the institution into a “good bank” and a “bad bank” - like India did for Unit Trust of India a decade or so ago. Usually, the bad bank sells the 'bad” assets for anything they can get for it – which could be single digit percentages of the book value. In Dexia's case, this is apparently not feasible because (a) Belgium's Government does not have the money and the political will (there is no functioning government now!) to bail out Dexia because it would mean choking its own source of funding; and (b) “Good bank” assets have not takers almost anywhere in the world today. So the good bank-bad bank solution will not work very well for Dexia. But that is the only solution – so you can expect sell-offs of any saleable assets.

    Already, Reuters reports Qatar as being interesting in buying out Dexia's Luxembourg business. So the dismembering of the Bank has officially begun. The vultures are circling, but then, there aren't too many vultures, this time. Trading has been suspended in Dexia's shares, and S&P has downgraded Dexia's group companies steeply. In its downgrade press release, it notes that there is negative revaluation reserve in respect of available-for-sale securities of almost €6.9 Bn. Moody's has followed S&P in steeply downgrading (by 3 levels) the sovereign rating of Italy, and also some Italian banks in the last 2 days. Besides, 12 UK banks and 9 Portuguese banks have also been downgraded. Sovereign ratings of Spain, Ireland, Greece, Portugal and Cyprus have been cut as well. From the US, Ben Bernanke has said that the US economy is close to faltering. Deutsche Bank has warned that it will miss its profit target.

    One must remember that failing banks are not just like manufacturing or services companies that fail. Banks, as they fail, tear asunder the transaction enablement capability of its citizens. Thus, slitting the banking system's throat is akin to slitting the underbelly of a crocodile – however strong the economy may otherwise be, the banking system is its weakest link. This, all the above news in just a few days is bad news indeed, for the entire world. When banks collapse, other businesses will follow, and depositors will panic, causing a financial logjam in not just those countries, but in all countries where businesses have business ties with enterprises in countries whose banking systems are collapsing.
    In India, our very own SBI has suffered a downgrade because of its low Tier-I capital level that would require it to raise money and/or ask for Government help/ support. So where is the good news? If at all, it is in India where the Government has both, the wherewithal (with some difficulty) and the will and inclination, to support its banks.
    PostScript: This is the text of an email I received. Makes for interesting reading.
    Uncertainty has now hit Japan. In the last seven days, Origami bank has folded, Sumo Bank has gone belly up and Bonsai Bank has announced plans to cut some of its branches. Yesterday, it was also announced that Karaoke Bank will go up for sale and will likely go for a song, while shares in Kamikaze Bank were suspended today after they nose-dived. While Samurai Bank is soldiering on after sharp cutbacks, 500 staff at Karate Bank got the chop and analysts report that there is something fishy going on at Sushi Bank, where it is feared that staff may get a raw deal.


  1. Future is looking very bleak with the way world news are emerging from all corners...There are only two silver linings for India.. One, as you rightly pointed out, the RBI and our strong banking system..Two, our domestic market and its potential offered by millions of self employed population..