“Given the risks to the outlook, I consider it appropriate for the [Federal Open Market] Committee to proceed cautiously in adjusting policy,” Fed Chair Janet Yellen told the Economic Club of New York Tuesday, citing slower growth in the US and China and weak commodity prices. Her opposite number at the European Central Bank, Mario Draghi, knows better: on March 10 he announced that the ECB would buy corporate bonds to continue quantitative easing, the first time a major central bank has put large amounts credit risk on its balance sheet in living memory.
Draghi feared a collapse of confidence in Italian banks, who in turn own 405 billion euros of Italian government debt, or more than a fifth of the total. The trouble is that the Italian banks probably are insolvent by a wide margin. Non-performing loans stood at about 18% of Italian banks’ total loans at the end of 2014 and the total probably has increased since then.
The Fed’s threat to raise US interest rates sent world stock markets into a tailspin during the first six weeks of the year. Markets snapped back after the US, European and Japanese central banks responded with monetary ease and the promise of more. The central banks are right to worry. The European banking crisis of 2012 was never resolved, just swept under the carpet. It threatened to erupt again in February.
Nonperforming assets are larger than shareholders’ equity in all the top four Italian banks. The basket case is Monte dei Paschi, the third-largest private commercial bank, with non-performing assets at more than 500% of equity. Depending on recovery value, Unicredito and Intesa San Paolo, the two largest banks, might be solvent, presuming that they aren’t lying about their non-performing assets. By contrast, Bank of America and Citigroup have non-performing assets valued at 3% to 4% of their equity.
Chinese banks–the subject of endless scrutiny by foreign analysts–reported nonperforming loans of just 1.6%, and the Hong Kong brokerage house Reorient Group estimated NPL’s at 4.2% of bank assetsin a recent report.