According to the ECB, banks in the euro area only made ?21 billion in write downs from August 2007 to the end of February 2008 (9.5 % of their total asset level of ?22 trillion), and they have been able to raise capital enough to deleverage 8 percentage points and compensate most of them.
-Some euro area banks have created, with the approval or consent of their supervisors, off-balance sheet vehicles that proved to be riskier than their rating, so both asset-backed securities commercial paper markets have been drying up since August 2007, falling by more than $450 billion.
These off-balance sheet vehicles (SIV and other conduits), which were created with minimum capital, were borrowing short in the asset-backed securities commercial paper market both in the United States and Europe and investing long in asset-backed securities and other instruments; the purchased assets were used as collateral.
For example, although the ABX HE index is not a very reliable source of valuations given that transactions are small and few, the fall in their values is remarkable. After an improvement in the indexes during April and May, today, triple A asset-backed securities has fallen from 100 in January 2007 to less than 50, double A has fallen to less than 10, single A to less than 7 and triple B to 5. That trend means that banks write-downs may continue for some time, because subprime credits are increasingly defaulting as every year there is a new reset of their interest rates upwards (teaser rates), and in 2008 it will affect $280 billion of them.
-As banks are unable to refinance these investing vehicles in the capital markets, they may be forced to put them back into their balance sheets.
It is estimated that if all these vehicles were to be reincorporated into the euro area banks balance sheets, their regulatory capital would fall by more than 1 percentage point, from 8% to 7% of total eligible assets and therefore, if no capital were raised -highly improbable - credit would have to be reduced by 12%.
Neither a crunch nor a squeeze
Nevertheless, for the time being, seasonally adjusted annual credit growth in the euro area keeps slowing down rather slowly.
According to the June ECB report on bank lending, the annual growth rate of total credit to the private sector fell from 12.2 % in March to 12.0% in April and to 11.9% in May. Lending annual growth rate to private sector companies fell from 10.8% in March to 10.6% in April and to 10.4% in May. Annual growth rate of loans to non-financial corporations decreased to 14.2% in May from 14.9% in April. Annual growth rate of loans to households fell from 5.4% in March to 5.2% in April and to 4.9% in May.
