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London banks in doomsday planning

Reports that London-based global banks are playing “war games” to work out what to do if a country quits the eurozone or the currency collapses, is a stark indication that the financial crisis is out of control. Survival is the only item on the agenda as meltdown looms.

The scenario planning coincides with rising political tensions across Europe, with the Franco-German alliance seeking to sideline Britain. Der Spiegel has dubbed Britain the “sick Empire” in advance of today’s meeting between chancellor Merkel and prime minister Cameron. Other right-wing papers and members of her ruling party have stoked up old enmities between the two countries.

Merkel and French president Sarkozy want, it seems, to make Frankfurt and not London the pre-eminent financial centre in Europe. It is hard to see how that squares with the deepening crisis of the euro itself, with Spain and other countries facing unsustainable interest rates on new loans.

Traders are selling bonds (fixed-term loans) as fast as they can. No one wants to be holding Spanish, Italian or anyone else’s debt when the music stops. And stop it will, with Terry Pratt of IG Markets remarking that Spain’s difficulties are “the latest blow to the common currency, which is now looking ever more moribund as each day passes”.

According to the Bank of England, UK banks do about half their lending outside Britain, with Europe accounting for about a third of the total. But it’s their ability to absorb large losses that is in the spotlight. Their exposure to France and Germany alone is equal to 130% of their core capital. At least one lender has Italian exposure equivalent to 54% of capital, according to the Financial Times.

And then there are indirect exposures which no one seems to be able to total up. A UK-based bank may have lent to an overseas hedge fund which in turn is tied up in Greek or Italian bonds. Hence the “war games”, with the FT reporting:

It is Friday night, after stock markets have closed across Europe, and there is some shocking news: Greece has pulled out of the euro. By the time markets reopen on Monday morning, UK banks must be prepared for the worst. How dangerous could this be for other eurozone governments and banks? What would it mean for customers? Investors? Would funding markets freeze instantly? These are some of the war-game scenarios UK bankers are acting out – often in real time over a weekend – as they plan for some grim possible consequences of the eurozone debt crisis.

A new credit crunch is well under way, with inter-bank lending crucial to sustaining the financial system, drying up. As in 2008, the fear is of lending to another institution and then finding they can’t pay it back. This only adds to growing liquidity problems and the UK authorities are apparently monitoring funding levels twice daily.

Not all the FT’s readers are sympathetic about the plight of the banks, with one writing:

Looks like the bank's bonus pools are finally under threat owing to the destruction of the real economy through excessive leverage, reckless mortgage lending based on fraud and deceit, financial speculation and looting. The sooner the banks are nationalised, bonus pools used to invest in the real economy and bank management put in jail the better.

The question is, how do we achieve that goal? Ed Miliband, the Labour leader, has again committed his party to building a “responsible capitalism” and the parliamentary system is a proxy for corporate and financial power. While the bankers do doomsday planning, a strategy for a new political and economic democracy ought to be top of our agenda.

Paul Feldman
Communications editor
18 November 2011

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