You would expect that to happen, given the way that banks both provide financial support to governments and are supported by them (as I discussed yesterday).

To repeat: banks are encouraged by financial regulation to be big investors in government debt or bonds, so are exposed to substantial losses as and when there's a risk of the relevant governments failing to repay all they owe; in extremis, a bank's liabilities are guaranteed by the state, but that guarantee isn't terribly valuable as and when the state itself is perceived to be in danger of going bust.

So with the governments of two big economies, Italy and Spain, finding it harder and more expensive to borrow, it would make sense for there to be evidence of increasing stress in the banking system. Is there evidence of such stress?

Well, data published by the European Central Bank suggests there is. The indicators show twin related trends: on the one hand, banks are finding it harder to borrow from each other and from financial institutions, and are therefore having to borrow more from the European Central Bank to stay afloat; and the stronger banks are showing a preference for parking their cash at the European Central Bank, rather than lend to the weaker banks.

So, for example, the European Central Bank yesterday provided 247bn euros of seven-day loans to eurozone banks, in what's known as its Main Refinancing Operation - which is the most it has lent in this way since 17 June 2009, when it lent 310bn euros.

In normal, relatively unstressed markets, the ECB would provide between 50bn euros and 150bn euros of week-long loans. So 247bn shows that banks are having difficulties borrowing from normal commercial sources. That said, stress levels are slightly below red on the alert scale: for seven weeks in the autumn of 2008, at the height of the banking crisis, the ECB provided well over 300bn of this finance.

Or to put it another way, we have not - at this juncture - returned to the dysfunctional market conditions of the world after Lehman. Then there are the figures for how much banks are lending to the ECB, as opposed to borrowing from it - and these too are elevated.

On Monday, banks deposited 235bn with the central bank, compared with under 50bn that you would expect in normal times. When a bank decides to park cash with a central bank, it is valuing the certainty of getting its money back above the additional rewards available from lending its cash to other banks: it only gets 0.5% interest from the ECB, compared with at least twice that from lending the money elsewhere.

So it is not a healthy sign when banks want to lend to the ECB. For what it's worth, however, this indicator of banks' anxiety was worse earlier in November, when they deposited 299bn euros at the central bank.

The final indicator of stress worth examining is the use of the Marginal Lending Facility, which is a way for banks to borrow overnight from the ECB when they're unable to reconcile their borrowing and lending needs at the end of the day. Again, it is not a good sign if banks can't manage their day-to-day financing needs without a bit of last-minute help from the central bank: it is not good banking practice to live hand-to-mouth in this way.

On Monday, eurozone banks borrowed 2.4bn euros overnight - which may not sound like much, but when markets are calm, use of this overnight facility drops well below 100m euros. This measure shows that bank stress has been rising pretty significantly from mid September onwards. On 23 October, overnight borrowing peaked at 4.6bn euros.

What does it all mean?

Well, it is moot whether what may eventually force eurozone leaders into bold, evasive action to solve the eurozone crisis is a run on a government, or a run on banks, or some combination of the two.

Update 09:30: Data just released by the ECB shows that on Tuesday eurozone banks deposited 231bn euros with the European Central Bank, a tiny bit less than on Monday but still high. And, also on Tuesday, eurozone banks borrowed 2.6bn euros of overnight money, a little more than on Monday.

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AUSTRALIA'S central bank will provide a facility to ensure commercial banks have enough cash in times of financial crisis. The Committed Liquidity Facility (CLF) is part of Australia's response to the Basel III reforms, a new set of international banking standards being implemented to avoid a repeat of the 2008 global financial crisis.

Reserve Bank of Australia assistant governor (financial markets) Guy Debelle today gave more details on the facility, announced last week.

He told the Australian Prudential Regulation Authority Basel III Implementation Workshop 2011 the main implementation issue for Australia was a marked shortage of high-quality liquid assets outside the banking sector (that is, not liabilities of the banks).

Most countries adopting the Basel III proposals are requiring banking institutions to have sufficient high-quality liquid assets, such as government bonds, which they can sell when they need funds.

But with Australia's low level of government debt, that approach is not feasible, so the RBA, instead, will create the CLF. "At the moment, the gross stock of commonwealth debt on issue amounts to around 15 per cent of GDP (gross domestic product), state government debt (semis) is around 12 per cent of GDP," Dr Debelle said.

"These amounts fall well short of the liquidity needs of the banking system."He said the Basel standard included balances with the central bank in its definition of high-quality liquid assets. Plus, he said, the RBA and APRA would also allow banks to use other high-quality liquid assets.

"Thus, to reduce the likelihood of systemic risk, a bank will be able to hold some share of its liquid assets in the form of self-securitised mortgages. "There is a trade-off here between systemic risk and reduced market liquidity of the banks' asset holdings, but the bank will have access to liquidity from the RBA with these assets," Dr Debelle said. "While these reforms are not costless to comply with, the benefits of a stable banking system are considerably larger."

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Britain cut all financial ties Monday with Iran over concerns about Iran's nuclear program, the first time it has ever cut an entire country's banking sector off from British finance, the British Treasury announced.
The move comes days after an International Atomic Energy Agency report highlighted new concerns about "the possible military dimensions of Iran's nuclear program," the Treasury statement said Monday.
The IAEA's governors approved a resolution last week expressing "deep and increasing concern about the unresolved issues regarding the Iranian nuclear program. Iran insists its nuclear program is peaceful and has called the U.N. watchdog's report "unbalanced" and "politically motivated."

"The IAEA's report last week provided further credible and detailed evidence about the possible military dimensions of the Iranian nuclear program," British Foreign Secretary William Hague said in a statement. "Today we have responded resolutely by introducing a set of new sanctions that prohibit all business with Iranian banks."

U.S. Secretary of State Hillary Clinton and Treasury Secretary Tim Geithner will "outline new steps the United States is taking to increase pressure on Iran" on Monday afternoon in Washington, the State Department said.

The United States will name Iran, as well as its central bank, as a "primary money-laundering concern" but will not place sanctions directly on the central bank, a senior Treasury Department official told CNN.
The Obama administration plans to impose fresh sanctions against Iran's petrochemical industry, diplomatic sources familiar with the plans said Friday. U.S. sanctions already prohibit American companies from doing business with Iran.

The British sanctions underline "the severity of the government's concerns about Iran's activities," the statement issued by Britain's chancellor of the exchequer said. All British credit and financial institutions must end their business relationships and transactions with all Iranian banks, their branches and subsidiaries by Monday afternoon, it said.

"Iran's activities that facilitate the development or production of a nuclear weapon pose a significant risk to the national interests of the UK and countries across the region," it said. "Iranian banks play a crucial role in providing financial services to individuals and entities within Iran's nuclear and ballistic missile programs, as companies carrying out proliferation activities require banking services."

The chancellor's statement said other "partner countries" will make similar announcements about banking sanctions against Iran. "We believe that the Iranian regime's actions pose a significant threat to the UK's national security and the international community," Chancellor George Osborne said. "Today's announcement is a further step to preventing the Iranian regime from acquiring nuclear weapons."

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Ari Ben-Menashe, the lobbyist whose dealings prompted Canada’s top spy watchdog to resign last week, is about to lose his banking privileges in Canada after a judge refused to intervene Friday.

Quebec Superior Court Justice Richard Nadeau began proceedings by declaring “What a strange case” before eventually ruling that the Canadian Imperial Bank of Commerce was within its rights to sever its relationship with Mr. Ben-Menashe.

“In this case, you’re asking me to force the bank to do business with your client,” Justice Nadeau said to Mr. Ben-Menashe’s lawyer, Neil Peden. Under the terms of a banking contract, a bank is entitled to end the relationship without explanation as long as it gives reasonable notice, the judge found. “It’s contract law, pure and simple.”

Mr. Peden told the court Mr. Ben-Menashe recently learned he is on an international list of “politically exposed” people maintained by the London-based company World-Check. World-Check’s private database is used by banks and law-enforcement agencies to prevent “financial crime and corruption,” according to a company news release.

The blacklisting would explain why, in addition to CIBC, all other major Canadian banks have refused to do business with Mr. Ben-Menashe. The Caisse Desjardins du Québec this month informed him it “has information that you are a politically exposed foreign person within the meaning of the Proceeds of Crime and Terrorist Financing Act.” The Caisse also alleged that he was involved in arms trafficking.

CIBC provided no reason when it advised Mr. Ben-Menashe in September that it planned to close his chequing and credit card accounts on Nov. 29. He had opened the accounts in October 2010 after the Bank of Montreal closed his accounts, also without explanation.

Mr. Ben-Menashe was seeking a safeguard order Friday that would have forced CIBC to keep his accounts open until his request for an injunction could be heard. He can still proceed with the injunction, which would order CIBC to maintain a banking relationship with him, but that will likely take months to be heard.

In an affidavit supporting his request, Mr. Ben-Menashe attributed his banking troubles to a soured business deal with Arthur Porter, who quit last week as head of Canada’s Security Intelligence Review Committee. Dr. Porter had wired Mr. Ben Menashe $200,000 from his personal account as part of a deal aimed at raising $120-million in infrastructure projects in Sierra Leone. The deal fell apart in October 2010, and Mr. Porter’s money was returned. “Very shortly after that,” Mr. Ben-Menashe stated, the Bank of Montreal informed him it no longer desired his business. This, Mr. Ben-Menashe claimed, was “directly related to the business dispute I was having with Dr. Porter.”

François Giroux, the lawyer for CIBC, described the allegation that Dr. Porter was involved as “a conspiracy theory that is just sketched out.” In an affidavit filed in the bank’s defence, Suzie Scherrer, CIBC’s director of corporate security, referred to Mr. Ben-Menashe’s 1992 book Profits of War: Inside the Secret U.S.-Israeli Arms Network, to justify why dealing with him represented a “reputational risk” for the bank.

She said the fact that Mr. Ben Menashe’s account regularly received deposits wired from a third-party bank in the United States “would make any efficient verification of Ben-Menashe’s account activity at CIBC difficult.”

Justice Nadeau said of Mr. Ben-Menashe: “It seems this person has had a very interesting life, to put it mildly.” Mr. Peden argued that Mr. Ben-Menashe finds himself on a secret list with no recourse for removing his name. “Maybe there is a reason why your client is on a black list,” the judge said.

Mr. Ben-Menashe said the ruling means banks can do whatever they please. “Basically they’re telling me to leave Canada,” he said.

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China's banking regulator warned lenders that some projects backed by local governments may run out of funds, and loans to property developers are likely to sour as sales slow, a person with knowledge of the matter said.

The China Banking Regulatory Commission told lenders last week to step up asset sales and debt restructuring for unprofitable local government financing vehicles that are struggling to repay loans, the person said, declining to be identified as the instructions were private. The watchdog also said banks should cut “high-risk” loans to developers, the person said.

China's banking regulator tightened capital requirements and clamped down on off-balance sheet assets this year. Still, the International Monetary Fund this week called for closer oversight of the banks as risks increase. Home sales plunged 25 per cent in October from the previous month. Industrial & Commercial Bank of China Ltd. and its three biggest local rivals have lost about $71 billion in market value this year.

“The government is still very careful about the property market as it doesn't want volatility in housing prices,” Ivan Li, deputy head of research at Kim Eng Securities Hong Kong Ltd., said by telephone today. “You can see there are pressures building up: The government is worried that some developers may shut down, triggering defaults on bank loans.”A Beijing-based press official for the banking watchdog said he couldn't immediately comment.

Cooling speculation
Premier Wen Jiabao's battle to lower housing prices in China began in April last year, when the cabinet raised minimum mortgage rates and down-payment ratios for some home purchases, saying “more forceful” steps were needed to cool speculation. Authorities tightened the rules further this year and imposed housing purchase restrictions in about 40 cities. Home prices may fall as much as 30 per cent in the next year, Barclays Plc's research unit said last week. They had risen by 140 per cent from 1998 to the end of last year, according to the national statistics bureau.

Wen said during a Nov. 7 visit to Russia that the country won't waver on its property market curbs.
The CBRC told lenders to visit developers that have borrowed money, the person said. The watchdog expressed concern that property companies have raised additional financing from non-bank lenders, trusts and bond sales, which may curtail their ability to make repayments on bank loans, the person said.
Improper Funds

The regulator said some developers have used projects funded by such bank loans to improperly raise funds from trusts, which may trigger “major credit risks,” according to the person. Property loans that need to be restructured should be classified as “substandard” at a minimum and downgraded, the watchdog said.

“Despite ongoing reform and financial strength, China confronts a steady buildup of financial sector vulnerabilities,” the Washington-based IMF said in its first formal evaluation of the Chinese system on Nov. 15. Banks need to upgrade risk-management systems, and the central bank and regulators should add skilled personnel and disclosure standards must be raised, the IMF said.

ICBC and its three closest local rivals, which are among the world's eight largest banks by market value, have declined an average 21 per cent in Hong Kong trading this year. Investor concern has mounted that defaults by small companies, developers and local governments will climb and endanger growth in the world's second-largest economy.

Loan inspections
The CBRC last week told banks to inspect loans to local government financing vehicles, 35 per cent of whose debt matures in the next three years, the person said. Local governments, previously barred from directly selling bonds or borrowing from banks to pay for projects including roads and bridges, set up more than 6,000 financing vehicles and amassed 10.7 trillion yuan ($1.7 trillion) of debt by the end of 2010, with 80 per cent owed to banks, the National Audit Office said in a June report.

Premier Wen had ordered the first audit of local-government borrowing in March, amid concern spending designed to support the economy following the 2008 global financial crisis would leave a legacy of bad debt.

The regulator warned last week that some local governments are circumventing regulatory restrictions and raising funds by using companies that aren't classified as financing vehicles, the person said.
The banking regulator said it will also stop approving the sale of wealth-management products with maturities of one month or less, the person said. That move was reported earlier by 21st Century Business Herald, which cited unidentified people.

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China needs to revamp its banking system so that it relies more on market mechanisms, such as interest rates, to head off a "steady build-up of financial sector vulnerabilities," the International Monetary Fund said, in its first broad review of China's financial system.

While the IMF applauded what it called Beijing's "remarkable progress in its transition toward a more commercially-oriented and financially sound system," it said in a review publicly released on Tuesday that Beijing's financial system still depended too much on the state for direction. The state all but guarantees profits to big state-owned banks by barring them from competing for deposits and setting lending rates well above deposit rates.

The result, the IMF said, is a system that tilts heavily to state-owned firms, encourages over-investment and creates asset bubbles, especially in real estate. Citing work by other economists, the IMF said that since 2001 China invested 40% more for every $1 of GDP created than Japan and South Korea did when they were at a similar stage of development. "The cost of these distortions is rising over time, posing macro-financial risks," the IMF warned.

China's central bank on Tuesday said it found the overall report to be constructive but lodged objections to timeline and sequence of the IMF's suggested reforms.

A few points in the report "are not sufficiently comprehensive or objective," the People's Bank of China said in a statement, adding that "the time frame and suggested priorities of some proposed reform measures need to be further analyzed."

The PBOC didn't specify what specific reform suggestions it was objecting to, but it said that interest-rate and exchange-rate reform have already "made significant progress." The concrete timetable for such reforms should remain flexible based on the country's situation, it said.

In its report, the IMF listed interest-rate and exchange-rate reform as "high" priorities to be achieved in the medium term, which it defines as within three to five years.

The IMF review, called the Financial System Stability Assessment, was largely a snapshot of the Chinese financial system at the end of 2010, when work on the report concluded. It took many months for China to approve publication of the report–different from the IMF's annual review of China's economy, which was completed in June and published in July. Chinese authorities blamed the assessment's publication delay on the need to get approvals from different financial agencies reviewed.

There may have been political reasons too. The IMF, for instance, criticized China's financial-crisis management system because it reported to the State Council, the country's top government body. In effect, that meant that the state could be counted on to bail out the country's largest banks, thus reducing the banks' incentive to make prudent decisions. "This implies significant moral hazard," the IMF said, financial lingo for an institution not having to worry about the consequences of its decisions.

But the China Banking Regulatory Commission was wary of criticizing its bosses in the State Council or seeking more independence. Reporting to the council "serves as a check and balance on the CBRC and other government agencies to exercise authority in accordance with the law," the CBRC said in a response included in the IMF report.

The IMF said it conducted basic stress tests of the 17 largest commercial banks, in conjunction with the People's Bank of China and CBRC and found that they "appear to be resilient to isolated shocks," including a sharp deterioration in real-estate markets or changes in the exchange rate. "If several of these risks were to occur at the same time, however, the banking sector could be severely impacted," the IMF said, though it said its analysis of such a possibility was hindered by lack of data.

"The notion of China having a solid banking system is based on a set of indicators that clearly present only a partial picture," said Eswar Prasad, a China expert at the Brookings Institution, in an email. "That the Chinese banking system gets so few unsatisfactory (materially noncompliant) ratings conveys a sanguine picture about banking system stability that belies the reality."

Stress tests of the effect of a real estate downturn appeared to be conducted by a team from the PBOC and CBRC. A 30% decline in property prices, the regulators found, would have only a "minimal impact" on banks' capital buffer. The report estimated that banks' nonperforming loans were just 1.1% at the end of 2010.

Since the IMF conducted its review of the financial sector, some of the issues it discussed are coming to fruition. Property prices in major cities are headed downward, with some analysts forecasting that they may drop 30%. The spree of lending following the 2008 financial crisis to bolster economic growth is widely expected to boost the level of nonperforming loans, especially by local governments. Off-balance-sheet lending, which is harder to track, is growing.

To deal with such problems, the IMF recommended "deepening the commercial orientation of banks and other financial firms," and boosting China's ability to deal with crises. "A designated government entity should be vested with resolution powers" to deal with firms that are judged to be beyond saving, the IMF said.

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Europe’s banks need to keep dumping Italian bonds and other assets tainted by the region’s debt woes to avoid being sucked into the epicenter of the crisis, said Christian Clausen, president of the European
Banking Federation.

“The banks are doing exactly what they should be doing: they are reducing their risk toward this event. We can see that clearly as now Italian bonds are being sold off,” Clausen, who is also the chief executive officer of Nordea Bank AB (NDA), said in an interview in Stockholm. “They should keep doing what they are doing. The banks are actually moving out of the epicenter.”

The yield on Italian 10-year bonds surpassed 7 percent last week, the level that prompted Greece, Ireland and Portugal to seek bailouts, as investors fled the third-largest euro economy and its 1.9 trillion-euro ($2.6 trillion) debt burden. Europe’s banks are offloading assets infected by the debt crisis to meet stricter capital rules, said Clausen of the Brussels-based EBF, which represents Europe’s national bankers associations.

Lawmakers in Rome this weekend passed budget cuts to reduce Italy’s debt, which the European Commission estimates reached 120.5 percent of gross domestic product this year. Tensions over the austerity bill toppled Prime Minister Silvio Berlusconi’s government and will see in an administration likely to be led by former European Union Competition Commissioner Mario Monti.

Europe’s banks will need to raise 106 billion euros in fresh capital under tougher rules being introduced in response to the euro area’s sovereign-debt crisis, the European Banking Authority said last month. The extra reserves are needed to meet a temporary requirement for lenders to hold 9 percent in core reserves, after sovereign-debt writedowns.

CoCos for All
Banks’ “actual holdings in bonds” sold by Europe’s most indebted sovereigns “have come down quite dramatically,” Clausen said in the Nov. 10 interview. “The banks are raising capital, they are holding back retained earnings, all kinds of things.”

Clausen said it’s likely that Europe’s banks will make broad use of hybrid capital to meet tougher regulatory requirements. Contingent convertible bonds that convert to equity when banks’ reserves slip below a given level, or CoCos, will become a standard feature of banks’ balance sheets, he said.
“All banks will have to do that. This will be all over,” he said. “There will be core capital and then extra capital. All banks will have to add in other types of capital.”

The political response to the debt crisis so far shows there is a determination to keep the currency bloc intact, Clausen said. Still, the unraveling of governments in Greece and Italy amid opposition to austerity programs presents a risk to the integrity of the single currency bloc, he said.

Euro Risk
“I don’t think, for now, there is a euro risk, as such,” Clausen said. “But there is a risk that if the governments don’t start to really work on this, there might be a real euro risk at the end.”In Sweden, home to Nordea, regulators want banks to adhere to tougher requirements than those targeted elsewhere. The largest Nordic country should impose higher capital requirements than most European countries because its bank industry is more than four times the size of the nation’s economy, Financial Markets Minister Peter Norman said in an interview. The spread of Europe’s debt crisis to Italy underlines the need for bigger buffers to guard against losses, he said.

If the Italian “crisis affects, for example, French banks, the banks are so entangled that it will affect Swedish banks,” he said. “It is important for the Swedish taxpayers to have higher capital requirements than the rest of Europe.”

‘No Bank Is Bulletproof’
Sweden’s four biggest banks, Nordea, Svenska Handelsbanken AB, SEB AB and Swedbank AB, should have core Tier 1 capital ratios that are “a few percentage points more” than the 10 percent minimum Sweden is targeting by 2013, Lars Frisell, the chief economist at the country’s financial watchdog and a member of the Basel Committee for Banking Supervision, said in an Oct. 24 interview. “No bank is bulletproof these days, but they are much better prepared than they were back in 2008,” said Jan Erik Gjerland, an analyst at DNB ASA in Oslo.

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HSBC Holdings Plc, Europe’s largest bank by market value, said investment banking profit fell in the third quarter amid Europe’s sovereign debt crisis and posted higher bad-debt provisions for its U.S. unit.

Pretax profit at the investment bank, led by Samir Assaf, fell 53 percent to about $1 billion in the third quarter from a year-earlier, London-based HSBC said in a statement yesterday. Bad loan provisions increased to $3.89 billion from $3.15 billion, a rise attributed to its U.S. unit, the bank said. The shares fell.

HSBC has so far set aside more than $65 billion for souring loans in North America following its purchase of U.S. subprime lender Household International in 2003. This quarter’s increase in loan impairment charges is a consequence of foreclosure moratoriums in some U.S. states, Finance Director Iain Mackay told journalists yesterday. HSBC, like Barclays Plc and Royal Bank of Scotland Group Plc, also recorded a slowdown in revenue from investment banking amid volatile European markets.

“The big humdinger, which has caught everybody on the hop, is the bad debt charge,” said Christopher Wheeler, a London- based analyst with Mediobanca SpA. HSBC made provisions against its Household business at the onset of the financial crisis in 2006, Wheeler said. “Here we are again, doing the same thing.”

HSBC fell 5.8 percent to 506.3 pence in London yesterday, the eighth-worst performer in the Bloomberg Europe Banks and Financial Services index, valuing the bank at 90.4 billion pounds ($144 billion).

‘Significant Headwinds’

Bad loan provisions in the U.S. rose 21 percent to $2.39 billion, as HSBC yesterday warned of “pressure on future credit performance” in the U.S. and “further house price weakness” as more properties come onto the market. The bank has about $50 billion of U.S. subprime mortgages in runoff, Mackay told analysts yesterday.

“We are unable to foreclose on a broad base of customers who are delinquent,” Mackay said. “If they stop paying there’s very little we can do in terms of foreclosure. People are taking payment holidays” because “their bank cannot foreclose on them.”Bad loan provisions in Hong Kong rose to $112 million from $35 million, the company said.

The pick-up in Asian loan impairments could have a “negative read across” for Standard Chartered Plc, Credit Suisse Group AG analysts including London-based Amit Goel wrote in a note to clients yesterday. Standard Chartered, which earns most of its profit in Asia, fell 2.6 percent to 1377 pence in London.

Headwinds

The banking industry also faces “significant headwinds” because of continuing political, regulatory and macroeconomic uncertainty, especially in Europe, Chief Executive Officer Stuart Gulliver said. Investment banking revenue declined 19 percent to $3.5 billion because of its credit and rates business in Europe.

“Our fixed income business was very directly impacted by the uncertainty in the euro zone and to a lesser extent some of the events in the U.S. in the third quarter relating to the debt ceiling,” Mackay said. These lines of the business “will continue to be stressed for some period of time,” he said.

RBS, the U.K.’s biggest government-controlled bank, last week said third-quarter investment-banking revenue slipped 29 percent to 1.1 billion pounds from a year-earlier. Barclays said revenue at its Barclays Capital investment banking unit fell 15 percent to 2.25 billion pounds when it reported earnings on Oct. 31.

‘Softer End’

HSBC’s net trading income fell to $106 million from $1.39 billion, the company said. The lender’s cost-efficiency ratio for the nine-month period, minus a gain from its own debt, worsened to 59.1 percent from 54.4 percent a year-earlier.

The bank is seeking to meet the “softer end” of its target range for cost-efficiency of 48 percent to 52 percent by 2013, and a return on equity of 12 percent to 15 percent, Gulliver told analysts on a conference call yesterday.

The anticipated $2.4 billion joint cost of the U.K. bank levy on their foreign operations and the Independent Commission on Banking’s proposals is “too high,” Mackay said. HSBC would probably not be in a position to decide on whether to relocate its headquarters for at least another 12 to 18 months, Gulliver, said. “This is a non-trivial decision,” he said. “You don’t move your head office on a regular basis.”

Shield Taxpayers

Britain’s Chancellor of the Exchequer George Osborne has pledged to implement the ICB’s proposals by 2019. The plans, aimed at shielding customers and taxpayers from another financial crisis, may cost the industry as much 7 billion pounds, according to the ICB.

The bank’s net investments in the sovereign debt of Greece, Ireland, Italy, Portugal and Spain fell 33 percent to $5.5 billion, from $8.2 billion in June.

“The outlook for the global economy is very challenging as problems in developed markets begin to affect growth rates around the world,” the company said. “Faster-growing markets clearly possess significant potential for growth, however, and continue to offer attractive business opportunities.”

Net income increased 66 percent to $5.22 billion from $3.15 billion a year-earlier, lifted by $4.1 billion gain on the value of its own debt, the lender said. That beat the $3.84 billion median estimate of eight analysts surveyed by Bloomberg.

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BNP Paribas SA and Commerzbank AG are unloading sovereign bonds at a loss, leading European lenders in a government-debt flight that threatens to exacerbate the region’s crisis.

BNP Paribas, France’s biggest bank, booked a loss of 812 million euros ($1 billion) in the past four months from reducing its holdings of European sovereign debt, while Commerzbank took losses as it cut its Greek, Irish, Italian, Portuguese and Spanish bonds by 22 percent to 13 billion euros this year.

Banks are selling debt of southern European nations as investors punish companies with large holdings and regulators demand higher reserves to shoulder possible losses. The European Banking Authority is requiring lenders to boost capital by 106 billion euros after marking their government debt to market values. The trend may undermine European leaders’ efforts to lower borrowing costs for countries such as Greece and Italy while generating larger writedowns and capital shortfalls.

“European regulators and leaders are shooting themselves in the foot because a big investor group for sovereign bonds has been taken out of the market,” said Otto Dichtl, a London-based credit analyst for financial companies at Knight Capital Europe Ltd. “The downward spiral will continue until policy makers find a back-up solution for the sovereigns.”

Barclays, RBS

European banks cut their foreign lending to the Greek public sector to $37 billion as of June 30 from $52 billion at the end of 2010, according to the most recent data from the Bank for International Settlements. European banks’ lending to the Irish, Portuguese and Spanish public sectors also fell, according to Basel, Switzerland-based BIS.

Financial companies can reduce risk through writedowns, sales and hedges, as well as by letting bonds mature.

Barclays Plc, the U.K.’s second-largest bank by assets, said on Oct. 31 that it cut sovereign-debt holdings of Spain, Italy, Portugal, Ireland and Greece by 31 percent in three months. Royal Bank of Scotland Group Plc, Britain’s biggest state-controlled bank, said on Nov. 4 that it reduced central- and local-government debt of those countries to 1.1 billion pounds ($1.8 billion) from 4.6 billion pounds at year-end.

Italian Yields Climb

Greek bonds have dropped 42 percent since July, the most among 26 sovereign-debt markets tracked by Bloomberg/European Federation of Financial Analysts Societies indexes. Italian debt declined 8 percent and Portuguese securities 5 percent, the indexes show.

Italian benchmark yields climbed to a euro-era record yesterday on concern that the region’s third-largest economy will struggle to manage its debt as growth stagnates.

European leaders are demanding that banks raise capital to increase their resilience after firms represented by the Institute of International Finance agreed last month to accept a 50 percent loss on Greek sovereign holdings to help tackle the debt crisis. Policy makers also announced plans to boost the region’s rescue fund to 1 trillion euros.

The EBA examined how much capital the region’s biggest lenders would need to reach a core Tier 1 ratio of 9 percent by the middle of next year after marking their sovereign holdings to market, an exercise omitted during bank stress tests in July. Most major European countries’ sovereign debt was considered risk-free in the past.

‘Damp Squib’

“The recapitalization of European banks is also turning out to be a damp squib,” according to a Nov. 6 note from CreditSights Inc. “This does nothing to fix the main problem of restoring sovereigns’ risk-free status.”

Forcing Europe’s lenders to boost capital based on sovereign markdowns “will cause a number of serious problems,” the IIF, a Washington-based group representing more than 450 financial firms, warned in a letter to French President Nicolas Sarkozy before last week’s Group of 20 summit in Cannes, France.

“The market value of the debt of the countries most under scrutiny is likely to decline further as banks unload sovereign bonds,” according to the letter, signed by Managing Director Charles Dallara. “This is contrary to the goal of stabilizing and underpinning the outlook for sovereign debt in Europe.”

The losses on Greek bonds and efforts to reduce sovereign- debt holdings have hurt banks’ third-quarter earnings. Commerzbank, Germany’s second-biggest lender, reported a 687 million-euro loss on Nov. 4 after writing down the value of its Greek government debt and selling securities of southern European nations at a loss. Chief Financial Officer Eric Strutz said the Frankfurt-based firm booked a “three-digit-million” euro loss on Italian bond sales, without elaborating.

Creating Supply

Strutz, on a conference call with analysts that day, blamed regulators for worsening the situation by including mark-to- market rules in the stress tests, effectively encouraging banks to sell sovereign bonds.

“It’s a little bit strange to see that the regulators are actually fueling the whole debate by going into the other direction of creating more supply in the market,” said Strutz. “If you have a mark-to-market, all banks will further sell down their sovereign bonds, because in the end, you need -- whether implicit or explicit -- you need higher capital for that.”

While Commerzbank doesn’t want “a fire sale,” it’s willing to take “a small loss” to free up capital as the lender further reduces sovereign holdings, he said.

Reiner Rossmann, a Commerzbank spokesman, declined to comment beyond Strutz’s statements.

Losses on Debt

Third-quarter profit at BNP Paribas fell 72 percent because of a 2.26 billion-euro writedown on Greek sovereign debt and losses from selling European government bonds, the Paris-based bank said on Nov. 3.

BNP Paribas, the largest foreign holder of Italy’s bonds, reduced that nation’s debt in its banking book by 8.3 billion euros between the end of June and the end of October, according to a Nov. 3 presentation. Chief Executive Officer Baudouin Prot said on a conference call with reporters the same day that the Italian bonds were “sold in full on the markets” and not to the European Central Bank.

BNP Paribas said it cut the total sovereign debt in its banking book by 23 percent to 81.5 billion euros.

“We very much reduced our exposure to sovereign debt,” Prot said in a Nov. 3 Bloomberg Television interview. “We incurred losses for that.”Isabelle Wolff, a spokeswoman for BNP Paribas, declined to elaborate.

ECB Purchases

“You can’t really blame BNP or other European banks for selling sovereign debt,” said Christophe Nijdam, an AlphaValue bank analyst in Paris. “The European rescue fund hasn’t enough financial firepower, we still don’t have a rescue fund equipped to make sizeable purchases on the secondary market. As a banker, you don’t want to wait to see what happens for Italy and Spain.”

While it’s difficult to determine who’s buying the bonds, Knight Capital’s Dichtl said that beyond purchases by the ECB, some Greek government bonds may be bought by hedge funds or distressed-asset investors and Italian debt is still being purchased by asset managers and pension funds.

Of about 355 billion euros in outstanding Greek debt, about 127 billion euros is held by the European Union, the International Monetary Fund and the ECB, while about 90 billion euros is held by European banks, led by Greek lenders, according to estimates by Open Europe, a research group based in London and Brussels. About 80 billion euros is held by foreign non- banks such as hedge funds and insurers. Data is scarce, making estimates difficult, according to Raoul Ruparel, an economic analyst at Open Europe.

‘Disentangle the Links’

In the past, domestic banks in countries such as Greece and Ireland “filled the gap” when foreign demand for their nations’ bonds slipped, said Alberto Gallo, head of European credit strategy at Edinburgh-based RBS.

“The question is how to disentangle the link between banks and sovereigns,” said Gallo, who described the situation as a Catch-22, referring to Joseph Heller’s 1961 novel that describes the no-win situation faced by a World War II pilot trying to avoid duty. “If you do, you have a risk of accelerated de- leveraging. If you don’t, you end up with a bank system very correlated with sovereign bonds and vulnerable to shocks.”

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With per capita incomes rising and the affluent among the rural population growing, the Indian private banking AUM ( assets under management) has grown by 25 per cent in the last three years. An expectation that this growth would continue to hold up presents a good opportunity for banks to tap into this space. That said, the future is not without challenges.

Presenting the findings of a McKinsey survey in this regard, Mr Ramnath Balasubramanian, Associate Partner said that Indian banks have not been able to make a dent into private banking in a manner expected to as they have “high cost margins and low revenue margins” in this line of business. In a session on “Capturing High Networth opportunity”, Mr Ramnath put forth four key questions for discussion to a panel of bankers on the way forward.

Two questions predictably focused on the customer - What is the best way to acquire private banking customers? And, how could banks segment them? Providing viable but low-cost customer acquisition models, Mr Sandeep Das, MD and Head-India, Standard Chartered Bank suggested leveraging on analytics, watching credit card and mortgage patterns, using third party and client referrals and entering into strategic tie-ups with business groups to help banks build a strong customer base.

Considering the shift in the kind of customers accessing private banking – from the earlier ‘business class’ to the ‘salaried class’ now – Mr Vikram Kaushal, President and country head, wealth management, Yes Bank, brought to light the need to segment customers based on their needs and the kind of relationship they want. “Rather than being product-centric’, banks must be customer centric “, he said.

However, the panel also recognized the need to diversify the product offerings from the plain vanilla equity and debt options being provided at the moment. For example, India does not have a vibrant corporate bond market for retail, foreign exchange markets, hedge funds or alternative investments avenues.

“A far more comprehensive product platform could add more value to the customer and in the end address the question of profitability by helping banks increase the charges too”, felt Mr Atul Singh, MD and head of global wealth management, Merill Lynch. In fact, widening the product platform and improving banks’ productivity on the private business side were the other two questions posed by McKinsey.

Rounding off the discussion, Mr Tashwinder Singh, MD –Global Market Manager Citi Private Banking pointed out that productivity of the talent boiled down to the quality of the talent that the bank has. He said that, Indian banks could make deeper inroads into the private banking space if they have relationship managers with competence and knowledge about the markets, with an understanding about the client’s operating business and with longevity in the organization.

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