This data dump should one day result in a blog post or video about the geography of Europe’s financial system…
I am Jan Musschoot.
Warren Buffett once said: “Only when the tide goes out do you discover who’s been swimming naked.”
And boy, have people been swimming naked in 2022!
Investors saw the valuations of tech companies crash by 50, 70 or even more than 90%.
The so-called “geopolitical” European Commission – who wants the EU to be the first climate neutral continent – had to beg for gas around the world after boycotting Russia.
But the naked swimmer that I want to focus on is the ECB, a favorite of this podcast.
This is what Lagarde said about inflation at the end of 2021:
So inflation was supposed to have been a hump, gradually coming down to the 2 percent target over the course of 2022.
But in fact, inflation had been too high since the summer of 2021, and it basically kept on going up for the entirety of 2022. In December of 2022, it dropped a little, but it was still 9.2 percent according to Eurostat.
The ECB’s economists have been worried a lot about inflation expectations and wage-price spirals.
But what’s been driving Europe’s inflation for more than a year has been the cost of energy. It’s not clear at all how the metrics that central banks usually look at are relevant for this kind of inflation. I did some research last year that showed that if you look at government deficits, the unemployment rate, or the central bank interest rate, these are basically irrelevant when it comes to predicting the inflation that we observed.
What’s mostly correlated to the current inflation is the amount of energy economies use relative to their size. In other words, energy intensity is what drives inflation.
If the ECB had funded investments to make us less dependent on imported fossil fuels, inflation would have been much lower.
Imagine that the EU had invested massively in building renovation, heat pumps and clean energy sources while inflation was below target.
This would have reduced our vulnerability to Russia and other geopolitical rivals.
And fossil fuels would be a much smaller part of the consumer price index.
On top of that, Europe’s industry would have plenty of cheap energy right now…
So energy-driven inflation was the first tide that showed that the ECB was swimming naked.
Now on to the second tide.
With inflation out of control, the ECB needed to do something. While Lagarde said in 2021 that it was unlikely they would raise rates in ‘22, the central bank has raised rates 4 times since the summer. The deposit facility rate went from negative 0.5 percent to positive 2 percent.
But this exposes the ECB to another problem, which is the mismatch between its assets and liabilities. While inflation was below target, the ECB bought trillions of euros of bonds. A lot of these have a fixed, negative yield. Under the PEPP, the pandemic emergency purchase program, the ECB put a turbo on this QE.
And how were these bond purchases funded? With bank deposits.
Now what happens when interest rates go up? The central bank starts to pay interest on these bank deposits, while its assets have a fixed yield.
According to one estimate, the Eurosystem is going to lose about 600 billion euro because of this failing risk management.
Anyone with a basic grasp of finance could have predicted this.
I even told the ECB to issue bonds instead of funding their assets with reserves.
Of course, they didn’t listen, because they’re so smart…
And what’s extra sad, is that the ECB has been complaining that governments haven’t invested enough in infrastructure.
Central bankers also complain about how untargeted government relief to help citizens and companies with their energy bills contributes to inflation.
The problem is again that the ECB didn’t put its money where its mouth was.
For years, QE has kept government funding costs in check, without any conditions on how governments should spend to keep inflation in check.
Maybe as a serious, non-political central bank, the ECB should have actually made sure that these crucial investments got done?
Instead, the ECB basically acted as a financial speculator, counting on low inflation and low interest rates forever.
Again, just imagine that the ECB would have invested not in securities, but in real infrastructure over the past decade.
How much better off Europe would be right now!
The final tide that went out in 2022 is that of Lagarde’s leadership.
Everybody knows that she’s not an economist. So maybe we shouldn’t blame her for failing to anticipate the inflation or the financial losses.
But she was previously a minister in France and the head of the International Monetary Fund.
So she must be a strong leader, right?
For those of you who’ve been listening to the podcast for a while, you might remember what I wrote in my New Year’s letter to Lagarde a year ago.
I suggested that either she quit, or she starts doing her job.
Obviously she’s still the President, so she didn’t quit.
But as the President, she should have fired the people who’ve been feeding her false predictions for all of this time.
At the end of 2021, ECB staff projected that euro area inflation would be about 3% in 2022. And core inflation would be below 2%.
I don’t know if it’s even possible for Lagarde to fire the most high profile economists like Isabel Schnabel or Philip Lane. But you’d expect some heads to roll.
But we didn’t see that at all. What we did see, was ECB staff asking for higher wages, to keep up with inflation.
Irony is dead…
Now before I go, I want to thank everybody who has supported this podcast and my YouTube channel. It’s not always easy to combine this with my other work, but I do appreciate your feedback!
In the coming year, I’m planning to release one podcast episode per month. And I want to do about a dozen deep dives into central banking and the financial system on the Finrestra Youtube channel.
So if you want to keep informed, please subscribe!
This has been another episode of the Finrestra podcast.
You can follow me on Twitter @janmusschoot.
You can mail me at email@example.com
Thanks for listening and till next time!
(P.S.: Lagarde cartoon created with Dream by Wombo)
The start of the new year is a good time to reflect on some things I did.
Last year, I wanted to get 150,000 views on YouTube.
Although I didn’t reach that target, I am quite pleased with the progress I made. Especially given that the first half of 2022 was so busy that I could hardly create any new videos.
So as of 8 January 2023, the Finrestra YouTube channel has 33,551 views and 247 subscribers.
Some videos did well, others didn’t get the number of views that I expected they would get. That’s life…
One of the features of YouTube is that your content can suddenly be picked up by the algorithm, even when it has been posted months earlier. For me, that a big advantage compared to social networks like Twitter and LinkedIn.
In addition, I’d like to make a podcast episode every month (minus the summer holidays).
Rather than maximize the number of views, it would be great if I can get more watch time. Currently, my most popular video has been watched for 150 hours.
If I can create 10 videos that get watched 200 hours or more in 2023, I’ll be very happy 🙂
Thanks for your support!
- Interest rates rose across the yield curve
- The Eurosystem shrank its balance sheet
- European bank stocks dropped, but recovered
Hello and welcome to another episode of the Finrestra podcast! I am Jan Musschoot.
In this episode, I will talk about the sale of HSBC Canada and especially what HSBC can do with the cash it will receive from this sale. But first, let’s do a quick recap of the financial news of November.
FTX, a crypto trading platform, went bankrupt and its founder SBF went from being a multi-billionaire to essentially being broke.
In the euro area, inflation finally went down a little. Inflation was 10% in November whereas inflation was still 10.6 percent in October. Inflation is going down a little thanks to lower energy prices.
In other banking news – and also the topic of today’s episode – HSBC sold its Canadian subsidiary to Royal Bank of Canada (one of the largest Canadian banks). This fits into a broader pattern that I in one of the previous episodes of the Finrestra podcast called Go big or go home.
If you look at where HSBC derives its revenue from, Canada is barely three percent of revenue. It’s about four percent of profits and also four percent of the balance sheet. So banking in Canada is just a small part of the global group that is HSBC.
So it makes sense to exit this market, because you cannot have the scale you want to be highly profitable. Canada also has some big domestic banks who dominate banking in the country, so it makes sense for HSBC to exit the market, especially given that they received a good price for it.
This Go big or go home strategy is something that HSBC has been following for a few years now. For example, last year they also announced that they would exit [part of] the retail banking business in the US and that they would sell the French retail banking business, which was also about three percent of the group’s revenue. But they cannot compete to with the large French banks in France. And then in November 2022, so last month, HSBC also sold its bank in Oman (in the Middle East) to a local bank.
And this ‘let’s go big or go home’ strategy is not unique to HSBC. For instance last year I did a podcast episode about the sale of Bank of the West by BNP Paribas. The French multinational bank sold its US retail banking division to focus more on its core markets. And that’s also what HSBC has been doing here with the sale of HSBC Canada.
In financial terms, it seems that HSBC has done a pretty good deal because they received 13.5 billion Canadian dollars (which is about 10 billion US dollars). That’s about eight percent of HSBC group’s market cap. So that’s actually a good deal. If you look into the financial statements, they say they will make a net profit of more than 5 billion dollars on this sale above the book value1. And of course, selling the Canadian division will also shrink HSBC’s assets by a little less than 100 billion US dollars. So the sale provides a good boost to the capital ratio of HSBC as well.
Now let’s focus on what HSBC could do with the cash that it will receive.
One possibility is just to return it to the shareholders in a dividend. But that’s kind of boring, so what I would do is to follow the Go big or go home strategy and ‘go big’ in the core markets of HSBC.
HSBC’s core markets are firstly in Asia, where it’s the biggest bank in Hong Kong and also has significant operations in China, India, in the Middle East, and in some other Asian countries.
So what could we do with the cash (or the cash plus some extra borrowed money)?
The obvious takeover candidate would be Standard Chartered. Standard Chartered is another British bank that is based in London and is mostly operational in the Far East (and also partly in Africa and the Middle East). If HSBC were to buy Standard Chartered, there would be synergies of course in the London offices. I’m not sure if they would be allowed to take over the Hong Kong division of Standard Chartered because maybe HSBC would become too dominant in Hong Kong, but at least buying the Asian divisions would be a huge boost to HSBC in Singapore and it would also strengthen the bank in China, India and South Korea. Also in the United Arab Emirates and Asian economies like Malaysia, Indonesia, Vietnam. All those countries would contribute to a higher market share of HSBC and hopefully also to higher profitability and economies of scale.
I already mentioned that they should probably sell the Hong Kong division of Standard Chartered. And I guess they should also sell the African subsidiaries of Standard Chartered because I don’t see a lot of synergies there. And HSBC is mostly focused on Asia and not on Africa. So that would also bring in some extra cash because the 10 billion US dollars won’t be enough to buy standard Charters. But I think there’s a very clear business case to purchase Standard Chartered.
Another possibility would be to stay in the United Kingdom. So I found some research by Mordor Intelligence showing the market share of banks in the British market. You see that Lloyds is the clear market leader while HSBC is only the fourth largest retail bank in the UK (together with Santander UK). So a possible takeover target would be NatWest, which is the parent company above Royal Bank of Scotland – which is currently the third largest bank in Britain. Together with HSBC, they would be about as large as Lloyds Banking Group. So they would be the first or second largest bank in the United Kingdom. This [acquisition] would definitely provide some economies of scale on its British home market and would be quite easy to integrate. I think that deal makes a lot of sense also from a business perspective. Compared to Standard Chartered, where you would need to do a lot of divestments and integration in a lot of markets, the NatWest acquisition would be quite simple in terms of geography. You would also only need the approval of the British authorities. So I think that makes a lot of sense as well.
And then finally, thinking out of the box, we could also look at Credit Suisse. I wouldn’t suggest to buy the entirety of Credit Suisse, although its market cap is so low that with $10 billion you could almost buy the entire bank.
But what is probably a better idea is if HSBC would buy the Asia Pacific operations and maybe also the Middle Eastern operations of Credit Suisse. So I guess you don’t need the entire amount of 10 billion dollars. But by buying the Asia Pacific operations of Credit Suisse, HSBC could strengthen its wealth management in countries like China but also in Singapore and in other East Asian countries. And maybe also strengthen some of the investment banking operations in Asia. I think management of Credit Suisse would probably be happy to sell those divisions because then Credit Suisse can focus more on its core divisions in Switzerland and the Americas. While now CS are a global bank but they don’t have the size they need to be a real global bank.
So these have been three ideas. HSBC has sold its Canadian division for a lot of money. They could either buy Standard Chartered, or NatWest, or the Asian activities of Credit Suisse. I’m very curious of course what you think. Should they just return the money to their shareholders? Or should they buy other banks? Or do you have any other ideas? Maybe they should focus on share buybacks.
This has been another episode of the Finrestra podcast. Thanks a lot for listening and till next time!
- Crypto exchange FTX went bankrupt
- Euro area inflation dropped to 10%
- Monte dei Paschi di Siena and Credit Suisse raised capital
- HSBC sold its Canadian subsidiary to Royal Bank of Canada
European inflation is driven by energy (intensity). Inflation falls as energy prices drop.
Credit Suisse profile
- Your favorite DSGE sucks
- Paris overtakes London as Europe’s biggest stock exchange (but read the fine print)
- SNB not alone with a balance sheet loss
- The fiscal cost of QE (about €600 billion)
- Shifting economies in the EU (cartograms showing GDP per country)
- Benjamin Hennig’s website has many brilliant cartograms, e.g. on diamond production, world population and GDP, inequality in Europe, wealth on the British Isles
- Create cartograms online
- UBS strategy defies crisis
- Cost of mitigating high energy prices