Читать книгу The Incomplete Currency - Marcello Minenna - Страница 19

A single currency area represents an extension of the territory where the economic agents regulate their financial transactions through a shared currency having legal tender. Generally this area coincides with the territory of a sovereign state, whose government is able to forcibly impose the use of this medium of exchange (the “forced circulation”), and has sovereignty over the issuance of new currency.

In a monetary system, it is quite natural that within the currency area there can be no subject less risky than the state itself: in fact, if a state is destined to default on its debt, it is probable that any company or bank belonging to the nation will equally be in trouble. In addition, a state can always decide to repay a debt issuing new currency, which must be accepted in every case by the counterparty.

Consequently, the set of interest rates (the “single curve”) referred to the government of a sovereign state is the benchmark for the entire economic system of the nation. This implies that the interest rates paid by the government can be considered as “risk-free” interest rates (even if they are not) because it is not possible to invest their savings in anything less risky. Not even foreign business: for example, the United States may be perceived as a healthier state than Mexico, but for a Mexican citizen to invest in American government bonds means taking the risk of the exchange rate between the dollar and the peso, therefore for this subject, the low-risk investment remains a bond issued by the Mexican government.

The Euro currency area is the exception to the rule.

1.3.1 A Single Curve for All Government Bonds of the Euro Area Countries

The nations that have joined the Euro have exclusively surrendered their monetary sovereignty to the European Central Bank, while keeping all the other typical functions of any sovereign state, including the ability to borrow by issuing public debt securities. This fact is central in understanding the functioning of the Euro and its structural problems.

If the Eurozone does not have a federal government like that of the United States that can issue sovereign bonds, how is it possible to identify which investment is risk-free and therefore the single curve of interest rates?

Until 2007, when the effects of the international financial crisis from the United States to Europe started to unfold, the solution to the dilemma was guaranteed by the substantial convergence of the sovereign yield curves of all Eurozone countries. In essence, the risk perceived by the market operators was substantially the same for any government bonds considered: Italian, German, Greek etc. Same perceived risk, same return: the different curves of the various countries were practically indistinguishable from each other, realising in practice a single interest rate curve (see Figure 1.24).

Figure 1.24 Interest rate on 10-year government bonds of various Eurozone countries

Source: Bloomberg

The explanation of the phenomenon is hidden in the term “perceived”. In reality, the economies of the various European countries have always been profoundly different, with different growth rates and levels of debt and inflation. The risk of a bond issued by the Greek government has always been different from that of a German bond: the market simply ignored this phenomenon, assuming that the differences were so low as to be negligible. In retrospect, it was a serious error of judgement, favoured by the architecture of the European financial system that will be discussed in detail later.

Furthermore, the governments of the countries that joined the Euro voluntarily decided to give up printing money in order to repay their debts (the so-called monetisation); this structurally increases the risk of default of a sovereign State because it automatically reduces the room for manoeuvre. This point will be further explored later.

1.3.2 The European Interbanking Market: EURIBOR, EUROSWAP, OIS

The European financial system is largely bank-centred. Historically, the percentage of loans granted by banks in the Eurozone has always been more than 100 % of GDP, and in recent years was around 150 % (see Figure 1.25), despite the evolving global crisis.

Figure 1.25 Credit disbursed from the banking systems to the national economies (Eurozone)

Source: World Bank

As a result, the interbank market, through which banks cover part of their financial needs in the short term, assumes a notable importance in the complex functioning of the European financial system. Before going into the analysis of the system of relations between finance and real economy, let's examine better the structure of the interbank system.

The reference interest rates for the European interbank market are determined by the daily operations of a panel of 45 banks (see Figure 1.26). In general, at a fixed time of the day (11.00 am) every bank communicates a series of interest rates; these rates represent an estimate by the bank of the levels of the rates charged by the other panellists. These estimates are then collected and averaged, not before eliminating the most extreme values from the sample.

Figure 1.26 European banks involved in the determination of the interbank interest rates in the Eurozone

Source: European Central Bank

They take on different names depending on the type and maturity of the operation in question. In particular, with regard to the standard operations of interbank loans:

● EONIA: for very short-term lending operations (1 day or overnight);

● EURIBOR: for short-term lending (up to 1 year); and

● EURIRS: for medium- to long-term lending (for at least 1 year).

Figure 1.27 graphically represents the structure of the curve for interbank loans EONIA/EURIBOR/EURIRS. Loan maturities are represented on the horizontal axis, while the vertical axis shows the rates at which the transactions are settled; as a consequence, in the bottom left area we can read the interest rates relative to short-term and very short-term transactions, while rates tied to loans with a longer maturity, such as 30 years, appear in the top right. As it can be easily guessed, rates related to longer maturities tend to be higher, even if this rule is not always the case.

Figure 1.27 Term structure of the interest rates on interbank loans

Source: Bloomberg

Interest rates reported in the EONIA/EURIBOR/EURIRS curve are clearly calculated keeping in mind the risk of the transaction. Any bank that lends money to another bank takes on the risk of not seeing its loan being honoured and thus it determines the interest rate to apply according to the rule which we have already learned: the higher the perceived risk, the higher the yield.

However, it is possible to access some low-risk operations on the interbank market, so low as to be considered practically negligible. This regards the Overnight Index Swap (OIS), namely transactions in which banks exchange fixed and variable money flows; in a standard transaction a bank makes a series of variable payments that are anchored to the performance of the interest rate relative to very short-term loans (EONIA at 1 day), in exchange for certain payments calculated on the basis of a fixed rate swap (OIS). It is important to note how this swap rate by construction reflects the “average expected level” of the interbank overnight rate (EONIA) during the swap, thus implying a level of the EONIA rate which incorporates the estimates of the operators. The OIS rates, since they are linked to the EONIA rate at the shortest maturity, are therefore very low and are always below the interbank lending curve, even if these rates concern technical operations for the treasury management which don't have the same relevance as obtaining a real loan. Figure 1.28 graphically represents the structure of the curve relative to the Overnight Index Swap transactions. On the horizontal axis contract deadlines are highlighted, while the vertical axis shows the rates at which transactions are settled; as a consequence we can read the interest rates relative to the very short-term and short-term transactions at the bottom left which, given the lack of relevance of the expectations for the short term, are not surprisingly very close to the rates on the interbank loans, while at the top right we find the swap rates related to the longest maturities such as 30 years, where the role of expectations is very relevant.

Figure 1.28 Term structure of the interest rates on Overnight Index Swap (OIS) transactions

Source: Bloomberg

This interest rate curve has a very important and informative benefit: since it describes the reward of transactions that are very low-risk, the differential with the interbank interest rate curve represents a very clear measure of the perceived credit risk within the interbank system (EURIBOR-IRS/OIS spread). When banks don't trust each other and tend to lend very carefully, this differential widens a lot, while during peaceful periods the distance between the two curves is not significant (see Figure 1.29).