Is Global Banks’ Exposure to Global Shipping Being Neglected by Markets?
We see the major risk factors facing global shipping to be emanating from German banks which could be impacted by China’s credit market; an overvalued US dollar within the context of expectations of increased Federal Reserve bank interest rate hikes; geopolitical tensions between the West and Russia; and flat commodity prices. The world economy is still very weak and whilst there may be room for optimism, the path ahead remains very uncertain, particularly in the wake of Brexit. However, we believe the major current risks in shipping come from Germany.
The risks facing the global shipping industry feed through to the risk exposures of banks, particularly those located in Germany. It is estimated that German banks are exposed to about 25% of the world’s shipping industry and were the largest providers of capital to the sector prior to the Global Financial Crisis (GFC).
Deutsche Bank has been writing down its bad loans in shipping after the European Central Bank (ECB) earlier in the year expressed concern over European banks’ exposure to shipping and ordered a comprehensive review into the impact of shipping on banks’ capital adequacy. This is compounding the problems faced by Deutsche Bank in relation to fines from US regulators that exceed the current market value of its shares.
The root cause of the woes of the global economy has been cheap money for too long alongside Quantitative Easing (QE). For example: We find it hard to separate the extent of QE with current politics at the Bank of England. It has become an intertwined phenomenon since the Global Financial Crisis of 2007. Inflation having been benign, there is no need for the Bank of England to actively manage the price level as it has in the past and has become obsessed with ‘Monetary Socialism’ or QE/printing money.
The major problem in the world economy today is the fact that there has been a permanent shock to the risk-reward trade-off as the moral hazard issue has become more of a problem. The banks are becoming larger and the nature of the industry oligopolistic. With current tightening of lending in home loan markets, global banks have increased their exposures in shipping and commodities.
In our view, there is evidence of a huge asset bubble in global equity markets, bond markets and property since the commodity bust of 2015. One high profile academic, Professor Robert J. Shiller from Yale University, this year highlighted that we are probably living in an asset bubble. The markets seem not to have heeded his advice and continue to race ahead throughout 2016. This is potentially deleterious to global banks’ capital. Could it be that Deutsche Bank’s exposure to shipping sets off a domino effect across the globe causing yet another financial nightmare?
Global shipping is still in the doldrums as reflected in the Baltic Dry Index (BDI) which currently stands at about 800 (and dropping). It has been bumping along the seabed since the Global Financial Crisis. This downturn in shipping is also supported by the level of the S&P/Dow Jones Global Shipping Index, which stands at around 500, down approximately 50% in the past two years.
A key barometer to world trade which is often overlooked by the markets is the Baltic Dry Index which has plummeted due to the global oversupply of ships. The BDI cannot be manipulated by market participants as it is not traded on an exchange. Its behavior, since the GFC, is perhaps indicating that shipping is moving from a cyclical industry to one more akin to aviation. When compared with the level of global stock markets like New York and London, the BDI is pointing towards a massive bubble, reinforcing the sentiments of Nobel Laureate, Professor Robert Shiller.
In addition, the ill effects of the commodities price collapse in 2015 are beginning to be felt in the US as global banks aggressively marketed loans to oil companies due to a tightening of regulations in the residential home loan market. In a recent presentation at the ‘Oil, Finance & Shipping Symposium’ held in August 2016 at the University of Greenwich, Chatham Maritime, Senior International Monetary Fund (IMF) economists highlighted the precarious nature of major US banks dealings with the oil industry who lent heavily before the commodity bust in 2015 and have been left reeling from a wave of bad loans. There are indeed parallels to be drawn for the German banks’ current equivalent position in the shipping sector.
Meantime, in South Korea, banks have constructed a ‘bail-in’ fund to the magnitude of $9.5bn to act as a buffer to national banks’ exposure to shipping. It may well need to be the case in Germany as well, as we ride this ghastly wave of economic uncertainty.