Central Bank
Al-Hamour’s List: 2008 Doves of the Year
First and foremost, I would like to welcome all of you to 2009 and hope that you have enjoyed the holidays. After being away for so long I thought it best to start the year with a light but meaningful post.
As a follow up to 2008: Year of the Dove I have decided to create a list that gives the reader a snapshot of global central bank policy in 2008. Some of these men may have been named ‘most influential’ people by Newsweek, but on Al-Hamour these men are merely doves incognito. They are commended for their dovish efforts in trying to quell their respective financial markets and economies by using interest rates as their weapon of choice.
I have ranked each central bank by the percentage change for the 2008. This means that if at the beginning of 2008 the interest rate was 10% and finished the year at 5%, I would consider this a 50% drop in rate as opposed to an absolute 5%. In addition, interest rate cuts during the first quarter of 2009 will not be taken into consideration but it looks like the European Central Bank and the Bank of England are in the lead for this year’s list.
The list includes 55 entries but I have decided to only provide more detail on a few.
Source: Al-Hamour, Bloomberg
Source: Al-Hamour,Bloomberg
Source: Al-Hamour, Bloomberg
Source: Al-Hamour,Bloomberg
Source: Al-Hamour, Bloomberg
Source: Al-Hamour, Bloomberg
Source: Al-Hamour, Bloomberg
If you would like the sources of all the rates used for the different countries please email me and I will send you the information.
2008: Year of the Dove
The Chinese zodiac is quite unique in its construction. Based on a cyclical perception of time, the twelve animal signs are structured around a 12 year cycle. Starting with the Rat, they each represent various characteristics of people that are born during the Chinese year. [1] In China it is currently the Year of the Rat, a year symbolizing hard work, shrewdness, and ruthlessness. 2008 is also considered a lucky year as the number 8 is very auspicious and in Chinese, sounds similar to the word for prosperity or wealth.
The white dove and olive branch is arguably the most recognized worldwide symbol for peace. References of the dove range from The Holy Qura’an to Pablo Picasso’s artwork. [2] You can even purchase a War & Peace watch with a rotating Dove from the United Nations online bookshop for US$45.95. [3]
In the finance world however, references to doves are not exactly meant to illustrate peace. Instead, financial jargon defines these words as follows:
- Dovish: A Central Bank that is cutting (reducing) interest rates
- Hawkish: A Central Bank this is increasing interest rates
Simply put, a Central Bank that reduces the interest rate at which commercial banks can borrow at is said to be Dovish and vice versa. In general, interest rates lower debt cost. For example, in Kuwait, loans are usually quoted as a percentage over the CBK rate and most of the loan terms are actually pre-determined by the Central Bank of Kuwait. That means that if you took out an Al-Afdal loan from Gulf Bank today [4% + CBK rate] your interest would be 8.5%.
As we all have come to know, 2008 has been terrorized by the banking and financial crisis and according to the latest SMS circling Kuwait, a year where only two banks are expected to remain - the Blood Bank and the Sperm Bank. However, the Central Banks have many tools at their disposal to deter such an event from becoming a reality. Increasing or decreasing interest rates are one of the many gadgets used to promote financial and economic stability. During these moments of crisis the Central Bank policy makers have joined together in a coordinated effort to reduce interest rates hence making this year a Dovish one.
The graph below highlights the year to date interest rate for the US Federal Reserve, Bank of England, and the European Central Bank. The US has been more aggressive than its peers in reducing interest rates as it struggles to keep its economy afloat.
Interest Rates - YTD %
- Source: Bloomberg
- ECB: 3.75%
- US FED: 1.00%
- BOE: 4.50%
Policy Effectiveness:
Merely noting the net change in the interest rates does not give a clear picture as to whether the policy was effective in achieving its objective. One measure of credit and liquidity risk in the banking system is the TED spread. It is calculated by taking the 3 month London Interbank Offer Rate [LIBOR] and subtracting the 3 month T-Bill yield.
- LIBOR: It is a measure of how much banks are willing to lend US dollars to each other. The reported rate is an average of participating banks.
- T-Bills: The interest rate at which you can borrow, essentially risk free, from the US government.
As a rule of thumb, when the TED spread is:
- High: Banks are less willing to lend to each other as they believe other banks are not safe
- Low: Banks are more willing to lend to each other as they expect to get their money back
In this particular case, policy makers reacted to a nosedive in global equities during September and scrambled to take action. From September until about mid October, the TED spread continued to rise as banks simply stopped lending to each other. However, after interest rates were reduced globally the TED spread started to come off its high.
- All time High: 4.57% [October 10, 2008]
- All time Low: -0.034% [September 12, 2001]
TED Spread
- Source: US Federal Reserve. Bloomberg. Al-Hamour.
We can see that the coordinated rate cuts were effective in reducing the credit risk in the banking system as banks became more willing to lend to one another. As of November 1, 2008 these are where things stand:
- TED Spread: 2.41%
- LIBOR: 3.02%
- T-Bill: 0.61%
However, when comparing the TED spread to the May 1987 average of 1.7% and the October 1987 average of 2.26% we are still at higher levels. This is somewhat anticipated as the current crisis is far greater in depth and breadth than The Crash of 1987 which started on October 19, 1987 in Hong Kong. [4]
TED Spread
Source: US Federal Reserve. Bloomberg. Al-Hamour.
In summation, I would like to leave you with a recap of the main points discussed in this post and what you can anticipate going forward:
- Dovish Central Banks help reduce the overall cost of debt and aid in de-leveraging of the economy
- The TED Spread is a measure of credit and liquidity risk in the banking system
- Expect LIBOR rates to decrease as liquidity is injected into the system and inter-bank trust is restored
- Expect Central Banks to continue to reduce interest rates
- Consider making a deposit at your local Blood Bank and/or Sperm Bank
I will be posting a follow up to this topic later this week and will discuss the various Central Bank actions year to date.
Please do not hesitate to leave a comment or send me an email if you have any inquiries or would like to discuss the post.
[2] Dove of Peace. Pablo Picasso.
[3] Online Bookshop. United Nations.
[4] Investopedia
Gulf Bank Chairman submits resignation
The wrath of the Credit Reaper has shaken the second largest Kuwaiti bank and has left little room for compassion. I have just received news that Mr. Bassam Al-Ghanim, Chairman of Gulf Bank of Kuwait, has resigned. It is unclear at the moment who will take his place but since the Al-Ghanim family represents a large holding in the bank another member of the family might step in. Mr. Kutayba Al-Ghanim has been made aware of this and the family is addressing the situation accordingly. I have full faith that this matter will not jeopardize the bank’s clients. It is also expected that the CEO and Head Treasurer face pressure from the Central Bank to step down as this derivative debacle is sorted out.
The total estimated loss for the derivative trade is greater than the Euro 700 mm noted in my previous post. As the markets opened on Monday the 27th Gulf Bank offloaded the first US$ 1 bn leg at approximately EUR/$ 1.2580. Later in the day the other portion was closed out at EUR/$ 1.25. This amounts to a total loss of US$ 1.2 bn or KD 313 mm, which represents 70% of Gulf Bank’s Tier 1 & 2 Equity.
I think the greater issue at hand here is determining which party will bear the risk of the loss. These are the scenarios that I see playing out (Please feel free to discuss):
Responsible party
- Gulf Bank: In this situation the bank will need to be recapitalized. This can be done either through a merger, acquisition, or capital increase. However, it is possible that the Central Bank extend a facility to GBK to cover the loss in which case the repayment terms will be lenient or the Kuwaiti government may want to acquire a stake directly in the bank, following in the footsteps of the Bank of England.
- Clients: Given the clients currently exposed to the derivative trade, it is highly unlikely that they can afford payment. I will include a more detailed analysis of their financial health in my next post as I am currently gathering all the information. Therefore, as mentioned in my previous post a rise in bankruptcy filing of individuals or corporations would not be unexpected.
In any case either party will try and avoid payment and seek the legal route, a process which can take a long time before a decision is made. However, the Central Bank along with the new Crisis Management Council headed by the Governor Shaikh Salem Abdulaziz Al-Sabah, might be able to expedite the process if need be.
Again, I would reiterate my position that I have full faith in the members involved in this unfortunate incident to act accordingly and in the best interest of the bank’s clients and shareholders. I also have full faith in the Central Bank Governor to honor his statement to secure the bank’s deposits, as he has shown considerable leadership in the past.
Please do not hesitate to contact me if you have any inquiries or would like to discuss further. All comments are welcome.
Disclaimer: All values are internal estimates and actual numbers may vary significantly from stated numbers.
Update: Mr. Kutayba Y Al-Ghanim has been appointed Chairman of Gulf Bank. He currently holds the following positions in Kuwaiti incorporated companies:
- Chairman: Gulf Bank of Kuwait K.S.C. [Bloomberg: GBK.KK EQUITY]
- Chairman: Alghanim Industries (Private)
- Chairman: Kuwait China Investment Company K.S.C.
Mr. Adel M R Behbehani has been appointed Vice-Chairman of Gulf Bank. He currently holds the following positions in Kuwaiti incorporated companies:
- Chairman: Kuwait Pipes Industries & Oil Services K.S.C [Bloomberg: PIPE.KK EQUITY]
- Vice Chairman: Gulf Bank of Kuwait K.S.C. [Bloomberg: GBK.KK EQUITY]
- Director: The Investment Dar K.S.C. [Bloomberg: TID.KK EQUITY]
Press interview with Mr. Kutayba Y Al-Ghanim at Gulf Bank’s Board Room [Link]