Banks can, and do, go bust. The latest example looks to be German commercial bank Greensill, owned by Greensill Capital, a UK-based provider of supply chain finance. Greensill Capital filed for insolvency earlier this month and the fall-out could have far-reaching implications for the businesses using its financing, their suppliers, as well as investors. The Financial Conduct Authority is under fire for perceived lack of action and heads are already rolling at large investors such as Credit Suisse Asset Management, having announced its Chief Executive is to step down.
Another part of the tale is focussed on the maritime city of Bremen in Germany’s northwest. That’s where Greensill Bank is based, having previously been known as NordFinanz before it was acquired by Greensill Capital in 2014. The German financial regulator, BaFin, has submitted a court filing to start insolvency proceeding for the bank, following freezing all Greensill accounts and warning of an imminent risk that the bank would become over-indebted. BaFin has also filed a criminal complaint against the bank for suspected balance sheet manipulation.
The bank’s insolvency will likely lead to losses for its creditors, including German public sector bodies who had placed deposits with the bank. It has been reported that between €200 – 500 million were held with the bank across a number of municipalities, ranging from one federal state to small towns. Some are looking at potential losses on up to a third of their liquidity balances. One particularly unfortunate situation is that of Cologne, which had recently borrowed money and placed it in banks ahead of it being spent on the construction of a theatre.
Individual investors in the bank will be covered by Germany’s deposit insurance scheme (up to €100,000 per person) but public sector bodies do not have the benefit of such protection since legislation changed in 2017. Their deposits would have had been insured had they been placed with public savings banks (known as Sparkassen) rather than a private sector bank such as Greensill. So why was Greensill Bank being used as a counterparty by so many public sector organisations? Yield. Interest rates in the eurozone have been negative for quite some time and deposits with the public savings banks would have attracted returns of around -0.5%, guaranteeing getting back slightly less than was invested. Greensill, however, was one of the few German banks offering positive rates of return to institutional depositors and so looked like an attractive option to avoid having to incur a negative yield.
Comments from some of the affected local authorities suggest that they were relying on the bank being a safe place to invest based on it being regulated, audited and having an investment grade credit rating from German rating agency Scope Ratings. For their part, Scope has suggested it now suspects Greensill both withheld relevant information and provided incorrect information to them.
Clearly, if there has been fraud involved then even close scrutiny of the bank’s activities may not have flagged problems. However, the bank’s collapse and the likely loss of public money highlights many of the themes Arlingclose’s creditworthiness and investment advice to our local authority clients seeks to address.
The first line of defence against investment losses for liquidity balances (negative rates aside) is a robust creditworthiness assessment that aims to avoid exposure to problematic counterparties in the first place. We have always strongly believed that this must go beyond reliance on credit ratings, which have often proved to be slow-moving indicators. Our advice has focussed strongly on bank bail-in risk since EU and UK legislation changed in 2013. This story shows the importance of understanding and keeping abreast of banking legislation and any protection – or more likely lack thereof – that may be available.
The capital structure of financial institutions and where an investor/investment sits within this hierarchy needs to be understood. Greensill, given its relatively smaller size, is going through insolvency rather than bail-in, but the principle is similar – a large swathe of retail depositors has protection and institutional investors are in line to take the pain. Given very low interest rates, the risk/reward trade-off for bank deposits looks relatively poor and has done for quite some time.
The second line of defence is diversification and the setting of sensible lending limits in order to ensure this takes place. If the worst happens and a counterparty defaults or goes through a bail-in, then the amount exposed to that event needs to be manageable. This story is another reminder of not putting too many eggs in one basket.
CIPFA’s framework for UK local authorities sets out the priorities of security, liquidity and then yield for investments. Whilst it’s understandable that accepting a negative return would not be ideal, chasing a positive yield has certainly not paid off in this instance. If interest rates were ever to turn largely negative in sterling then LA investors would need to consider whether security and liquidity were potentially being compromised to maintain a positive return.
We also often talk to clients about the additional credit risk involved in borrowing money before it is actually needed and having to invest it somewhere before it’s spent. The example of Cologne mentioned earlier demonstrates this reality.
The public bodies are looking towards the German central government to bail them out. Berlin, for its part, has pointed to the regulations which have been in place for a number of years now and reminded the municipalities that the rules are very clear. They knew - or should have known – the risks they were taking.
UK local authorities haven’t been immune to bank failures in the past. This saga is a reminder that managing credit risk and its impact needs to remain a priority.