11/12/2013: Will Europe Have Any Firepower for Banks Bail Outs?

The Banking Union debate drags on and on and on and the further we travel in time into this debate, the more apparent is the pathetic nature of the undertaking, and with it, the pathetic state of leadership across Europe... Here's the latest instalment:
http://blogs.ft.com/brusselsblog/2013/12/eu-bank-bailout-fight-more-leaked-documents/

Key quotes in this latest instalment:

"Both the European Commission and the European Central Bank – along with most eurozone finance ministries – believe a “break in case of emergency” backstop needs to be in place to provide a safety net for the bank rescue fund since, even when it’s completely full, it will only have €55bn in it. Given the recent crisis experience, that might only be enough to bail out two or three mid-sized European banks."

Laugh! or Cry! or both. The entire circus is about EUR55 billion. Not enough to backstop another Ireland (based on the 2008-2010 crisis dimensions). Not enough to backstop the retail division of the Deutsche Bank alone (based on 5% loss over capital cushion). Not enough to backstop anything, really. Administration, compliance, enforcement and other bureaucratic functions associated with this backstop (and the necessary Banking Union spoking it to the ECB and the eurosystem) will be running at somewhere around 5-10 percent of the entire fund, annually. If this is a form of insurance, you might getter better quote on insuring Titanic in its current state for passenger traffic.

"In addition, the fund will take 10 years to completely fill through levees on European banks, meaning some kind of backstop needs to be in place in the interim. The “SRF Backstop” paper basically says: we need a backstop, but we’re still not sure what it should be or how it would work."

Two things. Unless euro area hopes to remain in the Great Stagnation for the next 10 years, we shall see growth in banks balancesheets. Over 10 years horizon (even if balancesheets grow at 1.5% = real GDP growth expectation for euro area + HICP target, so 3.5% nominal growth pa in balancesheets), the banking assets side (covered liabilities from the SRF perspective) will have expanded by 41 percent. In other words, to provide the same cover as today's EUR 55 billion the fund will require EUR 78 billion. Forget the idea that in its current vision SFR will only be sufficient to bailout two or three mid-sized European banks. We'll be lucky if it can bailout 1 or 2 of mid-sized European banks in 10 years time.

14/7/2013: Banking Reforms : recent links

Some recent articles on Banks Reforms in the global and EU context:

"A viable alternative to Basel III prudential rules" by Stefano Micossi (9 June 2013) argues that Basel III "…proposed reforms will fail to correct flaws in the old system. The new rules are even more complicated, opaque and open to manipulation. What is needed is a radical shift to prudential rule based on a straight capital ratio."
Link: http://www.voxeu.org/article/viable-alternative-basel-iii-prudential-rules


And in a typically Bruegelesque fashion, "Basel III: Europe’s interest is to comply" by Nicolas Véron (5 March 2013) argues that since "the EU was once a champion of global financial regulatory convergence", then "the EU should drop its lacklustre inertia and pursue Basel III because, in the end, it’s in its interests to comply. EU policymakers ought to aim at enabling the adoption of a Capital Requirements Regulation that would be fully compliant with Basel III."
Link: http://www.voxeu.org/article/basel-iii-europe-s-interest-comply

His colleague, Daniel Gros is of a view that diversification is a good thing, but diversification not i regulatory space. In his "EZ banking union with a sovereign virus" (14 June 2013) he argues that: "The doom-loop between banks and the national governments played a dominant role in the Eurozone crisis for Ireland and Cyprus. A Eurozone banking union is usually viewed as the solution. This column argues that the doom-loop cannot be undone as long as banks hold oversized amounts of their government’s debt. A simple solution would be to apply the general rule that banks are prohibited from holding more than a quarter of their capital in government bonds of any single sovereign." Here's the problem, however, in both Cyprus and Ireland sovereign bonds holdings of own governments were not a problem. In Cyprus the problem was holding of Greek Government bonds, and in Ireland, the contagion mechanism was from inter-bank lending and banks' own bonds issuance to the sovereign via a blanket 2008 Guarantee.
Link: http://www.voxeu.org/article/ez-banking-union-sovereign-virus


"Implementation of Basel III in the US will bring back the regulatory arbitrage problems under Basel I" by Takeo Hoshi (23 December 2012) says that "rejigging financial regulation is in vogue. But, in the world of international finance, how well do different regulatory systems join up?" In the US context, the author "argues that the US Dodd Frank Act and Basel III are, in part, incompatible and that harmonising them may lead to unintended consequences. The US ought to tread carefully here but should also try hard to maintain the spirit of better financial regulation."
Link: http://www.voxeu.org/article/implementation-basel-iii-us-will-bring-back-regulatory-arbitrage-problems-under-basel-i


There's a huge amount of opinion published on Voxeu.org on bank regulation: http://www.voxeu.org/debates/banking-reform-do-we-know-what-has-be-done


ZeroHedge classic: http://www.zerohedge.com/node/475643 "The Secret Sauce Of Iceland's Success Story: Debt Liquidation?" argues that "That Iceland is so far the only success story in the continent of Europe, which continues sliding into an ever deeper depressionary black hole, as a result of the complete destruction of its financial sector and its subsequent rise from the ashes, is by known to most. …As it turns out, perhaps the biggest jolt to Icelandic economic growth is what we said was the correct prescription for resolving not only the US but global growth malaise that struck in 2008: debt liquidation."


Irish Times covers the outright bizarre and sublimely ironic day-dreaming that is going on in Ireland's highest policy circles. The latests instalment is transformation of the IFSC into a sort of "We've screwed up so comprehensively, we can sell this as competence" story: http://www.irishtimes.com/business/sectors/financial-services/ifsc-faces-radical-rethink-as-effects-of-crash-become-clear-1.1460832?page=2

Pearls of wisdom: "Ryan’s paper makes eight proposals, including “relaunching the IFSC brand” along product lines – global asset finance, a global servicing platform and a global listing platform." All of which have been already in place for years to various success. "The document recommends the creation of a JobsHub to allow firms seeking staff to “find people quickly and cost effectively”." Other things: setting up IFSC as a centre for 'bad banks' on foot of 'experience already present in NAMA'. This is the logic of converting Dublin Bay into a global toxic refuse dump for the UK and European waste disposal, because we 'already have considerable expertise' at the Poolbeg waste facilities. And last, but not least: converting IFSC into "global centre of excellence for property"… Even the Irish Times could not have escaped the obvious irony present in this idea.


Last, but not least, Bloomberg report on Michel Barnier balmy ideas on 'Bank-Crisis' plans for the EU: http://www.bloomberg.com/news/2013-07-09/eu-steels-for-battle-over-bank-resolution-plans-led-by-germany.html from July 9. "The European Union’s executive arm proposed procedures for handling failing banks with a 55 billion-euro ($70 billion) backstop, setting up a showdown with Germany over control of taxpayers’ cash." Good summery of current play on this.

15/5/2013: What IMF assessment of Malta has to do with Ireland?

Here's an interesting excerpt from the IMF Article IV conclusions for Malta, released today (italics are mine):

"In the longer term, regulatory and tax reform at the European or global level could erode Malta’s competitiveness. The Maltese economy, including the financial sector and other niche services, has greatly benefitted from a business-friendly tax regime. Greater fiscal integration of EU member states and potential harmonization of tax rates could erode some of these benefits, with consequences on employment, output, and fiscal revenues."

Now, Ireland is a much more aggressively reliant on tax arbitrage than Malta to sustain its economic model and has been doing so for longer than Malta. One wonders, how come IMF is not warning about the same risks in the case of Ireland?


Another thing one learns from the IMF note on Malta: "The largest banks will be placed under the direct oversight of the ECB from 2014. The MFSA should work closely with the ECB to ensure no reduction in the supervisory capacity of these banks."

Wait, we've all been operating under the impression that direct oversight from ECB is designed to increase quality and quantity of oversight. Quite interestingly, the IMF is concerned that it might reduce the currently attained levels of supervision.

2/4/2012: Banks bailouts and bonds eligibility

Two important documents relating to banks bonds, Sovereign Guarantees and the bondholders' haircuts.

First, the ECB decision of March 21 that was rumored to have been implemented by the Bundesbank last week - allowing the NCBs not to accept as collateral Government-guaranteed bank bonds from the countries currently in the EU-IMF financial assistance programmes (aka Greece, Ireland and Portugal). Here's the link. Key quote (emphasis mine):
"Acceptance of certain government-guaranteed bank bonds: On 21 March 2012 the Governing Council adopted Decision ECB/2012/4 amending Decision ECB/2011/25 on additional temporary measures relating to Eurosystem refinancing operations and eligibility of collateral. According to that Decision, National Central Banks (NCBs) are not obliged to accept as collateral for Eurosystem credit operations eligible bank bonds guaranteed by a Member State under an EU-IMF financial assistance programme, or by a Member State whose credit assessment does not comply with the Eurosystem’s benchmark for establishing its minimum requirement for high credit standards. The Decision is available on the ECB’s website."

Hat tip for the link to @OwenCallan of Danske Markets.

However, the latest information is that Bundesbank clarified that it will continue accepting all EA17 Government bonds. See link here. Confusion continues as to what Bundesbank will and will not accept.

Second, today's release by the EU Commission of the consultation paper on dealing with future banks crises and bailouts. Titled "Discussion paper on the debt write-down tool – bail-in". The paper clearly states (emphasis is mine, again):

"Rather than relying on taxpayers, a mechanism is needed to stop the contagion to other banks

and cut the possible domino effect. It should allow public authorities to spread unmanageable

losses on banks' shareholders and creditors."

The proposals advanced by the EU are not new: "In most countries, bank and non-bank companies

in financial difficulties are subject to "insolvency" proceedings. These proceedings allow either

for the reorganization of the company (which implies a reduction, agreed with the creditors, of its

debt burden) or its liquidation and allocation of the losses to the creditors, or both. In all the

cases creditors and shareholders do not get paid in full."

Per EU: "An effective resolution regime should:

• Achieve, for banks, similar results to those of normal insolvency proceedings, in terms of allocation of losses to shareholders and creditors
• Shield as much as possible any negative effect on financial stability and limit the recourse to taxpayers' money
• Ensure legal certainty, transparency and predictability as to the treatment that shareholders and creditors will receive, so as to provide clarity to investors to enable them to assess the risk associated with their investments and make informed investment decisions prior to insolvency."

There is no point at this stage to explain that in Ireland's case, NONE of the above points were delivered in the crisis resolution measures supported by the EU and actively imposed onto Ireland by the ECB.

It is, however, worth noting that the Option 1 advanced by the EU includes imposing losses on senior bondholders and that the tool kit for doing this includes debt-equity swaps. Readers of this blog would be well familiar with the fact that I supported exactly these measures.

20/07/2011: EU's Banks Levy is a dangerous idea that will impede reforms in the sector

The latest calls for introduction of the banks levy within the EU (see here) as:

• the means for financing some of the banks rescue measures and
• the means for reducing the probability of the future crises
  

represents nothing more than a cynical and/or largely economically illiterate attempts by the EU lawmakers to dress up new revenue raising measures as ‘reforms’.

The core problems with this proposals are:

1. With current market structure & declining competition in Euro area banking sector, this levy represents another hidden tax on European households & companies. The current environment in banking sectors in many EU countries lends itself to the incumbent banks being able to pass the levy on to their customers without incurring any, whatsoever, direct moderation either on their own leverage levels or stabilization of their funding streams.
2. xWith declined competition in the sector, the new levy will act to further reduce Returns on Equity for any new entrant into the market, thus effectively acting as a barrier to entry and the means for protecting European zombie banks from competition from non-legacy banking institutions.
3. A levy will do absolutely nothing to resolve the problem if Europe’s zombie banks unable to exist as functional banking institutions, but sapping vital deposits and savings out of investment stream, thus starving the European economies of capital. European banks require some €250-500 billion worth of funds to cut their dependence on public funding and ECB/CB emergency assistance for funding and capital. Raising €10 billion annually through the proposed banks levy is simply too little to address the above gap.
4. In many cases, this levy will in effect result in a transfer of taxpayers’ own or guaranteed funds from the banks balance sheets (where these funds are now being deposited to support capital and funding activities of the zombie banks) to the EU collecting body.
   

A recent (June 2011) IMF Working Paper /11/146, titled “Recent Developments in European Bank Competition” by Yu Sun clearly finds that introduction of the common currency and the current financial crises have led to repeated reductions in overall degree of competition within the European banking sector, compared before and after EMU (1995–2000), post-EMU (2001–07) and post-crisis (2008-09)."

"Columns (3) and (4) in the table below report the H-statistic (higher H-stat reflects higher degree of competition in the banking sector) and standard error before EMU for each country or region, columns (5) and (6) after EMU. Column (9) displays the changes in the H-statistics from pre to post EMU period."

Thus, “the overall competition level in euro area dropped slightly after EMU, from 0.699 to 0.518 while competition levels across member countries converged [the standard deviation of H-statistics of euro member countries drops from 0.17 before EMU to 0.12 after EMU]."

“The finding that large and financially integrated countries or regions tend to exhibit less competitive behavior than smaller sectors is in line with others studies, including Bikker and Spierdijk (2008), who also find some deterioration in competitive behavior over time for Europe’s banks. They argue that banks in large and integrated financial markets are pushed by rising capital market competition and tend to shift from traditional intermediation to more sophisticated and complex products associated with less price competition."

“While the small decline in the level of bank competition for the euro area is statistically significant, it is somewhat smaller than the estimates reported by Bikker et al. (2008) using an un-scaled revenue function. For Austria and Germany, a slight increase in the competition level of their banking systems is estimated; however, the increase is not statistically significant. The H-statistics in Finland, France, Greece, Italy and Netherlands dropped after EMU. At the same time, Spain, the U.K. and the U.S. experienced some small but statistically significant improvement in the competition level of their banking systems."

Before and after the recent financial crisis: “The recent financial crisis and possibly corresponding policies seem to have left a strong mark on bank competition in many countries, as indicated by the competition indicators before and after the crisis for the sample…. Columns (7) and (8) of Table 3 show the H-statistics after the financial crisis. In the U.S., Italy, Germany, Spain and the euro area, bank competition seems to have declined following the financial crisis; however the declines in Germany, Italy and euro area are trivial.”

Bank competition among large (top 50) and small banks (bottom 50): “For some countries, like U.S. and U.K., small banks compete more intensively, while larger banks in Austria, France, Italy, Portugal and Spain are more competitive before EMU. In other countries, the competition indicators of larger banks are not statistically different from those of smaller banks before EMU”. Competition within small and large banks: “The euro area, France, Greece, Italy and Netherlands have experienced a significant drop in competition in both small and large banks, while both banks in the U.S. and U.K. showed a noticeable increase."

So overall, “the euro area experienced a significant but small decline in bank competition after EMU and the financial crisis. Some studies with similar findings have attributed the decline in competition to the process of consolidation, and the movement of bank activities from traditional financial business to off-balance sheet activities [both anti-competitive processes have accelerated under regulatory blessings of many Governments since the crisis]. More importantly, competition levels in euro countries seem to have converged after EMU, not just at the average national market level, but also between different bank types and ownership [so that less competitive markets became more competitive with euro creation, while more competitive ones became less so]. Finally, following the financial crisis, competition fell in many countries, and especially in some countries where large credit and housing booms took place."

In this environment, in my view, introducing a banking levy will simply reinforce the existent market structure and further prevent markets-led corrective adjustments in the sector. At the same time, the levy will exert new costs and pressures on banks clients.