JOSE Manuel Barroso's insinuation that Ireland infected the euro and its banking system can be safely filed away under 'popular fiction'. The EU Commission chief knows full well that the deeply integrated eurozone banking system is not cured of its chronic underlying disease -- too much debt.
The accumulating €700bn ESM fund is a measure of the scale of what may yet come if the current period of calm is merely an interregnum between crises. Europe's only escape route is economic growth at lift-off velocity -- an outcome that remains uncertain. What's less well understood is what's to happen first, before the ESM lends a cent to any eurozone government.
Pull the veil aside and what Ireland gifted Europe was the Cypriot solution debuting in March this year. This followed the template drawn up by the little-known Financial Stability Board (FSB) established by the G20 in London in 2009 and first chaired by the current ECB chief Mario Draghi. Its October 2011 report, Key Attributes of Effective Resolution Regimes for Financial Institutions, better called the Bail-In report, lines up deposits for haircuts and, where a sovereign is bordering on insolvent, depositor guarantee schemes may be breached before the cavalry arrives. The core of FSB thinking was adopted by an EU directive agreed between Barroso's EU Commission and EU finance ministers in Luxembourg in June 2013. No one is to become another Ireland. So as the year ends let's remind ourselves of March 2013 and Cyprus.
The Cypriot economy, roughly about an eighth the size of our own, contracted in 2009 following the US sub-prime crisis, plummeting commercial property prices by 30 per cent. Cyprus had allowed an outsized banking sector to grow, exposing a fifth of its assets to neighbouring Greek private sector debt. Bank deposits reached almost €100bn -- that's five times the size of the economy -- half of it from Russian businesses. Think Anglo on steroids.
On Saturday March 16 the Troika struck, the EU Commission, ECB and IMF announcing that a €10bn rescue, agreed with Cypriot negotiators, was contingent on a raid -- diplomatically termed a tax or levy -- on deposits at insolvent Cypriot banks ranging from 6.7 per cent under €100,000 to 9.9 per cent above. Horrified, the Cypriot parliament rejected the deal six days later, resulting in the closure and conversion of its second largest bank, Laiki Bank, to a bad bank -- much like Ireland's liquidated IBRC -- and a deep cut in deposits over €100,000 at Bank of Cyprus. Four in every 10 depositors were tapped for an amount of money equivalent to over 20 per cent of Cypriot GDP in return for worthless bank shares.
Dutch finance minister and president of the Eurogroup of finance ministers, Jeroen Dijsselbloem, gave the game away at the time: "Now we're going down the bail-in track and I'm pretty confident that the markets will see this as a sensible, very concentrated and direct approach instead of a more general approach." His blunt comments forced Barroso's EU Commission to soften the alarm his frankness spread, but the Dutchman echoed the views expressed by the German Finance Minister Wolfgang Schauble who had made it clear that insured deposits in Cyprus would be bailed-in because its government was insolvent.
Ireland's gift is that socialising bank losses by passing it to the sovereign to be paid off by taxpayers, must be avoided at all costs -- including depositor haircuts. That gift hasn't just permeated EU policy, but has gone global through the FSB into national policy and amending legislation from Australia to Indonesia and from South Africa to Brazil, according to GoldCore, the Dublin and London-based precious metal specialists, whose comprehensive report on bail-ins led by Trinity's Finance Professor Brian Lucey, and compiled by GoldCore's CEO Mark O'Byrne, follows the breadcrumbs with remarkable clarity and is compulsory reading.
Eric Dor, director of economic studies at 50-year-old Paris-based business school IESEG, has identified France as most at risk in the event of a new financial crisis, in a study that relies on models used on both sides of the Atlantic, the Volatility Laboratory of New York University Stern Business School and the Centre for Risk Management of Lausanne. Dor reveals who is least likely to be wearing Speedos if the tide goes out again in a fresh systemic crisis by calculating each bank's systemic risk index in the event of a 40 per cent stock market fall over six months -- like 2008, 1987 and 1929 all over again. The results are bracing, especially for those who fled these shores during Ireland's banking crisis for the perceived safety of big European brands.
Germany's highly leveraged bellwether, Deutsche Bank, would need between €78bn and €83bn in fresh capital, followed by Commerzbank at between €26bn and €28bn. The total required by German banks would reach between four per cent and five per cent of its GDP. French banks would require between 10 per cent and 12 per cent of French GDP totalling over €220bn, with Credit Agricole SA's infusion matching Deutsche Bank at €78 to €83bn, followed by BNP Paribas at €55bn to €61bn and Societe General at €45bn to €51bn.
Switzerland would face recapitalisation amounting to up to seven per cent of Swiss GDP with Credit Suisse Group AG requiring between €15bn and €20bn and UBS AG-REG between €9bn and €15bn. Meanwhile, of interest to the Irish market, Danske Bank would require between €11bn and €14bn, Barclays Plc €65bn to €95bn and Royal Bank of Scotland (which owns Ulster Bank) €39bn to €61bn. Belgium's KBC would need between €3bn and €6bn.
Ironically Europe also contains many of the world's strongest banks and sitting at the base of the top 20 as measured by the main credit rating agencies Moody's S&P and Fitch, is Rabobank -- despite being cut two to four notches from its previous AAA rating.
So park aside what you'll hear from politicians like Barroso, the European banking system is still vulnerable and until that changes here are my top 10 rules.
1 Expect future eurozone bank insolvencies to involve depositor bail-ins, swapping cash for worthless bank shares in surprise weekend moves followed by strict cash transfer limits.
2 Where sovereigns border insolvency, deposit guarantees are not sacrosanct.
3 Do not place more than €100,000 in any European bank and £85,000 in a British one.
4 Use strongest banks only for large deposits, corporate cash and for credit union holdings.
5 Diversification across the right assets remains the best defence.
6 Pay special attention to terms and conditions for lock-in periods that accompany higher interest rates.
7 Check out your bank's credit ratings and keep a watchful eye on any new dark clouds involving banks.
8 For deposits, at best, expect many years of negative returns after deducting taxes and inflation from the headline rate.
9 Bail-ins will account for at least eight per cent of liabilities in the event of a fresh eurozone systemic crisis, so deposits remain risky.
10 The ESM is highly conditional and is not designed to prevent bail-ins. It will take at least 10 years for a bank-levied resolution fund to gain scale, so don't expect safer ground to be reached for some time.