Tuesday 24 October 2017

Dan White: Eurozone's new banking deal may be a two-edged sword

There's no doubt bankers led politicians a merry dance, but new rules agreed by the EU could endanger stability, writes Dan White

Dan White

Dan White

LAST week's deal on bank resolution by EU leaders will transfer most of the costs of fixing future banking crises from governments to depositors and bondholders.

While we were all focused on the Anglo Tapes last week, the real banking action was taking place elsewhere. Although the sound of bankers behaving like, well complete bankers, had a certain grisly fascination, the agreement between EU leaders on a pan-European mechanism for dealing with bust banks was much, much more important.

When the Irish banking crisis finally erupted in September 2008, one of the big problems facing former finance minister Brian Lenihan was the fact that there was no legal mechanism for dealing with bust banks.

Whatever we may now think of the measures taken by the late Mr Lenihan and his colleagues, particularly the previous government's decision to unconditionally guarantee bank deposits and bonds, they were seriously handicapped by the complete absence of any legal framework. They were literally making it up as they went along.

With entirely predictable results.

As the contents of the tapes published last week reveal, when the crisis struck, the bankers were able to lead the politicians and regulators a merry dance. By the time official Ireland woke up to what had happened, it was too late and the Irish taxpayer was on the hook for €64bn of bank debts – a liability that would ultimately bankrupt the Irish state and lead to the November 2010 EU/IMF bailout.

Now five years and five bailouts later (Greece has had to be bailed out twice), the legal mechanism that was lacking in September 2008 is finally in place.

That's the good news – but as the saying goes, be careful what you wish for.

Ever since the Cypriot bailout last March it has been clear that German and ECB policy towards dealing with bust banks had changed. While the ECB was able to use the September 2008 guarantee to bully the Irish government into repaying bondholders in full in the run-up to our November 2010 bailout, it is now clear that such a template will not be used in future bailouts.

Instead it will be the Cypriot model, which saw depositors with more than €100,000 in the island republic's second-largest bank Laiki virtually wiped out, that will serve as the model in future.

Under the terms of the deal agreed last week, bondholders and large depositors will join shareholders in the firing line if a bank goes bust.

While depositors with up to €100,000 will continue to be guaranteed, the big boys will be expected to look after themselves.

So what are the implications, if any, of last week's bank resolution deal, for Ireland? While the outcome for this country would have been very different if the new regulations had been in force back in September 2008, that's now water under the bridge.

While under normal circumstances it could be expected that the government would attempt to use the new regulations to buttress its case (for Europe to retrospectively pick up some of the €28bn tab for recapitalising the continuing Irish banks), the publication of the Anglo Tapes and the political storm they have unleashed in Germany almost certainly puts the kibosh on these hopes, at least temporarily.

While it was always clear that any deal on retrospective recapitalisation would have to wait until after next September's German election, the cold fury evident in Angela Merkel's response to the tapes almost certainly means that any such deal, assuming it happens at all, will now be postponed until well into next year.

The Kanzlerin is not amused.

Meanwhile, as we continue to wait for a possible deal on retrospective recapitalisation, the new bank resolution regulations will come into force.

In the short term at least, the implications for Ireland are likely to be minimal. With the next set of bank stress tests having been postponed until 2014, the pressure is off the Irish banks for now.

If the new resolution rules have to be employed in the short term, then the banks of other peripheral eurozone countries (Portugal in particular springs to mind) are far more likely candidates. However, there is little doubt but that last week's agreement fundamentally alters the rules of the game.

Until last March, with the precedent of previous Irish and Spanish recapitalisations as evidence, eurozone bank depositors and bondholders could be fairly confident that their money was secure.

These certainties have been rudely shattered by last week's agreement. At the very least, large bank depositors will need to have their wits about them. What this means in practice is that large private depositors will have to perform the due diligence on banks that is already routine among large corporate depositors.

The danger is that last week's agreement will accentuate the "flight to quality" already evident in the eurozone banking system. Will last week's agreement, far from contributing to the stability of the eurozone banking system, lead to even greater instability instead?

Irish Independent

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