Overnight we saw some interesting action on the Single Resolution Mechanism for the Eurozone banking system. From the FAQ.
The entry into force of the Single Resolution Mechanism and the Bank Recovery and Resolution Directive would mean that the shareholders and creditors accepted the losses of an ailing bank, just as in any other failing business. Instead of a bank being bailed out by taxpayers, it would be for the private investors in a bank to be bailed in.
The resolution fund consists of contributions from the banking sector. The idea of a resolution fund is not to replace private investors in absorbing losses and in providing new capital to a bank but to give financial aid such as guarantees or loans in the short or medium term to ensure the viability of the restructured bank and namely of its functions which are critical for financial stability and the overall economy.
The resolution fund would be built up gradually to ensure that banks’ lending capacity to the real economy was not negatively impacted in the short-term. Before it is sufficiently capitalised, the fund could, if necessary, levy additional funds from the banking sector. It could also borrow funds on the market. Under the draft Bank Recovery and Resolution Directive Member States would be free to decide what to do in this respect.
A public backstop could also lend money as set out in the draft Bank Recovery and Resolution Directive, notably in exceptional circumstances. This loan would be recovered from banks in the medium term to ensure that the mechanism was fiscally neutral. As the fund built up and banks’ capital positions improved, the need for credit from the public backstop would decrease in corresponding fashion.
As I have noted previously, the Eurozone is slowly trying to implement something along the lines of the Swedish plan, but there are still some serious issues with the implementation. As noted by the Swedish at the time of their own banking crisis, what needs to occur is two-fold. Firstly, swift and credible action and the availability of resources that ensures any operations are trustworthy by all economic actors. This is where the Eurozone has some serious issues:
The total target size of the resolution fund would equal 1% of the covered deposits of all banks in Member States participating in the Banking Union. In absolute terms and based on 2011 data on banks’ balance sheets, the fund would reach around €55 billion. The target size of the fund would be dynamic and increase automatically if the banking industry grew.
The fund would be built up over 10 years. This could be extended to 14 years if the fund made disbursements exceeding half of the target size of the fund. Thus, the banking industry would contribute annually around one-tenth of the target amount or in absolute terms, around €5.5 billion. The precise amount that an individual bank would contribute would be determined by a Commission delegated act taking into account the risk profile of a given bank.
After the initial phase to build up the fund, banks would be subject to additional contributions if their contribution basis grew or there were disbursements from the fund. If the available financial means of the fund became lower than half of its target size, banks would become subject to a minimum annual contribution of one quarter of the covered deposits of all banks in Member States participating in the Banking Union. In other words the banking industry would have to contribute around €14 billion per annum to the fund until it was fully replenished.
These figures are consistent with those underpinning the draft Bank Recovery and Resolution Directive, as set out in the impact assessment accompanying that proposal, revised and updated in light of developments since then.
The Single Resolution Fund would replace the national resolution financing arrangements of the Member States participating in it. Therefore, the Member States which have already established national resolution financing arrangements at the time of entry into force of this Regulation would be free to decide on the use of national financing arrangements according to their national law. For example, Member States could decide that those national resolution financing arrangements paid the contributions due to the Fund on behalf of their banks until those arrangements fully depleted.
Reuters has more on this point:
The European Commission proposed on Wednesday creating an agency to salvage or shut failed banks, but the absence of an immediate backstop fund to pay for a clean-up means it may struggle to do its job.
Working in tandem with the European Central Bank as supervisor, the new authority is supposed to wind down or revamp banks in trouble. It constitutes the second pillar of a ‘banking union’ meant to galvanize the euro zone’s response to the crisis.
If agreed by European Union states, the agency will be set up in 2015 and will eventually have the means to impose losses on creditors of a stricken bank, according to the blueprint.
But the new authority will be handicapped by the fact that it will have to wait years before it has a fund to pay for the costs of any bank wind-up it orders. In practice, this means it could be very difficult to demand any such closure.
Officials say the plan foresees tapping banks to build a war chest of 55 billion to 70 billion euros ($70 billion to $90 billion) but that is expected to take a decade, leaving the agency largely dependent on national schemes in the meantime.
So by 2025 there maybe a credible backstop fund. But seriously who is going to wait that long ? Spanish banks are already in serious trouble, and you’ll note that Spanish house prices continue to fall at pace, the Portuguese are also looking shaky, The Netherlands is on the beginnings of what looks to be a very slippery slope, and many other nations, Greece and Cyprus to mention just two, are still in significant economic strife.
But that’s not the truly immediate issue with this proposal. That, once again, is the German camp:
Germany has warned this may violate the EU’s basic laws by usurping national control over finances.
“We have to stick to the given legal basis, as otherwise we risk major turbulence,” German Finance Minister Wolfgang Schaeuble said yesterday in Brussels. “I would strongly ask the commission in its proposal for an SRM to be very careful, and to stick to the limited interpretation of the given treaty.”
Or in other words, German banks don’t want to be saddled with the burden of allocating capital to support the banking systems in other nations. This reaction should, of course, be no surprise to anyone following the European crisis for any length of time. German EU policy has always been about protecting domestic banks. Anything that levels the playing field against Germany, including things like EU-wide deposit insurance, has always been knocked back. With Basel pushing for further reform on risk-weightings, I can only see this getting worse because the German banking system has a significantly understated capitalisation issues that it would like to keep as quiet as possible.
This one certainly isn’t over, especially with just 2 months until the German elections.
In other poor news overnight we also saw a downgrade of Italy by the S&P, and you can assume the Italian banks will follow shortly:
Italy’s credit rating was lowered to BBB, or two levels above junk, by Standard & Poor’s because of expectations for a weakening of economic prospects and the nation’s impaired financial system.
The outlook on the rating, reduced from BBB+, remains negative, the New York-based ratings company said in a statement late yesterday. S&P analysts said that, even with unprecedented easing by the European Central Bank, real interest rates for non-financial companies in Italy exceed the level before the financial crisis.
“This is still two steps away from junk so that’s reassuring,” said Roberto Perli, a partner at Cornerstone Macro LP in Washington and a former economist for the Federal Reserve’s division of monetary affairs. “I can see some short-term volatility but not a lot more than that.”
Austerity measures, while enabling Italy to reduce its deficit to within European Union limits, deepened the nation’s slump. With the economy headed for its eighth quarter of contraction and joblessness at its highest since at least 1977, Prime Minister Enrico Letta in the last two months postponed a sales-tax increase and suspended a property tax payment.
“The rating action reflects our view of a further worsening of Italy’s economic prospects coming on top of a decade of real growth averaging minus 0.04 percent,” S&P said. “The low growth stems in large part from rigidities in Italy’s labor and product markets.”
So that’s the 9th largest economy in the world being downgraded towards junk, with a negative outlook. Again, nothing new, but this downgrade again highlights that the fundamental issues of Europe are yet to be addressed. Italy needs economic growth in order to continue to funds its massive debts, it still isn’t coming and the latest PMI data suggests the issue is getting worse. Italy’s political situation remains tenuous and with Beppe Grillo asking the Italian President to call new elections as well as stating that Italy needs to ‘renegotiate’ its public debts.
On the back of the Italian downgrade was a rumour of one for Spain as well, but at the time of typing that is yet to materialise and the latest report from the EC suggests it is happy with Spain’s on-going progress. Greek May industrial output was also reported overnight with a big fall of -4.6% Y/Y from revised +0.3% in April, while manufacturing production was down 1.8% y/y.
All up, this certainly was not the best 24 hours for Europe.