If European Banks Have So Much Cash, Why Are They Loading Up on Debt?

Brexit Fallout: The Impact on European Banks
  • Regulators will issue capital guidelines before end of year
  • Irish lenders are funded by deposits and don’t need the money

Irish banks are brimming with deposits and seeing little demand for loans, even with interest rates at record lows. Soon they will be the ones loading up on debt.

European regulators are drawing up rules designed to make sure banks improve their ability to deal with potential disaster. Lenders will have to sell hundreds of billions of euros in bonds in coming years to put more investors on the hook in the event of a bank’s failure rather than taxpayers. The European Banking Authority estimates as much as 470 billion euros ($517 billion) of financing is needed across the continent.

As home to the euro region’s worst banking crisis, Ireland is an important microcosm of things to come. Following the implosion of a real-estate bubble in 2008, Ireland injected 64 billion euros into its financial system, forcing the nation to seek an international bailout. Since then, its banks have become largely funded by deposits. At Allied Irish Banks Plc, its ratio of loans to deposits is 99 percent.

“This is an issue for many deposit-funded banks,” said Roger Francis, an analyst at Mizuho International Plc in London. “They don’t have much debt, but they will have to magic up some. We will see more debt issued by banks in Europe, even if loan book growth doesn’t justify it. ”

The regulations cover the minimum requirement for a bank’s own funds and eligible liabilities. They are due by the end of the year and force banks to issue securities which can be written down or converted to equity to recapitalize a lender if it fails. During the financial crisis, the senior bond holders were largely spared at the expense of taxpayers.

Following meetings with bank executives, Dublin-based securities firm Davy estimates that Irish banks will have to sell about 1.3 billion euros a year of debt. Spokespeople at AIB and Bank of Ireland declined to comment. The central bank said lenders may have to sell debt to meet any shortfall, while declining to comment on specific capital requirements.

For Irish banks, the money is purely to satisfy regulators rather than meet demand for their services. AIB’s total loans fell 9 percent in the first half of 2016 from a year before, while Bank of Ireland’s dropped 8 percent.

For more on how Irish banks are struggling to sell loans, click here

They will still have to incur the cost of selling the debt, which is more expensive because of the extra risk. Investors typically demand a yield premium to hold bonds that may be “bailed in” if a bank collapses. The difference in yields between two bonds issued by Barclays Plc -- one potentially vulnerable to losses and another that would be protected -- has averaged about 60 basis points in the past 12 months.

The yield on AIB’s senior bonds due March 2020 stood at 0.71 percent on Thursday, down from 0.89 percent at the end of June. Bank of Ireland’s April 2020 senior note yields 0.39 percent, compared with 0.14 percent for Irish government bonds maturing 2022. Moody’s Investors Service rates Bank of Ireland’s senior bonds at its second-lowest investment grade, while AIB’s note has a junk rating.

“The crucial thing for us is that the banks get a bit more time to get their credit ratings back up to where they were before,” said Stephen Lyons, an analyst at Davy. “These bonds will be seen as a bit more risky when the banks issue them, so the banks will likely have to pay a bit more.”

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