Espirito Santo Shows EU’s Need for Speed Under Banking Rules

Banco Espirito Santo’s collapse showed that European Union regulators now have more powers to handle a failing bank. But do they have the cash?

Portugal’s maneuvers to contain the fallout from Espirito Santo, its largest lender by market value just a month ago, were helped along by some of the 6.4 billion euros ($8.6 billion) the government had left over from the country’s 2011 bailout.

Other European nations may not have such resources on hand and EU officials haven’t proved their default option of tapping investors is agile enough to tackle a crisis, according to Richard Murphy, director of U.K.-based consulting firm Tax Research LLP.

“Going to the markets takes months,” Murphy said in an e-mail. “Action to save a bank has to take place overnight.”

The need for speed raises the prospect of European governments facing cash crunches if more banks run into trouble during the European Central Bank’s Asset Quality Review. Lenders may require short-term public intervention because capital markets can’t step up in time, frustrating the efforts of creditor countries like Germany and the Netherlands to ensure that taxpayers are no longer on the hook for bank failures.

Portugal channelled its public rescue money through a bank resolution fund and will seek to recoup its costs when it can sell off the new bank created from the wreck of Espirito Santo. ECB President Mario Draghi said today this means taxpayers won’t pay the final bill.

55 Billion Euros

“The resolution fund owns this bank and probably and hopefully soon will sell it back,” Draghi said at a press conference in Frankfurt. “In this sense, there was no public money directly -- or eventually -- involved into this.”

Involving public money even temporarily counts as a rescue, countered Frances Coppola, a U.K.-based banking analyst. “On this, Germans are right,” she said by e-mail. “This is a public sector bailout of BES.”

After the four-year euro crisis forced five of the currency bloc’s 18 nations to seek rescues, EU leaders decided to create a banking union to prevent a new round of sovereign debt and financial-sector panics. The ECB will take over supervision and, over eight years, bank fees will build a 55 billion-euro resolution fund that can handle costs like those from Banco Espirito Santo.

Greece’s Pot

In the meantime, a country could request aid from the European Stability Mechanism. Yet policy makers say they purposefully made that option very hard to take.

The chances of the ESM stepping in are “very, very small,” Dutch Finance Minister Jeroen Dijsselbloem told lawmakers in The Hague on July 2.

So if nations are going to intervene, they may need to have the money on hand. And some are better placed than others.

Greece has about 11.5 billion euros in the Hellenic Financial Stability Fund, the bank recapitalization pool created as part of its own rescue. Greek authorities would like to use that money to repay debt and cover a funding shortfall in the next two years, yet they won’t be allowed to until after the AQR results come out. Italy, which hasn’t been bailed out, is only now developing a public backstop.

Nest Egg

“Portugal was fortunate that it had rescue funds in place to plug the capital shortfall,” Nicholas Spiro, managing director of London-based Spiro Sovereign Strategy, said in an e-mail. “Other peripheral economies with vulnerable banking sectors, notably Italy, may not be able to act as expeditiously given the paltry sums available.”

Portugal needed to cover the upfront costs of dealing with Espirito Santo by tapping its bank-sector nest egg left over from the bailout.

Until the resolution process is complete, the government, which only exited its sovereign bailout program in May, will be operating without much of its financial cushion. This may curb investors’ appetite for re-capitalizing other lenders because there are fewer resources to deal with follow-on problems, Barclays Plc economist Fabio Fois said in a note to clients.

Portugal’s rescue for Espirito Santo became necessary as it became clear the lender couldn’t raise privately the funds needed to stave off a bank run, Michael Huenseler, who helps manage 11.5 billion euros including bank shares and debt at Assenagon Asset Management SA in Munich, said in a phone interview.

“The chances of a recapitalization through the private sector got slimmer with each day that passed,” Huenseler said. Assenagon sold its holdings of BES’s subordinated and senior debt in May when the bank disclosed that its holding company had run into difficulties.

Before it's here, it's on the Bloomberg Terminal.