Bank Lenders Dodge Losses Suggesting Loopholes in New Regulation

  • EU avoids bondholder haircuts in Greece, Italy, Portugal
  • SRB's Koenig says creditors need clear standards to invest

A critical pillar of Europe’s banking union is less than two weeks old, but already plans to make bondholders share the pain when lenders fail are running into old national habits.

Creditors are supposed to take losses when European financial companies collapse under rules that took final effect Jan. 1, but regulators’ actions late last year suggest that may be true more in theory than in practice. Bankers and supervisors in Italy and Greece found ways to shield investors in failing firms; in Portugal, regulators chose who should be impaired; and in Germany, private-sector protection schemes mean bondholders may never suffer imposed losses.

Nearly four years in the making, Europe’s banking union has encountered turbulence every step of the way, with Germany’s government resisting what it sees as attempts to underwrite weaker member states. Finance ministers on Friday will be briefed on the project’s status for the first time since the new rules have been fully in force.

“The practical effect of this is that people are going to get more creative,” said Nicolas Veron of the Brussels-based Bruegel research group. “We have a banking union on the books, but bankers are still acting as if banking-sector soundness was assessed by the marketplace on a national basis.”

The financial meltdown of 2008 that led to a debt crisis spiraling from Greece across the now 19-nation euro region prompted governments to embark on a banking union designed to break the link between failing banks and countries. Dutch Finance Minister Jeroen Dijsselbloem said on Jan. 7 that he’ll use his nation’s presidency of the EU to push for the completion of controls that would further integrate the bloc’s financial system.

Regulatory Haircuts

Even countries like Germany, one of the biggest proponents of strict rules to mandate creditor losses, have laid the groundwork to avoid regulatory haircuts by setting up private-sector solutions that don’t require immediate taxpayer funds. Veron said these mutual protection schemes, present in all levels of the German banking sector, benefit from implicit government guarantees, while letting regulators say the industry is successfully bearing its own costs.

Other tools like precautionary government aid and privately arranged debt swaps allowed struggling banks in Greece and Italy to steer clear of forced haircuts while winning approval from European Commission state-aid authorities. Regulators also have leeway to make exemptions that prevent contagion and preserve the public interest under the tougher rules that kicked in this year.

That strategy won the day in Portugal last month when regulators cherry-picked certain Novo Banco SA senior creditors to absorb losses from the failure of Banco Espirito Santo SA. Other bondholders were spared in a move that enraged investors and was defended by the Bank of Portugal as necessary “based on public interest” and “to safeguard financial stability.”

Greece also avoided bailing in creditors by overhauling its four biggest banks under the bailout it won in August, even though euro-area creditors made a special point of putting senior bondholders in line for losses in exchange for rescue funds.

Risky Investments

The EU’s new bank resolution chief wants exemptions to be a last resort under the bloc’s new framework. Single Resolution Board Chair Elke Koenig said creditors need stable rules to be able to invest with confidence and that precautionary bailouts should be used sparingly.

Greece was unique because its entire financial system was on the brink, Koenig said in an interview last month. Italy was another special case in the way it handled four small banks in November, when some of the nation’s big banks lent money to the public resolution fund to shield creditors from taking losses. This move earned a public guarantee, but no censure from EU competition authorities as long as the government credit line isn’t used.

Going forward, regulators need to do more to prevent retail customers from buying risky investments, Koenig said. Rather than using workarounds to shield family savings tied up in bank bonds, governments should focus on keeping that money out of harm’s way.

“Investors need to understand the game, market authorities need to understand the game, and need to know that if you buy a bond, you are a creditor,” Koenig said. “Say this is not an instrument for the average saver. Clearly after you have made a fortune and you are a very experienced saver you can go for that but make sure that you address the topic also from the mis-selling perspective.”

Regulators in the new year are seeking to wean lenders and their governments off their historic bailout habits. Portuguese Finance Minister Mario Centeno said on Dec. 21 that “the regulatory change that will take place on Jan. 1, 2016, will make all bank resolution processes more serious,” and Koenig said the industry needs to take note.

“I’m very much in favor of having very clear rules, at the same time, I’m also very much in favor of giving a bit of leeway to the authority,” Koenig said. “Hopefully we’re not getting started with such messy questions.”

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