Yves here. Another sighting on the sorry state of Eurozone banks. Keep in mind that the Eurozone banking system is a prescription for bank runs, although they have mainly been the slow motion kind. First, the deposit guarantee schemes are national, not Eurozone-wide, and are typically very much underfunded. Second, even before the January 2016 effective date of the Bank Recovery and Resolution Directive, the Eurozone had made clear its fondness for bail-ins via the ones it forces on the two biggest banks in Cyprus in 2013, as well as encouraging banks to issue “co-co” bonds, as in bonds that were convertible into equity in a crisis. Their performance when Deutsche Bank looked wobbly in late 2016 confirmed what a bad idea they were.
Moreover, the predilection of bank regulators in Europe is to keep visibly sick banks functioning, which also encourages deposit flight. The extreme example was Greek banks, which were clearly bust but the ECB continued to deem solvent so as to provide support under Target2. That meant the authorities could put the banks under at any time by yanking the drip feed. Not a place anyone who feels exposed and has options would like to be in.
By Michael J. Schussele, a Registered Investment Advisor, MA, and CPA whose website is mjscpaplan.com. Originally published at his website, The Pursuit of Financial Happiness
I have been researching Eurozone banks’ excess reserves and repo availability for a few weeks trying to work my way through muddled commentary and sort the reality from the assumptions and found myself questioning what I know. In doing so, I have misstated to others what I am thinking and even the data, facts, and issues about which I am concerned. Sometimes it is best to just stand back and look for the string that pulls the material together.
I have yet to write that article which will address whether Eurozone banking rules to promote solvency of banks is creating a liquidity problem, because the Eurozone banking resolution authorities seem to have so badly mismanaged the Banco Popular resolution to the point of intensifying a bank run despite monitoring bank liquidity on a daily and hourly basis.
Banco Popular was Spain’s 6th largest bank having been in existence since the early 20thCentury and one of the more profitable banks until about 2016. In February 2017, it announced it had a €3 billion loss on asset writedowns and Non Performing Loan sales while maintaining it still had more than sufficient quality assets on its balance sheet.
By the end of May and first days of June reports were circulating that Banco Popular had received only €3.5 billion on €40 billion collateral rather than the €9.5 billion it had expected one month previously and had applied to the Bank of Spain for liquidity support receiving only 10% of the collateral it pledged drawing €2 billion and €1.6 billion which it managed to burn through in just a few days. Banco Popular had been down rated by all foud major credit rating agencies between April and the 19th of May causing institutional clients with minimum credit requirements for banking to start withdrawing deposits during as period when the bank was trying to receive bids to privately resolve though a sale of the bank. But on May31st, an anonymous EU official leaked to Reuters that an “early warning” had been issued. This was followed by an immediate denial by the Single Resolution Board, which would have been the entity issuing such an early warning. As a consequence, it experienced 20% daily drops in stock value on June1, 5, and 6 and by 6th June had supposedly endured (never publicly verified yet) €18 billion deposit outflows. While this may have been, according to EuroIntelligence, someone going to the press because the Single Resolution Board had communicated to the Single Supervisory Authority it was going to initiate early intervention measures, the communication to Reuters was the early warning had been issued, although, according to FROB (Spain’s resolution authority), the Single Resolution Board had notified them on June 3 of their intention to act.
This had caused some people to postulate that the Eurozone bank resolution mechanism actually encourages bank runs.
Additionally, the valuation of Banco Popular subsequently commissioned by the Single Resolution Board found a negative €2 billion to a negative €8 billion in a stressed scenario. Banco Popular was considered solvent immediately prior to this meeting its minimum regulatory capital requirements and a positive value of €11 billion, which would a €20 billion difference in value. This has caused many people, including Bank of Spain supervisors, to question and demand to know how those figures with such a huge range were determined adding to the controversy over whether this was an actual solvency crisis or rather a liquidity crisis caused by the valuation of its collateral by the bank of Spain and the ECB and the refusal of the Spanish government to defy Eurozone authorities and aid a private resolution.
Banco Popular was sold for €1 to Santander further consolidating banking in the Eurozone, which raises the issue of the Eurozone bank resolution process creating large, systemically dangerous banks in the Eurozone.
For several years I have communicated privately that I believe any Euro crisis will start in Spain and spread to Italy, which would be the keystone. I have come to believe it will not happen quickly but accumulate momentum over time. The ECB worked very hard a few years ago to strengthen the asset quality of Spanish banks and stabilize the Spanish banking system, while Italy had reorganized its small state banks prior to the Great Financial Crisis (Spain had not).
The Italian government has been actively seeking to resolve the two banks through a precautionary recapitalization based on the December 2016 legislative decree used to enable a precautionary recapitalization and liquidity support to Monte dei Paschi.and official statements. The Italian authorities have talked with several large Italian banks, although it appears to be devolving down to Intesa Sanpaolo. Veneto Banca will have a €85 million payment on a subordinated bond due on 21 June 2017 delayed until mid-September as a result of the legislative decree, because both banks need a total of €6.4 billion in capital while they try to sale bad debts and because the Italian government and the European Commission have been been debating for months the European Commission’s demand that private investors put €1.25 billion in both banks before any taxpayer money can be used. This European Commission demand has held the precautionary recapitalization from proceeding. It appears that a consortium of banks and private investors have rejected the European Commission demand and the Italian government is no looking for a good bank.bad bank split and sale of the good bank for €1 as no willing buyer wants to take on the non performing loans.
Under Eurozone bank resolution you have the choices of private recapitalization, private sale resolution, good bank/bad bank, or liquidation. If the European Commission is going to continue to insist on the €1.25 billion private investment in the two banks to permit Italy to use taxpayer money, the possibility of creating a bad bank becomes much more difficult. The only way I see it happening is if the Italian authorities either arrange the private investment to happen or if the Italian authorities defy the European Commission and act consistent with the 23 December legislative decree.
If this fails, it will only feed the anti-eEuro political climate in Italy, which is already looking at elections next year and the possibility of a more right wing government coalition of Berlusconi and Renzi. Then what happens in the Eurozone? And with Eurozone banks?