No magic potion for eurozone banks

Woman withdrawing money from an ATM

As I mentioned a couple of weeks ago, the biggest short-term risk to the stability and cohesion of the eurozone is that banks in the financially stretched southern European countries run short of cash, as their depositors and creditors withdraw their money faster than it can be replaced by the European Central Bank.

The slow and silent run on banks in Italy and Spain - and Greece, of course - is a reality, according to bankers and regulators, although not yet a lethal one.

It has gained momentum with the rising probability of Greece leaving the eurozone, because that has increased the associated risks of loss from default or devaluation for those with money in banks deemed more likely (than others) to follow Greece out of the currency union.

Interestingly, British banks with subsidiaries in these countries are beneficiaries of this disenchantment with the local banks: they are gaining deposits at the expense of indigenous rivals.

There are three trends:

  1. Foreigners moving their money out of Greece, Italy and Spain, because for them even a small risk of devaluation or default is not worth taking. This is the biggest change to the structure of eurozone banking right now. It matters, because big international banks depend on borrowing from big multinational businesses, financial institutions and wealthy individuals.
  2. Local depositors moving their money out of more vulnerable banks to bigger stronger banks and foreign banks. So in Spain, Santander has picked up deposits from the savings banks. And, as I mentioned, British banks with branches in southern Europe are also seeing an influx of clash.
  3. Locals moving their money abroad, often from the local branch of a Greek bank - for example - to a German branch of the same bank.

In response, two things have happened. There has been an acceleration of work on the creation of a Europe-wide deposit protection scheme. And there has been a flurry of activity in Spain to create the perception that its weaker banks are being strengthened.

However, in both cases, what's going on may be rather less helpful and pertinent than it may seem.

Let's take the deposit protection scheme, for example.

If, as seems likely, the Commission says quite soon that it is full steam ahead to the creation of a pre-funded scheme that would give retail depositors across Europe the confidence that their savings up to 100,000 euros are safe, that might well be a good thing in the long term.

But quite apart from the obvious problem that these things take an age to agree in the detail and then implement, such a scheme misses the point of the current crisis.

It would give no protection against the biggest immediate risk for depositors, which is that the value of their savings could halve in a devaluation.

And, if it were a eurozone protection scheme, rather than an EU scheme, it would not protect against default - because if a country were to leave the eurozone, it would presumably also be obliged to leave the deposit protection scheme.

Now there are lots of interesting and important things to be said about whether the eurozone and the European Union needs more centralised regulation of banks and more centralised protection of depositors for the stability of its banking system in the years and decades ahead. I will come back to those issues later this week - because they have fascinating ramifications for the future of bank regulation in the UK.

Bankia logo covered in grafitti The Spanish government’s rescue of Bankia may hasten a bailout of the country

But for the immediate challenge of rebuilding confidence in Greek, Spanish and Italian banks, any talk of a pan-European deposit protection scheme is irrelevant at best.

I say "irrelevant at best", because if - as seems likely - any new scheme would leapfrog the putative new protection scheme and retail depositors to the head of the queue for repayment when a bank collapses, there is the risk that banks on the cusp of being deemed vulnerable would find it even harder to borrow from financial institutions, because the status of these non-retail creditors would be downgraded (you may have to read that paragraph a few times for it to make sense - sorry).

And what of the Spanish government's supposedly bold plan to inject 19bn euros of new capital into Bankia, the country's largest pure retail bank, laid low by reckless property lending? Well there is a wonderful story about this in the Financial Times, which - if you are a geek like me - will either make you laugh or cry.

What the FT says is that the financially challenged Spanish government is a bit worried about raising the 19bn euros by selling government bonds in the normal way - because, as probably hasn't escaped your notice, investors have become more wary of lending to Spain, and its borrowing costs have therefore risen very sharply (the implied interest rate on 10-year loans to Spain was 6.4% this morning).

So rather than borrow the 19bn euros from third-party investors in the normal way, the Spanish government wants to give Bankia 19bn euros of its bonds in return for a majority stake in the bank - or so the FT says.

Now you might think this would be a very odd way to restore confidence in either the finances of an important bank or of a rather important eurozone government: one load of government IOUs of questionable intrinsic value would be swapped for a dubious right to future profits in a bank whose foundations have been crumbling.

On the face of it, what would be transpiring is only a little bit better than two individuals on the verge of bankruptcy promising to honour each other's debts.

But it is a bit better than that, because of the magnificent rules of central banking. The point is that Bankia can take those 19bn euros of Spanish government bonds and swap them for cash at the European Central Bank.

Hey presto, as if by magic, problem solved: Bankia would have billions in new capital and cash.

Except that if Bankia has really been strengthened by this financial engineering, then there would have to be a very significant transfer of risk to the European Central Bank - and therefore, by implication, to its shareholders, or the other central banks and taxpayers of the eurozone.

However, the European Central Bank, under its statutes, is not supposed to take that kind of risk. And, on the basis of recent history, it is fair to assume that the Bundesbank and many Germans would go bonkers if they thought they were really being forced to bail out a bank that bankrupted itself by rampant speculation on land and property.

So presumably, if the deal is allowed to proceed, the ECB will ensure that all the risk actually remains with Bankia and the Spanish government - and therefore with Spanish taxpayers - by imposing a massive discount (or haircut) on the amount of cash it would exchange for the bonds.

Which means that the deal may turn out to be too clever by half.

If it creates the perception among Spain's creditors that the Spanish government has secretly recognised that it cannot afford the true costs of strengthening Spain's banks, Spain will find it even harder to borrow. So the backdoor bailout of Bankia could actually hasten the day when Spain asks its EU partners for a bailout.

Robert Peston, economics editor Article written by Robert Peston Robert Peston Economics editor

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This column may be a bit quiet for a bit, because I am away from the office.

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  • rate this

    Comment number 30.

    27 - You're right about the credit expansion under Brown (though it started in 83). But who demanded the laws be changed and who made all the money out of it? The CoL ran rings round NuLab and they are completely compromised by that era - as damaging as Lamont & ERM - and its also notable where most of the luminaries of that government are now working

    And who has been left with the obligations?

  • rate this

    Comment number 29.

    21 Watriller

    What is the point of growth, when you export this straight to China, and the middle east.

    Fix trade imbalances, both huge surpluses and huge deficits are bad.

    Borrow/Print money to infinity does not work.

  • rate this

    Comment number 28.

    The true financial horror of Spain is yet to be revealed. Losses continue to be hidden in just about every crevice of the Spanish financial system.

    Government sanctioned misdirection abounds, and there remains a Spanish penchant for mass delusion - probably because memories of reality remain and are ultimately painful.

    Meanwhile Deutsche Bank...

  • rate this

    Comment number 27.

    "Brown understood causes of Financial Crises and called US Banking and Toxic Instrument's to blame."

    LOL. Under Brown we saw the bigeest expansion in credit imaginable. Who controls MS - BOE. If you mis price the stuff for sucha lengthy perios the consequences are all too plan. There are plenty of lessons from history.

  • rate this

    Comment number 26.

    Eurobonds would sort things out, automatically moving the situation closer to a USA T-bills type scenario

    Monetary integration or Monetary collapse

    Make your choice now folks

    So the euro would be like the dollar, with a Euro-Fed in charge of monetary policy

    Germany resisting pressure to launch eurobonds

  • Comment number 25.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 24.

    One underlying problem is the decline in asset values. Banks lending policies pumped up values particularly in property, and as value declines, which surely it must in response to reduced demand, so the banks have much less security, but they do have security! To save the banking system the EU needs to preserve asset value, with low interest rates which has given imprudent borrowers a big benefit.

  • rate this

    Comment number 23.

    Is it any wonder?

    Last Friday, HMG spent £113m on schemes that may actually reduce the tax take at Treasury.

    Today, HMG is spending another £80m but, hopefully {emphasis on hope} this expenditure might reduce the benefits bill, but evidence from the '80's&'90's has to be set against the hope.

    We cannot keep spending ...

  • rate this

    Comment number 22.

    I was under the impression the property speculation that led to this was largely funded by german banks? If so why should they not bear some of the risk/losses? As for prioritising retail customers in the event of bankrupty - surely big investors will feel justified in putting their interest rates up to even more ruinous levels.

  • rate this

    Comment number 21.

    The root of Bankia's problem is the collapse of the property/asset market which is being seriously exacerbated by austerity programmes in Spain and beyond. Symptoms are being badly treated. Eurozone has to move away from the ultimately self defeating Micawber moneynomics of austerity and ECB fund a recovery growth programme. Why no talk of the long term damage austerity is doing to economies?

  • rate this

    Comment number 20.

    " by ... wrecking 'real economy' and forcing massive state bailouts"

    This is just not correct. The economy was on an unsustainable footing for the whole of the 2000s. Govt spending blewout on back of this. Brown was borrowing massively when times were "good". Any downturn & disaster was ineviatble.

    For someone supposedly not poltical your posts have a huge poltiical bent!

  • rate this

    Comment number 19.

    Would be interesting to see target2 balances, and how far out of balance will they be allowed to go.

    Banks that are bust should be allowed to go bust, best way of wiping out the debt mountain.

    Continually fudging hides the problem, and will result in a bigger crash. (See Indian Rupee). Not a currency issue.

    Rather bad management is the problem.

  • rate this

    Comment number 18.

    The original function of a bank is to offer the depositor security for cash. We can see that is no longer assured by the banking system. So there is little merit letting a bank look after your money. The possibility of money being devalued would make any rational person seek to protect its value by moving it to a safe haven, so the flight of money will be exacerbated as bad press continues. Scary.

  • rate this

    Comment number 17.

    @11.Crystal Ball
    , the ECB could easily find itself bust!

    The ECB is the currency-issuer of the Euro. It can never run out of Euros so it cannot be forced to go bust due to liabilities in Euros, it can decide to go bust or be told to by its political masters to go bust but it cannot be forced to go bust

  • rate this

    Comment number 16.

    The poison pill swallowed by the banks is giving unsustainable, unrepayable, economy crushing, credit to the property market.

    The idiots in the regulators let this happen - they were/arr either asleep or inept or cretinous - but they let this happen. This crushes the banks & in turn the economy for a generation.

    This is the situation of all the Western World's banks - both in the UK & the EZ.

  • rate this

    Comment number 15.

    Got much quieter in these hys eurozone threads recently

    Even the most fundamentalist pro-euro posters are finally waking up to the financial realities of the eurozone

  • rate this

    Comment number 14.

    It always comes back to the fact that people don't trust the ECB to do what a normal central bank would do & all the evidence is, they're right. The first step is a Greek bailout package that rebuilds the economy rather than destroying it combined with a guarantee to support the banking system then people will believe Greece won't be forced out of the Euro & neither will Italy or Spain

  • Comment number 13.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 12.

    Not sure about the lurid pic you suggest ... but ...

    ... the first duty of a Bank manager (as taught by the IoB in its exams!) is to ensure the security of his bank ...

    ... and that doesn't just mean locking the door at 5.30pm after switching on the alarms when you go home!

  • rate this

    Comment number 11.

    The last few years have seen the ECB taking on huge unsecured risk within the Eurozone. It's bought so much European debt from troubled EZ countries that when the current run on the banks turns into a full scale cascade, the ECB could easily find itself bust! That of course would be the end of the Euro and possibly the whole EU project!
    The ECB is effectively setting it's own trap to fall into.


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