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

This column...

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

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  • rate this
    +3

    Comment number 170.

    @160 Up2Stuff
    I agree the issue is more comple but it's difficult to deal with that here.

    In the UK our political class bet the shop on financial services and R&D based industry (Pharms and IT) and lost the bet. The risk to the rest of us in financial services was always too high when successful but when they sold unreal products to themselves for abnormal profits the risk was far too high

  • rate this
    +4

    Comment number 169.

    The really galling think about this episode is that the Eurocrats were warned many times that the way they were setting up the Euro was fundamentally flawed. Typically they ignored the techies advice and did it anyway because they saw it as a step towards further integration and the USE that is their goal. All of those responsible should held to account (fat chance I guess).

  • rate this
    0

    Comment number 168.

    @160
    Where people are left free to make choices, it is possible they will make wrong choices for all sorts of reasons.

    For example, if everyone here moaning about what banks did prior to 2009 had applied for loans in the years prior to autumn 2007 and been turned down ...

  • Comment number 167.

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

  • rate this
    0

    Comment number 166.

    Robert you are fixated by banks, many in Greece don't trust banks now.

    4. People (here in Greece) are withdrawing their money and putting it in a box under the bed.

  • rate this
    +2

    Comment number 165.

    #157 FTP Where does banking remain heavily regulated? What kind of regulatory system would allow banks to inflate their balance sheets to a level greater than the GDP of their domiciled nation.

    Who is regulating the $700 trillion of derivatives? Who (in the UK) is regulating rehypothocation?

    Who is regulating mark to fantasy accounting and who is regulating HFT algos?

  • rate this
    -4

    Comment number 164.

    re 153's score.

    There appears to be some poor soul who thinks that it is a good idea to destroy the England, the UK or our major trading partner the EU. Is there no limit to this stupidity?

    Whoever you are - try to understand if our customer or supplier is in difficulty WE will suffer dire consequences. Can you please try to understand this! Cease the bigoted anti EU/UK hatred.

  • rate this
    +3

    Comment number 163.

    #157 FallingTP - managing the risk of government intervention is part of the risk assessors' remit. Isn't that why they are rating government bonds?

    The reality is that risk is ignored until their gravy train is threatened to be derailed. No supervision happens of any great merit. And the bottom line is profit.

    Banks use the wall to stop, not brakes. That's why regulation needs to be tightened.

  • rate this
    0

    Comment number 162.

    That's tight, Up2snuff (160.). It's that complicated that we wouldn't be able to understand....

  • rate this
    +3

    Comment number 161.

    157.fallingTP

    "Banking was & remains heavily regulated"

    Perhaps, but we did and still have a fiat fractional banking system that allows banks to create money from thin air by adding some zeros to a computer screen - they can then leverage these new 000's to create more 000's by shifting around World Markets. This is utterly unsustainable.

  • rate this
    0

    Comment number 160.

    @155
    Can't help feeling that's a tad simplistic. Whether in the US or the UK, I still feel the whole thing was a combination of factors - in the UK rather more than the US.

    To merely blame deregulation alone, or bankers' hubris alone, is to deny the interconnectivity of social patterns, economic trends, fiscal choices, legislation changes, market forces, etc., in a globalised age.

  • rate this
    +1

    Comment number 159.

    At last, the free market is starting to work. Depositors are seeing the risks and moving their money. But what do the politicians do? Head it off with an innocuous sounding "depositor protection scheme", or more accurately “more state aid” or "another taxpayer funded bailout". Badly run banks should be allowed to go bust in a very public way as an example and warning to others.

  • rate this
    0

    Comment number 158.

    Okay FTP - Give us the real explanation - take several 400 ch. stabs at it.

    Spirit-of 56. Greenspan knew this was happening and fully chose to ignore it, he virtually egged 'em on.

  • rate this
    +1

    Comment number 157.

    "Greenspan concl..unregulated model doesn't work"

    Well as his monetary policy was one of majorl causes it's hardly surprising he looks to deflect blame. To argue that market leading up to 2008 was "unfetterd" is simply not true. Banking was & remains heavily regulated. Blaming non-existent free market for crisis that clearly result of govts extensive interventions in that market is unfair.

  • rate this
    0

    Comment number 156.

    Falling TP Many
    Even Alan Greenspan concluded from the crash that the simple unregulated model doesn't work, that risks were not factored into prices either of bank stock or of their products. If the unfettered market mechanism doesn't work then the solution has to be more regulation to allow for this.
    Unless you would prefer the system to collapse and all that entails including Marxist glee!

  • rate this
    +2

    Comment number 155.

    It is not so much regulation as self-discipline. What is the point in crashing a system that makes you money?

    The banks were so stupid yet somehow they have avoided the proper Darwinian outcome.

    This is now long overdue and should be encouraged from all sides: left or right. It makes no difference: these indebted institutions are now a huge mill-stone round the neck of our civilisation.

  • rate this
    0

    Comment number 154.

    "than relying on discredited economic theories"

    And what discredited theories are these?

  • rate this
    -1

    Comment number 153.

    147. jpwrighty "how it will affect the whole House of Cards known commonly as the EU."

    Don't wonder, get down on your knees and pray our states (EU / UK / England etc) survive as the consequence of failure of any one might be as bad as the end of the Roman Empire. (Economic Development level in 400 was not returned to till 1700! - 1300 year Depression.)

    Get used to those callouses on your knees!

  • rate this
    +2

    Comment number 152.

    Watch the example of Coryton slowly but surely expand, spread across the UK.
    Simply too expensive to do stuff in the UK now.

    http://www.bbc.co.uk/news/uk-england-essex-18239627

    And the governments response?

    http://www.bbc.co.uk/news/business-18231285

    Get young people indebted. And the sooner the better.

    Frightening, unbelievable, stupid are just some words that come to mind.

  • rate this
    +1

    Comment number 151.

    146.fTP

    Perhaps using a bit of common sense rather than relying on discredited economic theories, of either hue, would explain the whole matter better.

    Banks lobbied for lighter regulation whilst retaining the Too Big To Fail status. Why wouldn't they? They had their own key personnel in positions of power to their bidding for them. Then they just used the system to their own advantage.

 

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