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 Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 370.

    nautonier @368

    EU/EZ problems - as you say - always 'easy to see', not by most 'seen'

    You might be proved 'right', but not "because equality is unacceptable" (the proposition undeclared unexamined ever-ready), and not inevitably necessarily so

    Reflect again on 'tectonic', not 'just' continental logic & 'human sentiment', but 'the powers that be' (BEHIND the political) at least for now

  • Comment number 369.

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

  • rate this

    Comment number 368.

    367.All for All

    "warning 3yrs"

    This is the bit that most do not get - being in Euro/EU/EZ - means equalizing everything between member states - wealth, growth, immigration,debts, taxes etc - means equality - but member states will never accept this like Germany & Netherlands etc.

    The EU can only FAIL - fully politically integrated or not - cos equality is unacceptable

  • rate this

    Comment number 367.

    "warning 3yrs"

    Trouble not same as demise

    Euro not 'merely political', but from tectonic momentum

    Forces now as then: ready (through us) for any price, inflation and / or conflict

    And if sense were to prevail? If the People were to say "Enough! Let there be peace! Settled personal equality, whatever the best distribution of capital & money-productivity!"

    Euro stronger than ever

  • rate this

    Comment number 366.

    365 U.Dreamer
    364 Comrade O
    362 TimOthy

    Tell me about it! Warn ME there's an EU mess waiting to happen
    Of course, is UK catastrophic - the first phase outcome(s) isn't clear yet - but why do you think I posted hundreds of times in last 3 years warning all & sundry about the EU mess?
    Those others who called me 'Little Englander' for warning about EU mess - are going to find real EU soon!

  • rate this

    Comment number 365.

    #362 Nautonier, if the Euro crashes, the world economy crashes with it. Most exposed will be the country with most exposure to foreign debt. Probably the UK.

    You better hope that we find away to escape the "inevitable" because the consequences of collapse for Europe including us will be horrific.

  • rate this

    Comment number 364.


    "the Euro/EZ was destined to fail/crash"

    Will we be getting it back?

    Are you sure it's wise to come out with predictions here? :-)

  • rate this

    Comment number 363.

    It's 2012 the end of the Mayan calendar. The end of the world is nigh. Do you not think that if you have been predicting the end of the EU for three years and it's still there you might actually be mistaken?
    I agree with you there he was a good choice and as those who chose him were democratically elected you could argue that he was too.

  • rate this

    Comment number 362.

    4 Hours ago

    Please try to get you head round the facts...

    I've been writing on here - arguing with you previously over last 3 years to the effect that the Euro/EZ was destined to fail/crash

    It's coming!

  • Comment number 361.

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

  • rate this

    Comment number 360.

    Actually Mr Monti is a good choice just the process was
    not proper democracy

  • rate this

    Comment number 359.

    It certainly wasn't the EU. It was by agreement between the major Italian political parties who couldn't agree on anything other than they didn't want the other lot to govern so they picked Monti instead. Where do you get your information from not even the Daily Mail I think?

  • rate this

    Comment number 358.

    EZ & EC Undemocratic ?
    Who elected the Italian prime minister ?
    It was not the people of Italy .

  • rate this

    Comment number 357.

    DONT AGREE that problem is on TOP LEVEL.Yes there are misalignment for historic reason.In the past the big 4 ( UK,FR,GER,IT)
    pushed a lot.And now the big 4 dont share much anylonger.Italy is too weak,UK to uninterested,FR in stranglehold of GER and GER
    totally surprised that others are asking NOW to lead the continent.A election of a president will make only a symbolic difference

  • rate this

    Comment number 356.

    No I have nothing to do with this but I do have an understandigng of implications for our business. As for you your comedy is worser than your "serious" postings which present me with even more laughter.

  • rate this

    Comment number 355.

    Do you really need to shout. As for the undemocratic where do you get that from?
    Your 351
    "600(no 500) million Europeans are ruled by 27 unelected commissioners"
    They are, since when? I'm not sure what you had for lunch either. Is this some form of alternate history? Is there another EU in another reality because I certainly don't recognise the one you are describing.

  • rate this

    Comment number 354.

    One point from Robert's interview with J C Trichet was that
    his warnings about removing the original EURO stability pact criteria
    - an annual budget deficit no higher than 3% of GDP
    - a national debt lower than 60% of GDP or approaching that value.
    were ignored by the EC ELITE because the project was a "political neccessity".
    BUT now it is a "political (& economic) disaster".

  • Comment number 353.

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

  • rate this

    Comment number 352.


    A nightmare

  • rate this

    Comment number 351.

    Open your eyes. The EC problem is mainly at the top level.
    You cannot have a system where 600 million
    Europeans are ruled by 27 unelected commissioners.
    It is a step back into fuedalism.
    Even Germany now says that the EC President
    should be ELECTED by the people of Europe.


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