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ECB creates structural problem

As banks returned to the primary bond markets and their stocks rallied through the first quarter of 2012. Michel Barnier, European commissioner for internal markets and services, felt sufficiently confident to move ahead with the design of bail-in procedures for writing down bank debt in the event of imminent failure.

Barnier had delayed this key feature of the regulatory overhaul amid the financial panic at the start of the year. His plan now is to iron out the final details of how creditors will bear the costs of recapitalizing banks and to put final proposals to the June G20 meetings of heads of state.

No sooner had Barnier announced his determination to finalize quickly the remaining key questions of the triggers and timing for applying debt write-downs, which debts should be written down and to what extent to ensure restoration of banks’ essential functions, as well as the hierarchy of creditor claims, than the key pillars supporting benign financial conditions in the first quarter began to falter.

Weak economic indicators at the start of April revived fears of recession and with them the burden of bad debts on banks. Sovereign-risk fears revived and financial markets saw more risk-off days. Citi economists now suggest Spain could need a troika deal to ease it through a temporary pricing out from private debt markets this year.

Once again, investors in bank debt face concerns that closed the funding markets to bank issuers last year: their de facto relegation below not only depositors but also secured creditors in banks’ capital structure at a time when bank balance sheets are ram-jam full of doubtful assets.

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