Sovereign restructuring: Cyprus bail-in signals new eurozone order
Prompt for bank deposit and bond repricing... or a catalyst to accelerate bank harmonization efforts.
Opinion remains sharply divided on whether the precedent established in Cyprus by the taboo-breaking imposition of losses on uninsured depositors and senior bondholders – two classes of creditors that have largely been insulated from haircuts to date, outside of liquidation – will serve to fragment or reconsolidate the eurozone banking system. When Dutch finance minister Jeroen Dijsselbloem, president of the Eurogroup, touted Cyprus as a ‘template’, market consensus decided that the €17 billion bailout would change the rules about who pays for future eurozone bank restructurings, with the bail-in of creditors kicking in as a first resort, rather than recapitalization through the European Stability Mechanism.
EU officials de facto introduced the core element of the upcoming Recovery and Resolution Directive in the Cyprus bailout by restructuring bank liabilities outside the normal bankruptcy process with the so-called bail-in tool – affecting all bonds – established by statute rather than contract. This contrasts with the previous EU claim that any bail-in tool would be implemented via contract, rather than by statute, and only from 2018.
Although the loss for bondholders in Cyprus was exacerbated by their relatively small representation in the pool of total bank liabilities, the outsized nature of many EU national banking systems relative to GDP and the rise of asset encumbrance in banks’ funding all highlight the “likelihood of low recovery rates” for unsecured bondholders during future restructurings, notes Matt King, global head of credit strategy at Citigroup.
The jury is now out on whether a wave of repricing for uncovered deposits and unsecured bonds across the eurozone will kick in – increasing bank financing costs – or whether the reprivatization of bank liabilities, signalled by the Cyprus bail-in, will ultimately serve as a eurozone crisis circuit-breaker.
“Our funding costs will go up. But I’m quite happy to see that and our CDS spreads widen if that’s the price of demolishing the myth that we are dependent on state support,” the CEO of one national champion bank tells Euromoney. That’s fine for him to say: his bank is well placed to survive; some competitors far less so.
Barclays Capital analysts estimate that higher deposit rates could cost the eurozone banking sector around €8 billion annually – 6% of its profit. This extra burden, combined with the urgent need to finance national deposit guarantee schemes, plus a resolution fund, mean the broader consequences of the Cyprus saga equate to a €15 billion annual reduction of eurozone banks’ profits, 11% of the total, the analysts argue.
The projections echo the Institute of International Finance’s bearish – and self-interested – claims that economic growth, banking stability and the transmission of monetary policy in the eurozone will now be held under siege thanks largely to the precedent established in the Cyprus bailout. “Instead of mutualization of bank liability in case of need, it [the Eurogroup’s crisis-resolution plan] has become bailing in bank creditors and depositors. Such concerns could exacerbate the current outflow of deposits from troubled countries, adding to bank funding strains.”
But other analysts pour scorn on the notion that the Cyprus package will trigger a large wave of deposit repricing and outflows from banks in the periphery. “It is not so much that ‘Cyprus is a template’ (or otherwise) – Cyprus is the application of the already existing template to an unusual banking sector with large uninsured deposits and very little senior unsecured debt,” says Daniel Davies, banks analyst at Exane BNP Paribas, citing no systematic change in liquidity conditions, both during and subsequent to the restructuring, and the fact that the EU bail-in legislation has been on the cards for around two years.
Davies argues that continued bank bond issuance, a lack of stress in the wholesale bank funding market, and the fact there has been no material increase in surplus deposits at the European Central Bank by core eurozone banks are all evidence “that there has been no generalized shift of deposit balances from the periphery to the core, or that any such movement has been “recycled” through the interbank system”.
|Willem Buiter, Citi’s chief economist|
What’s more, the EU Troika, by facing down the threat of market contagion and forcing losses on creditors, might be sowing the seeds of a eurozone recovery, according to Citi’s chief economist, Willem Buiter. “On balance, the accelerated restructuring of insolvent banks initiated in Cyprus should speed up the arrival of the day that excessive leverage of banks, sovereigns and (in some member states) households, is a thing of the past, thus removing demand-side impediments to sustained growth,” he says. Echoing this sentiment, Zsolt Darvas, research fellow at Bruegel, a Brussels-based economic think-tank, argues that the Cyprus crisis will accelerate the EU’s banking harmonization efforts. “A single supervisory mechanism and a common resolution framework are now more important than ever and rightly on top of the political agenda,” he says. ECB governor Mario Draghi last month called for the common eurozone resolution framework to be introduced in 2015 rather than 2018. Nevertheless, German chancellor Angela Merkel’s rejection of “a unified European deposit insurance - at least for the foreseeable future” on April 25, highlights the holes in the EU banking union plan and how the solvency of national deposit guarantees will remain exclusively tied to the sovereign, laying bare the financing risks of bank rescues in the periphery.