“There’s no need for more evidence: bail-in debt doesn’t prevent bailouts. It’s time to admit this and move to a simpler solution that will work: more common equity.”
This was the conclusion of Federal Bank of Minneapolis president Neel Kashkari in July, following the involvement of public funds in three of four European bank rescues in a matter of months. “Regulators claimed that this was a unique circumstance, but there always seem to be unique circumstances when bailouts are concerned,” he observed.
It should perhaps be of little surprise that Kashkari is critical of European bank resolution procedures. In 2008, he was tapped by treasury secretary Hank Paulson to run the $700 billion Troubled Asset Relief Program at the tender age of just 35. It was capital injections from this fund that enabled many US banks to escape the current fate of their European counterparts.
Indeed, given that Italian taxpayers are now on the hook for as much as €17 billion as the result of the failure of two small banks that had already been recapitalized, Kashkari probably has a point.
The concept of bail-inable debt is the cornerstone of Europe’s Bank Recovery and Resolution Directive (BRRD) regulation, which is itself a cornerstone of the whole concept of European banking union. The president of the Federal Bank of Minneapolis may think that it is time to scrap bondholder bail-ins, but that is not going to happen any time soon.
Supporters of BRRD point to the fourth recent European bank rescue, that of Banco Popular in Spain, as a perfect example of BRRD working according to plan – subordinated bondholders and equity took the hit, and not a penny of public money was involved. This is true, but closer examination reveals quite a number of those unique circumstances that Kashkari points to.
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This is where the real Achilles heel of the BRRD concept lies. Every situation for which the new regulations are called into play will be different, and those differences can justify a multitude of exceptional circumstances that trigger the involvement of public money. The exceptions undermine, rather than prove, the rule.
On July 11, Elke König, chair of the Single Resolution Board, described the sale of Banco Popular to Banco Santander for €1 as “textbook-like”.
However, that textbook required a willing buyer to be part of the story. A slew of investors have subsequently launched legal claims against the deal, questioning both the determination of the €1 price tag and the fact that senior bondholders were not bailed in.
Santander itself has had to launch a €1 billion compensation scheme in an attempt to quiet investor unrest.
In the case of Monte dei Paschi di Siena, public funds were justified on the basis of a precautionary recapitalization, something that should only happen to avoid a serious disturbance in the economy of a member state and preserve financial stability. MPS is the fifth-largest bank in Italy.
“If bail-in debt couldn’t protect taxpayers from a mid-size bank failure when the global economy is stable, what are the odds it will work if a Wall Street giant runs into trouble when the economy looks shaky?” asks Kashkari, pointing out that the largest of the four banks to be rescued was just one 10th the size of JPMorgan.
In the case of the two Venetian banks, the unique circumstance was quite the opposite to that of MPS: it was deemed by the SRB that their resolution was not in the public interest. A buyer was again found for the banks (Banca Intesa Sanpaolo) but this time only for their good assets.
Indeed, in what looks like the deal of the decade, Intesa managed to be paid for the privilege of relieving the banks of any value that remained and leaving the state to sort out the bad stuff. This is particularly perplexing given that before the announcement of the banks’ deal with Intesa on June 23, they had also been pursuing a precautionary exemption solution along the lines of that granted to MPS since March.
As we have seen, this option is supposed to be open to banks when their failure risks a serious disturbance in the economy of a member state. Negotiations with the EC on this point had stalled, not because they did not meet the qualifications for a precautionary recapitalization, but because the EU wanted them to find an extra €1 billion in private capital to add to the €3.3 billion public funds they were seeking. When this proved impossible, they were suddenly deemed to not pose a serious risk to the Italian economy after all.
The fact that senior bondholders have remained untouched in all of these situations while taxpayers have been badly burned adds further to the sense that all that worthy burden-sharing that BRRD was designed to create is nothing more than a pipe dream.
Does this mean that bail-in is a waste of time? No. What it means is that BRRD is trying to impose it in legacy situations where politics will always be the driving factor behind decision making. And by imposing losses in an arbitrary manner on an investor base that it desperately needs to meet the region’s Minimum Requirement for Own Funds and Eligible Liabilities requirements, the European regulators may be doing more harm than good.