The Cyprus fiasco has the hallmark of a classic whodunit. Someone somewhere took a decision that now no one no-where appears to have made – to impose an unprecedented levy on bank deposit holders in Cyprus. Most commentary on the deal has been terribly negative, sometimes alarmist – it will spark off bank runs in Spain or that it rips the shirts of the backs of the poor in Cyprus. There were some exceptions to this negative coverage including yours truly.
A school of thought agreed with the need for a depositor bail-in but was uncomfortable with not exempting depositors under the Euro 100,000 deposit insurance cap – though technically such a limit is irrelevant for the clever levy that has been proposed. We at Re-Define belong to this school and did not criticize the concept of bailing-in depositors having agreed with the IMF that this was both fair and unavoidable in order to make the numbers add up in the rescue of Cyprus.
The short but important conclusions from the all night summit of Euro area leaders can be found here.
First the good news, four very important decisions were taken 1) A decision to eventually hand the European Central Bank direct supervision of Eurozone banks 2) A decision to allow, in principle, the European Crisis funds the EFSF/ESM to directly inject equity into troubled banks 3) A decision to waive seniority or preferred creditor status that Member States had claimed for the ESM, for Spain’s rescue 4) An agreement to activate crisis support for Spain and Italy through the EFSF/ESM buying bonds in order to bring borrowing spreads down.
In this post we highlight how concerns about regulation driven excessive pace of bank deleveraging can be reconciled with tackling the problem of too-big-to-fail institutions which is now worse than ever, particularly in the EU.
We suggest that a much more differentiated approach is needed wherein financial institutions classified as systemically significant at the Global, European, Domestic level face more stringent regulations proportionate to their systemic importance and smaller, less risky banks, particularly those that have a more direct connection to the real economy are given more leeway. This post is loosely based on the advice we have given to EU policymakers on this issue.
The future of the Euro area banking system hangs in balance. It would not be an exaggeration to say that were it not for more than a trillion Euros of implicit and explicit public support in the form of capital injections and funding guarantees from Member States & liquidity support from the European Central Bank, the Euro area banking system could well collapse.
While some may think that, four years after Lehman’s collapse, the biggest problems of European banks are now over, that may not be true. All things considered, the biggest challenges for Euro area banks still lie ahead. In particular, the combination of largely unreformed banking models, large scale regulatory changes and uncertainties around their final shape as well as the worsening Eurocrisis mean that Euro area banks face very large, potentially insurmountable challenges.
This appeared as a Comment piece in the Observer (Guardian) on 11th December
EU leaders promised to stop Europe’s spiral into economic oblivion. They needed to immediately restore confidence in the solvency of Spain and Italy, urgently take steps to kick start growth and credibly commit to changes addressing the institutional weaknesses of the Euro area. They failed on all three fronts and are now almost out of time.
Given the inability of EU leaders to tackle the problems of Greece, a small economy, investors have been losing faith in their ability to support the much larger economies of Spain and Italy that faced economic problems. This has driven up the borrowing costs to unsustainable levels. Unless policy makers can demonstrate how troubled EU economies could meet their borrowing needs at non-penal interest rates, the crisis would continue to deepen.