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The Rulebook: You put your bail-in in, you take your bail-in out

It’s becoming clear that the overall direction of travel, now that the Bank Recovery and Resolution Directive is in full implementation, is to allow retail investors off the hook, except, perhaps, when they are at the very bottom of the stack in equity.

Italy last year compensated retail investors who lost out after the bail-ins of four of its banks. And the Portuguese Ministry of Finance will soon judge whether 2,000 retail investors in Banco Espírito Santo should be compensated €432m in damages.

Previous rulings and official guidance across the globe have warned banks not to sell subordinated debt instruments to retail investors. And it seems that regulators are increasingly amenable to rescuing the remaining moms and pops from the debt stack so Europe can deal with its enormous NPL problem in a politically acceptable way.

The European Commission itself has already implied that there are ways around bailing in retail investors. And affording some flexibility to special situations is probably prudent, especially since the credibility of the entire BRRD regime would be at risk if a bail-in actually resulted in major direct losses by members of the public.

Italy has, of course, been desperately seeking a way to get around BRRD because so many retail investors hold subordinated bonds in their banks, including Monte dei Paschi.

The bank’s increasingly baroque plan to get rid of its NPL problem appears to have one kind of major flaw though. While senior, institutional holders of the floated securitization would be backed by a guarantee, retail investors in the equity get the junior chunks and the right to take part in a rights issue for the bank, putting them squarely at the bottom of the stack.

Meanwhile, it looks like, to the extent there is a risk transfer happening, it’s mainly Italian institutions that will take the exposure. So the Italian NPL problem is likely to stay right where it is.

BoE’s ‘guck’

The Rulebook's mother still makes fun of us occasionally by saying that we are just an adult version of our infantile self. Her cases in point:

1) As a baby, we would often crawl head first into a wall, sit back in shock and start wailing, crawl head first into the same wall, repeat;

2) Our first words were “I’m guck” — a garbled variant of “I’m stuck”; and

3) Our parents would sometimes put us on our back into a warm bath, and we’d start relieving ourselves vertically. The stream would sometimes hit us the face, which would make us angry, which would force a heavier stream, which would make us angrier, repeat. They’d let that cycle complete itself for their own amusement.

We only don’t mind saying this because we’ve just turned 33 and we proudly, only sort of still do one of those things.

But to be fair, so does the Bank of England.

The Old Lady announced on Thursday a cut to the bank rate to 0.25%, an expansion of QE to corporate bonds and a new term funding scheme.

The good news is the BoE thinks it’s going to not only hit, but exceed its 2% target inflation growth, largely due to the precipitous depreciation of sterling. The bad news is [cut and paste the good news here].

So the Bank decided to take action to combat the Brexit blues, with the dubious hope that maybe some banks will have freed up cash to lend to corporates that can’t fund in capital markets… even though governor Mark Carney had already said banks have plenty of money to lend (which he said that when he announced the countercyclical capital buffer won’t be increased, so that banks can have extra lending capacity they don’t really need).

And, the Prudential Regulation Authority is immediately giving banks the ability to discount certain central bank exposures when calculating the denominator for the leverage ratio — so they can have even more money to not lend.

The funding scheme the BoE is planning must be really innovative, because the last few Funding for Lending programmes were basically really Funding for Lloyd's programmes. It’s a big bank, sure, but it was pretty much the only one to use the cheap money.

What the BoE’s plan is likely to amount to is more mortgage lending and cheaper capital markets funding costs for UK companies.

From a DCM perspective, it’s all good. Banks are indeed more likely to see some sterling denominated bond issuance in the second half of the year, and sterling starved UK investors will surely not be able to resist.

‘Adam Smith… ANGRY!’

Meanwhile, the stress tests aren’t actually a very good thing, said think tank the Adam Smith Institute — a think tank that mainly says angry things about how free markets aren’t free enough.

In fact, the organisation says they create “false comfort”, at least in the case of the BoE’s tests. Pointing to cases of stress testing that found institutions healthy that would later fail miserably, and the notion that there is not a “single case where regulatory stress testing was ever proven to be of any use afterwards, ie by warning of an impending build-up so appropriate remedial action was then taken”, the Institute concludes the best option is a free-market competition to test banks (natch).

It does seem a bit like stress tests are a bit of a non-event. The results were pretty much correctly anticipated even for the EBA’s first stress test in 2014. Then, bankers and analysts predicted that there would be a handful of unsurprising failures to justify the validity of the tests without causing a shock to the system. That was true. It failed 24 banks, mostly in Italy, with some other mainly periphery banks to round it out.

Everyone knew that Monte dei Paschi would fail the 2016 test, if for no other reason than it was desperately trying to finalise and publicise a plan to get rid of its NPLs before the results were published.

And the assumptions made in any stress test are arbitrary, as Euromoney Conferences’ capital markets maven Richard Kemmish pointed out this week. In the EBA’s case, the tests kind of arbitrarily decided not to assume something that is already a fact, saying “the EBA is not properly taking into account negative interest rates, apparently because they want to avoid ‘shaping expectations of future monetary policy’ (really?!).”

That’s because negative interest rates aren’t applied in a way that reflects different business models. Some institutions tend to make more money in credit, some in rates, so they are disproportionately hard on, say, some German banks.

As for the BoE’s tests, angry Adam says, “an elementary analysis of the UK banks’ capital positions then shows that the UK banking system is actually very weak — a conclusion that the Bank of England’s ‘rocket science’ stress tests completely missed.”