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If we can’t nail down bail-in, we’re back to square one

By Toby Fildes
25 Jun 2013

Europe has hit yet another stumbling block on the path to banking union, just as central banks are being urged to look for an exit from QE. Without a solid financial system, including a resolution framework which gives the public confidence that bank failures can be handled, growth will continue to be constrained.

European banking union was always an ambitious project. The idea of centralising the regulation of over 8,000 banks, with myriad business models, across 27 EU member states, smacks of the “whatever it takes” desperation that has come to characterise the eurozone debt crisis. 

But when you think about it, it’s not much more insane than the idea of 17 different countries sharing the same currency, so it shouldn’t come as too much of a surprise. Saving the euro was always going to be an all-in bet.

Over the weekend, talks between European finance ministers over bail-in — one of the key building blocks of banking union — hit more obstacles. This is not what Europe needs, especially after Ben Bernanke’s justifiable insistence on considering a potential data-driven exit from quantitative easing has riled markets. 

EU commissioner Michel Barnier eloquently summed up the crux of the disagreements between Eurogroup ministers: Europe is not a federal system, and therefore a level of national discretion is necessary when the authorities are deciding how to rescue failing banks or resolve ones that are already past saving. But that flexibility must not compromise the integrity of the single market.

Black and white

But the whole idea of a pan-European resolution and recovery regime is that it specifies the exact process that must occur when a bank is judged to have reached the point of non-viability. The stability of any financial system is compromised when consumers are unsure about what is going to happen.

Given the lack of basic education about banking, a certain degree of misunderstanding in these situations is inevitable. But it is exacerbated if we do not have an established framework for dealing with the problem.

Take the example of the UK’s Co-op Bank. It took over a month for the bank to work out how it was going to fill its £1.5bn capital hole. That is a long time in financial markets, and if Co-op were a more systemically important institution, the shockwaves from the resulting uncertainty would have been far bigger.

In the end, Co-op Bank’s subordinated bondholders are set to suffer losses. It is a bail-in of sorts, but not quite. It is being conducted via a debt for equity swap. It panders to the political desire for bondholders to take the pain, rather than taxpayers, but uses coercive liability management as the mechanism to apply that pain. It’s messy and hardly the straight up haircut that bail-in is supposed to be.

Discretion = concession

The arguments for national discretion over bail-in are strong. Yes, different banks have different business models and funding structures. Yes, bailing in one banks’ investors could impact access to funding markets for other banks within that jurisdiction.

But it’s not enough to claim that every situation is an isolated case, meriting a different regulatory response. You can take that view, but if you do, you have to relinquish banking union.

Consumer and investor confidence is the bedrock of a thriving financial system. Confidence will only prevail if people have a good idea of what is going to happen if banks fail. Europe’s financial system is too deeply entwined by now for national regulators to pick and choose who shares the burden when banks fail. Such a policy is anti-confidence, and therefore anti-stability.

Set the rules. Enshrine the rules in regulation. Respect the rules. Do all of that, or you’re stuck with a bunch of idiosyncratic rules for idiosyncratic situations in idiosyncratic jurisdictions. If that is the case, we’re back to square one. And in that case, doing “whatever it takes” to save the euro might as well mean the ultimate act of self-sacrifice — letting it go forever.

By Toby Fildes
25 Jun 2013