The European Commission's final bail-in consultation paper, published on March 30, states that short term liabilities — defined as those with an original maturity of less than one month — should not see losses forced onto senior unsecured creditors. It also says that other short term liabilities — those with an original maturity of between one month and one year — should only be bailed in after longer term instruments.
This sounds sensible in theory, but in reality it creates a mismatch. Regulators are trying to push banks away from short term funding, fearing that institutions that are overly reliant on short term markets could fall prey to the kind of liquidity crunch that helped to sink Lehman Brothers in 2008.
But sparing short term debt from bail-in, as the EC is suggesting, could instead encourage banks to issue more short term paper. Some bankers estimate that once finalised, bail-in legislation will add 25bp-50bp to banks’ senior spreads. If short term senior debt is immune from bail-in, it will, to an extent, be immune from that increase in cost.
While this may be an exaggeration — banks are extremely unlikely to switch all their funding into maturities of less than one year — it nevertheless highlights the regulatory minefield that the EC must navigate when legislating for bail-in.
Short term debt must be given some sort of exception when it comes to bail-in. Equally, banks will continue to term out their maturities to satisfy regulators. But short end investors might be encouraged to stick to debt of less than one year if the EC precludes it from bail-in. That could mean banks lose the money market interest that helped drive deals so impressively in the 18 month to two year part of the curve in the first quarter of 2012.
Cynics might say this mismatch is an example of poor communication between Europe’s various policymakers. The EC must recognise this. Not to do so would undermine confidence in regulators’ ability to work together and their capacity to legislate effectively.
With the bank finance markets still fragile after last year’s shutdown and subsequent rescue by the European Central Bank’s long term refinancing operations, uncertainty is the last thing issuers and investors need.
A balance must be struck somehow, or the EC risks creating materially different risk profiles within the senior unsecured format.