(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own.)
By Neil Unmack
LONDON, March 28 (Reuters Breakingviews) - European
officials are hurriedly denying that the Cypriot bail-in is a
“template”. Markets know otherwise. The good bank/bad bank model
adopted in Cyprus shows how banks can be recapitalised without
government funds whilst protecting insured depositors – thanks
to senior bondholders and uninsured depositors taking losses.
It’s the right model for the future. For now, it worsens life
for Europe’s weak banks.
Credit spreads jumped on Cyprus’ first bailout proposal even
though it spared senior bondholders. They rose further after
senior debt was bailed in as part of the revised bailout
proposal, which the head of the Eurogroup of finance ministers
commended as the way to tackle bank failures. Investors cannot
afford to believe the swift retraction of that comment. Indeed,
the back-peddling has not brought spreads down.
Hopes for direct recapitalisation of banks by the European
Stability Mechanism bailout fund are history. Investors
naturally worry that senior debt could end up recovering very
little after default, possibly nothing, particularly if banks
now fund themselves more heavily through non-bail-inable debt,
such as insured deposits and central-bank funds.
Bank credit spreads may not have much further to go. Fitch
Ratings reckons the historic five-year average bank-failure rate
is just over 7 percent. A credit default swap spread of just
over 140 basis points should therefore compensate for the credit
risk, assuming zero recovery. The Markit iTraxx index puts the
cost of insuring senor-ranking financial debt at about 200 basis
points over five years – comfortably pricing in the risks for
the providers of credit protection, at least for the strongest
Bail-in was always a question of when, not if. The end
result should be safer, smaller banks, stronger governments and
fewer taxpayer-funded bailouts. But in the short term, it will
exacerbate euro zone tensions. Weaker banks, particularly those
in southern Europe, face higher funding costs and greater
pressure to shrink, hurting the economy. A new sovereign-bank
doom loop could emerge. Corporate depositors in peripheral
economies know they risk bail-in if their government seeks a
bailout and is forced, like Cyprus, to haircut them. They may
panic when sovereign yields rise, causing runs – and bailouts.
For the euro zone to hang together, extra support - be it
cheap liquidity, or bond buying or bailouts - is inevitable. The
European Central Bank is going to have to work harder.
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- The Markit iTraxx index of credit default swaps tied to
senior financial institutions' debt reached 200 basis points on
March 27, up from 143 basis points on March 15, before the
Cypriot bailout and the highest level since October last year.
The index largely comprises swaps ties to bank debt. A rise in
credit-default swaps signals an increase in perceived riskiness.
- Jeroen Dijsselbloem, head of the Eurogroup of finance
ministers, said in a March 25 interview with Reuters that the
resolution of Cypriot banks would be a template for
restructuring euro zone banks. The terms of the bailout require
uninsured depositors and unsecured bondholders of Laiki
CPBC.CY to take a haircut, or so-called bail-in. He later
rowed back from the comment.
- “If there is a risk in a bank, our first question should
be 'Okay, what are you in the bank going to do about that? What
can you do to recapitalise yourself?” Dijsselbloem said in an
interview with Reuters. “If the bank can't do it, then we'll
talk to the shareholders and the bondholders, we'll ask them to
contribute in recapitalising the bank, and if necessary the
uninsured deposit holders”, he said.
- Reuters: Cyprus reopens banks under tight restrictions
- For previous columns by the author, Reuters customers can
click on [UNMACK/]
(Editing by Chris Hughes and Sarah Bailey)
Keywords: BREAKINGVIEWS CYPRUS/BAIL INS
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