The EU offers the member states a directive on bank failures to protect customer deposits and create a ‘safe’ environment for the financial industry. Individual European countries had to find their own way to deal with a weak economy and a failing banking industry.
Portugal, for example, announced plans to impose heavy losses on almost 2 billion Euro of senior bonds at Novo Banco, the bank created from the ruins of Banco Espírito Santo. This controversial move (prompting threats of lawsuits from some investors) was the latest in a series of rescue operations launched for struggling banks in Greece, Italy and Portugal in the last few weeks of 2015.
In each case, national authorities were rushing to complete the financial reorganisations before tougher new rules were introduced across the European Union at the start of this year dictating how failing banks should be restructured.
Europe’s new system, which puts bank bondholders at risk of a bail-in rather than leaving taxpayers on the hook for a bailout, was cemented with the creation on January 1 of the Single Resolution Board. This new Brussels-based body will take over responsibility for deciding when a bank has failed and for overseeing its “resolution”.
Some investors are warning that the inconsistent and confusing way that authorities are dealing with bank failures in the early days of Europe’s new banking union is likely to push up the cost of funding for weaker lenders and could trigger consolidation.
While banks still need to issue more debt that can be “bailed in”, overall bank bond issuance has been stagnating in Europe. Last year it fell by more than 10 per cent to 196 billion Euro, excluding covered bonds. Analysts suggest sales of bonds may rise this year, in part to meet the new requirements.
In Italy, the government opted to bail-in junior, or subordinated, bondholders at four small regional banks that had run into trouble in 2015. The rescues spared depositors and senior bondholders, while injecting 3.6 billion Euro from an industry resolution fund.
That move caused political uproar because many of the banks’ junior bonds had been sold to retail investors as savings products, including one pensioner who later committed suicide. The controversy has prompted the government in Rome to promise a “hardship” compensation fund.
In Greece, the four main banks were forced to raise billions of euros by selling shares and converting bonds into equity (both at deep discounts) before they could gain access to bailout funding from Europe.
In both the Greek and Italian cases, banks were rushed into recapitalising before the new EU regime came into force on the first of January, which could have meant losses for large depositors. When depositors have been bailed in before (such as in Cyprus three years ago) it has caused public fury and economic instability.
However, it is the Portuguese situation that has most upset investors. The central bank chose five senior bond issues out of a total of 52 to move from Novo Banco to the “bad bank” it set up to hold its toxic assets after a bailout in mid-2014.
Investors have cried foul, claiming Portugal is discriminating between holders of the same class of bonds and thus breaching the pari passu principle of equal treatment to protect domestic holders of the bonds.
Investors say that while Portugal rushed this through before the new EU rules came into force, it would not have been prevented from doing so by the new regime. Article 72 of the Bank Resolution and Recovery Directive cites several circumstances in which “resolution authorities should be able to exclude or partially exclude liabilities”.
For many investors, it remains an open question whether the EU’s new regime for bailing out banks will be an improvement on what has become an increasingly confusing and complex area.