Preventing capital flight from banks in crisis-hit countries has been a priority for eurozone policy makers. But have they just shot themselves in the foot?
At the height of the region’s debt problems, the amounts held by foreigners in banks in Spain, Italy and other eurozone “periphery” countries shrunk worryingly.
Recent months have seen signs of improvement – thanks to a pledge by the European Central Bank to prevent a eurozone break-up, as well as government efforts to boost confidence in the banking system.
However, analysts warn the latest initiative to build a resilient eurozone “banking union” – which will put deposits by large corporations at risk of being “bailed-in” to rescue trouble-hit banks – may have the opposite effect and spark renewed capital movement away from the continent’s troubled southern economies while benefiting banks in the north.
“There’s already been a reassessment of risk between periphery and core over the past two years which has led to foreign deposits being moved away from the periphery,” says Huw van Steenis, banking analyst at Morgan Stanley. “The bail-in directive could potentially accentuate this reallocation.”
The change in the eurozone bank landscape is illustrated by the decline in foreign deposits since the collapse of Lehman Brothers investment bank in late 2008. Before then, the amounts held by foreigners in banks of the eurozone countries had been rising steadily. By the first quarter of this year – the latest period for which comparable ECB data are available – the total had dropped back to levels last seen in mid-2005.
Worst hit were the periphery countries. Unlike domestic depositors, large foreign depositors usually have easy alternative homes for their money. When fears of a eurozone break up were at their most acute, bankers say international companies were routinely sweeping accounts daily to remove funds from potentially vulnerable countries, with knock-on effects for economic growth.
“It raises the cost of credit for [periphery] banks and so they’re less able to provide credit to the economy,” says Myles Bradshaw, a portfolio manager at Pimco, the world’s largest bond fund manager.
Plans for a “banking union” were launched against that background. In March agreement was reached on a ‘single supervisory mechanism’ whereby the Frankfurt-based ECB will supervise the eurozone’s biggest banks. EU authorities are also working on a continent wide deposit guarantee scheme that would insure deposits to a certain amount to stop depositors moving their cash abroad if local banks run into trouble.
Progress on a banking union has been slow – and fallen short of initial expectations. But while the pledge a year ago by Mario Draghi, ECB president, to do “whatever it takes” to preserve the euro’s integrity has had a far greater effect, eurozone politicians’ actions have arguably also helped restore confidence in the region’s banking system. Recent ECB data on total bank deposits have suggested, for instance, that March’s banking crisis in Cyprus had relatively few lasting effects beyond the Mediterranean island.
Cyprus’s international rescue ended up imposing a “haircut” or levy on bank deposits over €100,000; at one point smaller depositors would also have been hit. Last week’s bail-in” proposals were part of plans for dealing in the future with failing banks without taxpayers having to pick up the bill. EU leaders agreed that ordinary savers’ deposits, as well as those for small and medium-sized companies, would receive special protection in the event of a bank default. However, large corporations’ deposits were excluded from the protected list – placing them squarely in the chopping line for losses and forcing them to reassess where they keep their money.
For companies with deposits in Greece, Portugal and Spain that is likely to provoke fresh nervousness.
“The bail-in agenda makes a lot of sense, but like all policies there are unintended consequences,” says Mr Bradshaw. “After these proposals I expect the trend would be for companies to hold their cash in large, systemic financial institutions in core countries such as France or Germany.”
The push for “depositor preference” threatens other, knock-on consequences. One could be to shunt senior unsecured bank lenders further down the credit hierarchy, leading them to demand more compensation for the greater risks they are shouldering. In turn, that will increase banks’ financing costs.
“If there’s a greater onus on bondholders taking a loss so where’s the quid pro quo?” asks Steve Hussey, head of financial institutions credit research at AllianceBernstein. “If we’re going to be treated like shareholders, we will want a greater say in how the bank is run . . . there needs to be a pay-off.”
The effect could be to encourage even more fragmentation across the eurozone banking system, bankers warn.
“Investors who want to stay in liquid credit will have to continue to buy financial institution debt,” says Alexandra MacMahon, head of financial institutions debt capital markets at Citigroup. “However, we do expect to see increased differentiation between different banks’ pricing levels, not least as investors reward banks with higher capital cushions which can absorb losses before senior bonds become at risk.”