Description
The purpose is to analyse how the policy approach to the immediate problems in the
European financial sector has long-term effects on implicit protection of banks’ creditors and, thereby,
on risk-taking incentives
Journal of Financial Economic Policy
Resolving Europe's banking crisis through market discipline: a note
Harald A. Benink
Article information:
To cite this document:
Harald A. Benink , (2013),"Resolving Europe's banking crisis through market discipline: a note", J ournal of
Financial Economic Policy, Vol. 5 Iss 4 pp. 413 - 418
Permanent link to this document:
http://dx.doi.org/10.1108/J FEP-07-2013-0033
Downloaded on: 24 January 2016, At: 21:48 (PT)
References: this document contains references to 13 other documents.
To copy this document: [email protected]
The fulltext of this document has been downloaded 208 times since 2013*
Users who downloaded this article also downloaded:
J acopo Carmassi, Richard J ohn Herring, (2013),"Living wills and cross-border resolution of systemically
important banks", J ournal of Financial Economic Policy, Vol. 5 Iss 4 pp. 361-387 http://dx.doi.org/10.1108/
J FEP-07-2013-0030
Adrian Blundell-Wignall, Caroline Roulet, (2013),"Bank business models, capital rules and structural
separation policies: An evidence-based critique of current policy trends", J ournal of Financial Economic
Policy, Vol. 5 Iss 4 pp. 339-360 http://dx.doi.org/10.1108/J FEP-06-2013-0025
Wenling Lu, David A. Whidbee, (2013),"Bank structure and failure during the financial crisis", J ournal of
Financial Economic Policy, Vol. 5 Iss 3 pp. 281-299 http://dx.doi.org/10.1108/J FEP-02-2013-0006
Access to this document was granted through an Emerald subscription provided by emerald-srm:115632 []
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Emerald is a global publisher linking research and practice to the benefit of society. The company
manages a portfolio of more than 290 journals and over 2,350 books and book series volumes, as well as
providing an extensive range of online products and additional customer resources and services.
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*Related content and download information correct at time of download.
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Resolving Europe’s banking crisis
through market discipline: a note
Harald A. Benink
Center for Economic Research (CentER), Tilburg University,
Tilburg, The Netherlands and
Financial Markets Group, London School of Economics, London, UK
Abstract
Purpose – The purpose is to analyse how the policy approach to the immediate problems in the
European ?nancial sector has long-term effects on implicit protection of banks’ creditors and, thereby,
on risk-taking incentives.
Design/methodology/approach – The near term issues in European banking are discussed within
a framework for long-term reform along the lines proposed for a European banking union.
Findings – The author advocates conducting a thorough stress test with potential consequences for
unsecured creditors of banks proven to be insolvent. Losses may have to be imposed on these
creditors, following the example of recent cases in Cyprus and in The Netherlands.
Originality/value – There is widespread consensus among international policy makers that the
European banking system is seriously undercapitalized. Unlike the USA, Europe failed to recapitalize
its biggest banks following the ?nancial crisis of 2007-2009. It is now urgent to start recognizing losses
on balance sheets to avoid a proliferation of Japanese-style zombie banks in Europe.
Keywords European banking crisis, Bank stress test, Bank recapitalization, Bank resolution,
Unsecured creditors
Paper type Viewpoint
1. Introduction
There is widespread consensus among international policy makers that the European
banking system is seriously undercapitalized. Unlike the USA, Europe failed to
recapitalize its biggest banks following the ?nancial crisis of 2007-2009. Instead, policy
makers gambled that economic recovery would lift the pro?tability of ?nancial
institutions, enabling them to increase their capital buffers over time. It is now clear
that this strategy has failed. The euro zone is in a new recession and the depressed
share prices of many banks signal that they are in dismal health. In this paper, we
argue that it is now urgent to start recognizing losses on balance sheets to avoid a
proliferation of Japanese-style zombie banks in Europe. To facilitate this, we advocate
conducting a new and thorough stress test soon. As a consequence, losses may have to
be imposed on unsecured creditors of banks with insuf?cient capital, following the
example of recent cases in Cyprus and in The Netherlands. Such a solution to Europe’s
immediate banking problems would enhance market discipline in the banking sector.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1757-6385.htm
JEL classi?cation – G21, G28
This paper is an extended an updated version of – Benink, H.A. and Huizinga, H.P. (2013a),
“Banish the threat from Europe’s zombie banks”, Financial Times, May 6 (www.ft.com) and
Benink, H.A. and Huizinga, H.P. (2013b), “The urgent need to recapitalise Europe’s banks”,
VoxEU.org, June 5 (www.voxeu.org) – published with permission.
Journal of Financial Economic Policy
Vol. 5 No. 4, 2013
pp. 413-418
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-07-2013-0033
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2. Low market valuation, hidden losses and implicit state guarantees
On average, the market-to-book value of European banks now is about 0.50 (Figure 1).
This indicates that accountants’ estimates of bank capital are far too rosy, and that
banks have substantial hidden losses on their books. In a speech on March 28, 2013
Klaas Knot, Dutch Central Bank President and European Central Bank governing
council member, noted that restoration of banks’ balance sheets is a crucial
requirement for economic recovery (Knot, 2013). To facilitate this process, Mr Knot
states, it is essential to create transparency about losses in the banking sector and to
have an orderly resolution of loss-making assets. Without this, banks will remain
restrictive in making new loans. Mr Knot adds that the planned European banking
union offers an appropriate opportunity for speeding up the resolution process.
We agree with Mr Knot’s analysis. Unfortunately, an orderly resolution of
loss-making bank assets is still a long way off, despite the fact that Europe has
conducted several bank stress tests in the past few years. As reviewed by Hardy and
Hesse (2013), these stress tests, lately under the auspices of the European Banking
Authority (EBA), failed to be credible as they applied stress scenarios that were too mild
and enabled banks to be insuf?ciently transparent about their losses and exposures to
problem sectors. Moreover, the EBA announced that it would delay a new stress test
until 2014 in order to involve the European Central Bank (as part of its envisaged role as
the single supervisor for the euro zone’s largest banks from Summer 2014).
Until now, Europe’s banking sector has been kept a?oat by implicit state guarantees
of virtually all liabilities. Bijlsma and Mocking (2013) of the CPB Netherlands Bureau
for Economic Policy Analysis ?nd that in 2012 these guarantees provided banks in
Europe with an annual average funding advantage amounting to 0.3 percent of total
assets. They base this estimate on a comparison of banks’ diverging credit ratings in
scenarios with and without government bailout support. An annual funding advantage
of 0.3 percent of assets can be capitalized to be equivalent to 2 percent of total assets, on
the assumption of a discount rate of 15 percent commensurate with banks’ uncertain
earnings prospects. Given total banking assets of e33tn in the euro zone, we are talking
about an implicit guarantee of about e650bn.
The plight of Europe’s banks worsened considerably when Jeroen Dijsselbloem,
Dutch Finance Minister and Eurogroup President, stated on March 25, 2013 that the
approach taken in Cyprus of resolving failed institutions without using taxpayer
Figure 1.
Price/book value ratio
of European banks
Note: Monthly data from April 1980 through April 2013
Source: De Nederlandsche Bank (2013)
90 85 90 95 00 05 10
3.0
2.5
2.0
1.5
1.0
0.5
0.0
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money would in future preferably apply throughout the euro zone (Dijsselbloem, 2013).
Consistent with this, Wolfgang Scha¨uble, German Finance Minister, stated on
May 12, 2013 his desire “to ensure that enrolling taxpayers to rescue banks becomes
the exception rather than the rule”, and that to achieve this “we need credible EU bail-in
rules as soon as possible” (Scha¨uble, 2013).
Mr Scha¨uble’s preference for limitingtaxpayers’ contributions to bankrescues implies
that shareholders and unsecured creditors can be expected having to absorb losses more
often in the future. In Cyprus, in March 2013, this was already implemented for the
shareholders andunsecuredcreditors (notablythe holders of uninsuredsavings deposits)
of the two largest banks. In The Netherlands, in February 2013, losses were imposed on
shareholders and holders of subordinated debt of SNS Reaal bancassurance group.
3. Resolution procedures and recapitalisation in crisis management
In a recent study, on developing distress resolution procedures for ?nancial institutions
Wihlborg (2012) notes that a common a response of governments to signs of stress in
the domestic banking system is to issue a blanket guarantee for banks’ liabilities.
During and after the ?nancial crisis of 2007-2009 it has been very rare that unsecured
creditors have been forced to absorb losses. Furthermore, Wihlborg analyzes the
criteria on how to design credible and effective resolution procedures.
Both at the level of the Financial Stability Board, the Basel Committee on Banking
Supervision and the European Union important work on the resolution of banks in
distress is taking place. Alexander (2013) notes that the recent crisis demonstrates the
EU’s lack of a clear and predictable legal framework to govern how a distressed
?nancial institution would be reorganized or liquidated in an orderly manner without
undermining ?nancial stability.
As part of the single market program, applicable to 28 countries, the EU adopted a
recovery and resolution directive for banks on June 27, 2013. This directive, due to be
implemented in the national laws of EU member states in 2018, contains rules for a
bail-in of shareholders, bondholders and some depositors, thereby making it possible to
impose losses on unsecured creditors of banks.
At the same time, the 17 countries belonging to the euro zone are working on a
European banking union which will consist of a single supervisory mechanism(with the
ECB becoming the supervisor of the largest banks in Summer 2014), a single resolution
mechanism(which will be based ona cooperation of national resolution authorities in the
near future and which may involve into a European resolution authority), and a
European deposit insurance scheme. Also, on June 20, 2013, the euro group agreed upon
a framework for direct bank recapitalization: under certain conditions the permanent
rescue fund, the European Stability Mechanism(ESM), can recapitalize banks. However,
the total amount available is only e60bn.
As noted by Lastra (2013) there is an uneasy coexistence between the banking union
and the single market legislative processes. The twin banking and sovereign debt
crises in the euro area have revealed the inadequacy of the principle of decentralized
banking supervision in a monetary union. Though this weakness was recognized long
ago, indeed from the very beginning of the euro project, it has been magni?ed in the
context of the global ?nancial crisis.
In October 2012, the European Shadow Financial Regulatory Committee (ESFRC,
2012) issued a statement arguing that, unfortunately, European crisis management has
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become hostage to the negotiations to create a European banking union. Crisis
management requires prompt action to allocate losses in asset values while the banking
union is a longer termproject to enhance integration, ef?ciency and stability of ?nancial
markets and institutions.
Banks in Europe are saddled with ample unrecognised losses on their assets,
estimated by many observers to be at least several hundreds of billions of euros and
mirrored by low share price valuations, and an additional loss of their present funding
advantage will be crippling.
Financial markets well understood Mr Dijsselbloem’s message, as shown by a
subsequent decline in the share prices of many institutions. Very low bank valuations
imply that they will ?nd it very dif?cult to recapitalise themselves by issuing equity or
debt that is convertible into shares – in part because share issuance would further dilute
the value of implicit state guarantees. Low share prices, in effect, imply that banks can
raise only limited capital by issuing new shares, and that they may need to accept
reduced issuance prices. Very few large European banks are raising capital by issuing
new shares, no doubt as they realize that this is not in the interest of current
shareholders. As exceptions, Deutsche Bank raised almost e3bn in April, while
Commerzbank announced plans to raise e2.5bn through a heavily discounted rights
issue in May 2013.
It is now urgent to start recognising losses on balance sheets to avoid a proliferation
of Japanese-style zombie banks in Europe. To facilitate this, we advocate conducting a
new and thorough stress test soon, similar to the one administered by US supervisory
authorities in 2009. Of course, the ?nancial position of most governments in Europe is
much worse than that of the USA in 2009. So Europe needs to take a path towards
recapitalization that in some respects differs from the earlier US approach.
First, a credible stress test should assess the losses hidden on the balance sheet for
each bank, as well as the likely cost of the removal of implicit guarantees of all
liabilities. This will result in an estimated capital shortage, taking into account capital
levels as required by international bank supervisors. Recently, the Financial Services
Authority (2013) conducted a stress test of UK banks, resulting in a necessary
downward adjustment of reported regulatory capital of about £50bn, and a resulting
regulatory capital shortfall of £25bn. The estimated capital shortfall of £25bn is likely
to be a lowestimate, as it is by and large predicated on the continuation of implicit state
guarantees in the UK. At any rate, thorough stress tests in other European countries
are likely to reveal sizeable capital shortfalls as well.
Second, supervisors need to assess whether the capital shortfall can be ?nanced by
international capital markets and/or national governments. In case the required
amounts are too high, the bank immediately must be entered into a resolution and
restructuring process imposing some losses on unsecured creditors (the Cyprus model).
The legal basis for this would be an intervention law, which some European countries
may need to enact through emergency legislation. Most banks in Europe, in contrast
with their Cyprus counterparts, have signi?cant ?nancing by bond holders and can be
recapitalised by imposing losses on holders of subordinated and common debt without
infringing on savings deposits. An additional advantage of this approach is that it
re-imposes market discipline on unsecured creditors, giving them incentives to monitor
the riskiness of a bank and take disciplinary actions, such as requiring a higher risk
premium and/or higher levels of bank capital, in the future.
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Third, in the event that capital shortfalls are relatively small, supervisors could
instead implement the US model. This would mean that banks are given a limited
period of time to issue equity on international capital markets, after which national
governments step into provide the remainder of the equity shortfall.
4. Conclusions: recapitalization and the design of banking union
Europe has postponed the recapitalization of its banking sector far too long. And,
without such a recapitalization, the danger is that economic stagnation will continue for
a long period, thereby putting Europe on a course towards Japanese-style inertia and the
proliferation of zombie banks. It is urgent that European policymakers make the right
choices soon.
The way in which Europe recapitalizes its problem banks now has a direct impact
on the design of the future European banking union. If many banks are recapitalized
by imposing losses on unsecured creditors, such as holders of subordinated and
common debt, this is likely to be re?ected in the design of the single resolution
mechanism that will determine the extent to which bail-ins are mainstreamed in future
bank resolutions in the EU. A single resolution mechanism along these lines will make
it easier to reach agreement on the powers of the envisaged future European resolution
authority. Moreover, the adoption of the principle that unsecured creditors should
absorb most of the losses of problem banks implies that only limited residual potential
losses will be borne by European taxpayers through the ESM and through any future
European resolution fund. And, ?nally, if unsecured creditors of banks start perceiving
a credible threat of potential losses, their incentives for engaging in risk monitoring
and disciplining of banks will be increased, thereby enhancing market discipline.
References
Alexander, K. (2013), “Bank resolution and recovery in the EU: enhancing banking union?”,
ERA Forum – Journal of the Academy of European Law, March 27, available at:
www.springer.com
Benink, H.A. and Huizinga, H.P. (2013a), “Banish the threat from Europe’s zombie banks”,
Financial Times, May 6, available at: www.ft.com
Benink, H.A. and Huizinga, H.P. (2013b), “The urgent need to recapitalise Europe’s banks”,
VoxEU.org, June 5, available at: www.voxeu.org
Bijlsma, M.J. and Mocking, R.J.M. (2013), “The private value of too-big-to-fail subsidies”,
CPB Discussion Paper No. 240, available at: www.cpb.nl
De Nederlandsche Bank (2013), Overview of Financial Stability in The Netherlands,
De Nederlandsche Bank, Amsterdam, Spring, Chart 2, available at: www.dnb.nl
Dijsselbloem, J.R.V.A. (2013), “The FT/Reuters Dijsselbloem interview transcript”, Financial
Times, March 26, available at: www.ft.com
ESFRC (2012), “Resolution and recovery in a European banking union”, Statement No. 36,
European Shadow Financial Regulatory Committee, London, October 22, available at:
www.esfrc.eu
Financial Services Authority (2013), “Methodology note on calculating capital pressures”,
March 27, available at: www.bankofengland.co.uk
Hardy, D.C. and Hesse, H. (2013), “The future of Europe-wide stress testing”, VoxEU.org,
April 20, available at: www.voxeu.org
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Knot, K.H.W. (2013), ECB-Beleid in de Schuldencrisis (ECB Policy in the Debt Crisis),
De Nederlandsche Bank, Amsterdam, March 28, available at: www.dnb.nl
Lastra, R.M. (2013), “Banking union and single market: con?ict or companionship?”,
Fordham International Law Journal, Vol. 36 No. 5 (in press).
Scha¨uble, W. (2013), “Banking union must be built on ?rm foundations”, Financial Times,
May 12, available at: www.ft.com
Wihlborg, C. (2012), Distress Resolution Procedures for Financial Institutions: SUERF Studies,
2012/5, SUERF – The European Money and Finance Forum, Vienna, available at:
www.suerf.org
Corresponding author
Harald A. Benink can be contacted at: [email protected]
JFEP
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To purchase reprints of this article please e-mail: [email protected]
Or visit our web site for further details: www.emeraldinsight.com/reprints
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doc_652755739.pdf
The purpose is to analyse how the policy approach to the immediate problems in the
European financial sector has long-term effects on implicit protection of banks’ creditors and, thereby,
on risk-taking incentives
Journal of Financial Economic Policy
Resolving Europe's banking crisis through market discipline: a note
Harald A. Benink
Article information:
To cite this document:
Harald A. Benink , (2013),"Resolving Europe's banking crisis through market discipline: a note", J ournal of
Financial Economic Policy, Vol. 5 Iss 4 pp. 413 - 418
Permanent link to this document:
http://dx.doi.org/10.1108/J FEP-07-2013-0033
Downloaded on: 24 January 2016, At: 21:48 (PT)
References: this document contains references to 13 other documents.
To copy this document: [email protected]
The fulltext of this document has been downloaded 208 times since 2013*
Users who downloaded this article also downloaded:
J acopo Carmassi, Richard J ohn Herring, (2013),"Living wills and cross-border resolution of systemically
important banks", J ournal of Financial Economic Policy, Vol. 5 Iss 4 pp. 361-387 http://dx.doi.org/10.1108/
J FEP-07-2013-0030
Adrian Blundell-Wignall, Caroline Roulet, (2013),"Bank business models, capital rules and structural
separation policies: An evidence-based critique of current policy trends", J ournal of Financial Economic
Policy, Vol. 5 Iss 4 pp. 339-360 http://dx.doi.org/10.1108/J FEP-06-2013-0025
Wenling Lu, David A. Whidbee, (2013),"Bank structure and failure during the financial crisis", J ournal of
Financial Economic Policy, Vol. 5 Iss 3 pp. 281-299 http://dx.doi.org/10.1108/J FEP-02-2013-0006
Access to this document was granted through an Emerald subscription provided by emerald-srm:115632 []
For Authors
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Authors service information about how to choose which publication to write for and submission guidelines
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About Emerald www.emeraldinsight.com
Emerald is a global publisher linking research and practice to the benefit of society. The company
manages a portfolio of more than 290 journals and over 2,350 books and book series volumes, as well as
providing an extensive range of online products and additional customer resources and services.
Emerald is both COUNTER 4 and TRANSFER compliant. The organization is a partner of the Committee
on Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archive
preservation.
*Related content and download information correct at time of download.
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Resolving Europe’s banking crisis
through market discipline: a note
Harald A. Benink
Center for Economic Research (CentER), Tilburg University,
Tilburg, The Netherlands and
Financial Markets Group, London School of Economics, London, UK
Abstract
Purpose – The purpose is to analyse how the policy approach to the immediate problems in the
European ?nancial sector has long-term effects on implicit protection of banks’ creditors and, thereby,
on risk-taking incentives.
Design/methodology/approach – The near term issues in European banking are discussed within
a framework for long-term reform along the lines proposed for a European banking union.
Findings – The author advocates conducting a thorough stress test with potential consequences for
unsecured creditors of banks proven to be insolvent. Losses may have to be imposed on these
creditors, following the example of recent cases in Cyprus and in The Netherlands.
Originality/value – There is widespread consensus among international policy makers that the
European banking system is seriously undercapitalized. Unlike the USA, Europe failed to recapitalize
its biggest banks following the ?nancial crisis of 2007-2009. It is now urgent to start recognizing losses
on balance sheets to avoid a proliferation of Japanese-style zombie banks in Europe.
Keywords European banking crisis, Bank stress test, Bank recapitalization, Bank resolution,
Unsecured creditors
Paper type Viewpoint
1. Introduction
There is widespread consensus among international policy makers that the European
banking system is seriously undercapitalized. Unlike the USA, Europe failed to
recapitalize its biggest banks following the ?nancial crisis of 2007-2009. Instead, policy
makers gambled that economic recovery would lift the pro?tability of ?nancial
institutions, enabling them to increase their capital buffers over time. It is now clear
that this strategy has failed. The euro zone is in a new recession and the depressed
share prices of many banks signal that they are in dismal health. In this paper, we
argue that it is now urgent to start recognizing losses on balance sheets to avoid a
proliferation of Japanese-style zombie banks in Europe. To facilitate this, we advocate
conducting a new and thorough stress test soon. As a consequence, losses may have to
be imposed on unsecured creditors of banks with insuf?cient capital, following the
example of recent cases in Cyprus and in The Netherlands. Such a solution to Europe’s
immediate banking problems would enhance market discipline in the banking sector.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1757-6385.htm
JEL classi?cation – G21, G28
This paper is an extended an updated version of – Benink, H.A. and Huizinga, H.P. (2013a),
“Banish the threat from Europe’s zombie banks”, Financial Times, May 6 (www.ft.com) and
Benink, H.A. and Huizinga, H.P. (2013b), “The urgent need to recapitalise Europe’s banks”,
VoxEU.org, June 5 (www.voxeu.org) – published with permission.
Journal of Financial Economic Policy
Vol. 5 No. 4, 2013
pp. 413-418
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-07-2013-0033
Resolving
Europe’s
banking crisis
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2. Low market valuation, hidden losses and implicit state guarantees
On average, the market-to-book value of European banks now is about 0.50 (Figure 1).
This indicates that accountants’ estimates of bank capital are far too rosy, and that
banks have substantial hidden losses on their books. In a speech on March 28, 2013
Klaas Knot, Dutch Central Bank President and European Central Bank governing
council member, noted that restoration of banks’ balance sheets is a crucial
requirement for economic recovery (Knot, 2013). To facilitate this process, Mr Knot
states, it is essential to create transparency about losses in the banking sector and to
have an orderly resolution of loss-making assets. Without this, banks will remain
restrictive in making new loans. Mr Knot adds that the planned European banking
union offers an appropriate opportunity for speeding up the resolution process.
We agree with Mr Knot’s analysis. Unfortunately, an orderly resolution of
loss-making bank assets is still a long way off, despite the fact that Europe has
conducted several bank stress tests in the past few years. As reviewed by Hardy and
Hesse (2013), these stress tests, lately under the auspices of the European Banking
Authority (EBA), failed to be credible as they applied stress scenarios that were too mild
and enabled banks to be insuf?ciently transparent about their losses and exposures to
problem sectors. Moreover, the EBA announced that it would delay a new stress test
until 2014 in order to involve the European Central Bank (as part of its envisaged role as
the single supervisor for the euro zone’s largest banks from Summer 2014).
Until now, Europe’s banking sector has been kept a?oat by implicit state guarantees
of virtually all liabilities. Bijlsma and Mocking (2013) of the CPB Netherlands Bureau
for Economic Policy Analysis ?nd that in 2012 these guarantees provided banks in
Europe with an annual average funding advantage amounting to 0.3 percent of total
assets. They base this estimate on a comparison of banks’ diverging credit ratings in
scenarios with and without government bailout support. An annual funding advantage
of 0.3 percent of assets can be capitalized to be equivalent to 2 percent of total assets, on
the assumption of a discount rate of 15 percent commensurate with banks’ uncertain
earnings prospects. Given total banking assets of e33tn in the euro zone, we are talking
about an implicit guarantee of about e650bn.
The plight of Europe’s banks worsened considerably when Jeroen Dijsselbloem,
Dutch Finance Minister and Eurogroup President, stated on March 25, 2013 that the
approach taken in Cyprus of resolving failed institutions without using taxpayer
Figure 1.
Price/book value ratio
of European banks
Note: Monthly data from April 1980 through April 2013
Source: De Nederlandsche Bank (2013)
90 85 90 95 00 05 10
3.0
2.5
2.0
1.5
1.0
0.5
0.0
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money would in future preferably apply throughout the euro zone (Dijsselbloem, 2013).
Consistent with this, Wolfgang Scha¨uble, German Finance Minister, stated on
May 12, 2013 his desire “to ensure that enrolling taxpayers to rescue banks becomes
the exception rather than the rule”, and that to achieve this “we need credible EU bail-in
rules as soon as possible” (Scha¨uble, 2013).
Mr Scha¨uble’s preference for limitingtaxpayers’ contributions to bankrescues implies
that shareholders and unsecured creditors can be expected having to absorb losses more
often in the future. In Cyprus, in March 2013, this was already implemented for the
shareholders andunsecuredcreditors (notablythe holders of uninsuredsavings deposits)
of the two largest banks. In The Netherlands, in February 2013, losses were imposed on
shareholders and holders of subordinated debt of SNS Reaal bancassurance group.
3. Resolution procedures and recapitalisation in crisis management
In a recent study, on developing distress resolution procedures for ?nancial institutions
Wihlborg (2012) notes that a common a response of governments to signs of stress in
the domestic banking system is to issue a blanket guarantee for banks’ liabilities.
During and after the ?nancial crisis of 2007-2009 it has been very rare that unsecured
creditors have been forced to absorb losses. Furthermore, Wihlborg analyzes the
criteria on how to design credible and effective resolution procedures.
Both at the level of the Financial Stability Board, the Basel Committee on Banking
Supervision and the European Union important work on the resolution of banks in
distress is taking place. Alexander (2013) notes that the recent crisis demonstrates the
EU’s lack of a clear and predictable legal framework to govern how a distressed
?nancial institution would be reorganized or liquidated in an orderly manner without
undermining ?nancial stability.
As part of the single market program, applicable to 28 countries, the EU adopted a
recovery and resolution directive for banks on June 27, 2013. This directive, due to be
implemented in the national laws of EU member states in 2018, contains rules for a
bail-in of shareholders, bondholders and some depositors, thereby making it possible to
impose losses on unsecured creditors of banks.
At the same time, the 17 countries belonging to the euro zone are working on a
European banking union which will consist of a single supervisory mechanism(with the
ECB becoming the supervisor of the largest banks in Summer 2014), a single resolution
mechanism(which will be based ona cooperation of national resolution authorities in the
near future and which may involve into a European resolution authority), and a
European deposit insurance scheme. Also, on June 20, 2013, the euro group agreed upon
a framework for direct bank recapitalization: under certain conditions the permanent
rescue fund, the European Stability Mechanism(ESM), can recapitalize banks. However,
the total amount available is only e60bn.
As noted by Lastra (2013) there is an uneasy coexistence between the banking union
and the single market legislative processes. The twin banking and sovereign debt
crises in the euro area have revealed the inadequacy of the principle of decentralized
banking supervision in a monetary union. Though this weakness was recognized long
ago, indeed from the very beginning of the euro project, it has been magni?ed in the
context of the global ?nancial crisis.
In October 2012, the European Shadow Financial Regulatory Committee (ESFRC,
2012) issued a statement arguing that, unfortunately, European crisis management has
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become hostage to the negotiations to create a European banking union. Crisis
management requires prompt action to allocate losses in asset values while the banking
union is a longer termproject to enhance integration, ef?ciency and stability of ?nancial
markets and institutions.
Banks in Europe are saddled with ample unrecognised losses on their assets,
estimated by many observers to be at least several hundreds of billions of euros and
mirrored by low share price valuations, and an additional loss of their present funding
advantage will be crippling.
Financial markets well understood Mr Dijsselbloem’s message, as shown by a
subsequent decline in the share prices of many institutions. Very low bank valuations
imply that they will ?nd it very dif?cult to recapitalise themselves by issuing equity or
debt that is convertible into shares – in part because share issuance would further dilute
the value of implicit state guarantees. Low share prices, in effect, imply that banks can
raise only limited capital by issuing new shares, and that they may need to accept
reduced issuance prices. Very few large European banks are raising capital by issuing
new shares, no doubt as they realize that this is not in the interest of current
shareholders. As exceptions, Deutsche Bank raised almost e3bn in April, while
Commerzbank announced plans to raise e2.5bn through a heavily discounted rights
issue in May 2013.
It is now urgent to start recognising losses on balance sheets to avoid a proliferation
of Japanese-style zombie banks in Europe. To facilitate this, we advocate conducting a
new and thorough stress test soon, similar to the one administered by US supervisory
authorities in 2009. Of course, the ?nancial position of most governments in Europe is
much worse than that of the USA in 2009. So Europe needs to take a path towards
recapitalization that in some respects differs from the earlier US approach.
First, a credible stress test should assess the losses hidden on the balance sheet for
each bank, as well as the likely cost of the removal of implicit guarantees of all
liabilities. This will result in an estimated capital shortage, taking into account capital
levels as required by international bank supervisors. Recently, the Financial Services
Authority (2013) conducted a stress test of UK banks, resulting in a necessary
downward adjustment of reported regulatory capital of about £50bn, and a resulting
regulatory capital shortfall of £25bn. The estimated capital shortfall of £25bn is likely
to be a lowestimate, as it is by and large predicated on the continuation of implicit state
guarantees in the UK. At any rate, thorough stress tests in other European countries
are likely to reveal sizeable capital shortfalls as well.
Second, supervisors need to assess whether the capital shortfall can be ?nanced by
international capital markets and/or national governments. In case the required
amounts are too high, the bank immediately must be entered into a resolution and
restructuring process imposing some losses on unsecured creditors (the Cyprus model).
The legal basis for this would be an intervention law, which some European countries
may need to enact through emergency legislation. Most banks in Europe, in contrast
with their Cyprus counterparts, have signi?cant ?nancing by bond holders and can be
recapitalised by imposing losses on holders of subordinated and common debt without
infringing on savings deposits. An additional advantage of this approach is that it
re-imposes market discipline on unsecured creditors, giving them incentives to monitor
the riskiness of a bank and take disciplinary actions, such as requiring a higher risk
premium and/or higher levels of bank capital, in the future.
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Third, in the event that capital shortfalls are relatively small, supervisors could
instead implement the US model. This would mean that banks are given a limited
period of time to issue equity on international capital markets, after which national
governments step into provide the remainder of the equity shortfall.
4. Conclusions: recapitalization and the design of banking union
Europe has postponed the recapitalization of its banking sector far too long. And,
without such a recapitalization, the danger is that economic stagnation will continue for
a long period, thereby putting Europe on a course towards Japanese-style inertia and the
proliferation of zombie banks. It is urgent that European policymakers make the right
choices soon.
The way in which Europe recapitalizes its problem banks now has a direct impact
on the design of the future European banking union. If many banks are recapitalized
by imposing losses on unsecured creditors, such as holders of subordinated and
common debt, this is likely to be re?ected in the design of the single resolution
mechanism that will determine the extent to which bail-ins are mainstreamed in future
bank resolutions in the EU. A single resolution mechanism along these lines will make
it easier to reach agreement on the powers of the envisaged future European resolution
authority. Moreover, the adoption of the principle that unsecured creditors should
absorb most of the losses of problem banks implies that only limited residual potential
losses will be borne by European taxpayers through the ESM and through any future
European resolution fund. And, ?nally, if unsecured creditors of banks start perceiving
a credible threat of potential losses, their incentives for engaging in risk monitoring
and disciplining of banks will be increased, thereby enhancing market discipline.
References
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ERA Forum – Journal of the Academy of European Law, March 27, available at:
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Benink, H.A. and Huizinga, H.P. (2013a), “Banish the threat from Europe’s zombie banks”,
Financial Times, May 6, available at: www.ft.com
Benink, H.A. and Huizinga, H.P. (2013b), “The urgent need to recapitalise Europe’s banks”,
VoxEU.org, June 5, available at: www.voxeu.org
Bijlsma, M.J. and Mocking, R.J.M. (2013), “The private value of too-big-to-fail subsidies”,
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Corresponding author
Harald A. Benink can be contacted at: [email protected]
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