Statements emerging from the European authorities about a new approach in allowing banks in difficulties to fail have hit the headlines. But these may be coded messages which are more about claims to power than how matters will operate in the future.
The European authorities are sending out contradictory messages. The European Central Bank claims everything will be done to bail out troubled governments, while the head of the newly-created Single Supervisory Mechanism has announced that sovereign debts are no longer considered risk-free, and that some banks are bound to fail and will be allowed to fail. The likely victims may be banks with large quantities of bad government bonds. These apparently contradictory messages may conceal two different stories which are not mutually exclusive – an attempt by the newly-created agency to lay claim to power; and a cautious approach by the ECB to prepare the ground for Euro-tapering.
What message are European bank regulators sending out following the statement from the eurozone’s new chief banking regulator, Daniele Nouy, that weak banks should be allowed to fail?Frenchwoman Ms Nouy was appointed chief supervisor of euro-area banks in February 2014 by the European Central Bank (ECB). Her statement made headlines when she revealed that European authorities have conceded that there are no risk-free assets, not even government debt – no irony was intended – and that some European banks are too fragile to survive.
But the statement said nothing really new as the European authorities had already declared in December 2013 – months after the Cypriot blunder – that the epoch of banks’ bailouts was coming to an end, and that stakeholders should prepare to bear the consequences of bankruptcy.
Her statement made headlines when she revealed that European authorities have conceded that there are no risk-free assets, not even government debt
Ms Nouy, who leads the so-called Single Supervisory Mechanism, left questions unanswered. Who will be responsible for assessing whether a bank is too weak to survive – the market, the regulators or the accountants? And what will be the role of the monetary authorities within the future regulatory context?
So what message are EU regulators sending out? Are they telling the public a platitude about risk-taking? Have they changed their minds about systemic failure?
European regulators and most banking experts have been telling public opinion for decades that banks were special, and deserved to be supported under all circumstances, in case their failure triggered a chain reaction with unimaginable catastrophic outcomes. Is that no longer true? What has motivated this change of attitude? And what can we expect as a consequence?
So what do the new regulatory attitudes involve from the regulators’ standpoint? Ms Nouy will employ some 800 people in her new role supervising the largest European banks. She has made it known that her agency will not hesitate to extend its powers to cover smaller banks too, in other words she will not refrain from interfering with the market.
Yet, it is also apparent that the regulators do not really know how strong or weak the world of banking is. They were unable to recognise decades of frauds, incompetence and mismanagement, and it is hard to believe that they know better now, when the situation is far more complex.
Despite their poor control over the situation, however, they are aware that additional massive injections of liquidity would no longer be tolerated by a number of key EU members and that, therefore, it might be appropriate to give the banks’ stakeholders – shareholders, bond holders, depositors and employees – some kind of advance warning about the future.
However, it is possible that this warning also indicates some untold stories. One such story could be the presence of tensions within the EU: as new regulators emerge, they are bound to compete for power with the incumbent policymakers, who are reluctant to step back and make room for the newcomers, and who are likely to insist in pursuing their own policies with no obligation to coordinate their views with other parties.
Her first task is to show that the Single Supervisory Mechanism is important and that bankers and politicians must pay attention to it
Second, we may be witnessing gradual preparation for a drastic change in monetary policy, so let us examine both issues in turn.
Ms Nouy has a tough job. Her new agency will have little power to regulate, is unlikely to perform more efficiently than her predecessors, and has not been enjoying unqualified support in Brussels, Strasbourg and Frankfurt. Moreover, she may encounter resistance from the national governments which are still responsible for supervising medium and small-size banks, an area that Ms Nouy wants to bring under her own supervision.
Her first task is to show that the Single Supervisory Mechanism is important and that bankers and politicians must pay attention to it. Her only means of obtaining that goal – given the lack of financial ammunition and of real regulatory power – consists in drawing attention to the fact that her agency will carry out independent assessments, that it can make life difficult for its counterparts, and that it will influence bailout decisions.
This was the real message Ms Nouy wanted to convey.
However, by doing so, Ms Nouy’s agency may contribute to blurring the overall policymaking picture. ECB chairman Mario Draghi has made it clear that he was and is determined to do all it takes to bail out troubled governments, while EU authorities have not been famous for consistency and transparency.
But investors have been told for the past three months that bailouts are no longer guaranteed.
Since the strength of banks is based on their borrowers’ ability to honour their commitments – including governments – what should the world of finance make of such contradictory signals? Which is the right one? And to which regulatory or policymaking authority should bankers listen?
The second issue regards monetary policy. United States tapering differs from EU tapering in one crucial respect – liquidity was injected in the US in order to stimulate the economy at large. The results have been mixed, but one can hardly claim that one industry has been privileged at the expense of all the others.
Thus, reaction to the Federal Reserve’s tapering programme has been mild both because it was widely anticipated, and because its repercussions were going to be absorbed by the entire economy.
The picture in Europe is different because liquidity has been injected to bail out governments’ creditors, or some of them. Many observers have argued in particular that easy credit was not motivated by concerns for the troubled governments, but rather by the desire to help banks, insurance companies and investment funds which had been buying risky government bonds.
Now, the ECB has decided to postpone tapering and is insisting on reassuring markets that government debt will be honoured. This sounds very reassuring. Yet, this behaviour also corresponds to how one would prepare for tapering in a context characterised by very modest growth and uncertainty.
In particular, if you want to avoid triggering a sudden increase in interest rates – with dramatic consequences for heavily indebted countries – you send out calming messages on liquidity, and let somebody else alert banks that sovereign debt is no longer considered risk-free, that banks should behave accordingly, and that help to the banking industry will be discretionary.
If you want to avoid triggering a sudden increase in interest rates – with dramatic consequences for heavily indebted countries – you send out calming messages on liquidity, and let somebody else alert banks that sovereign debt is no longer considered risk-free
These alerts about sovereign debt and discretionary assistance to the banking industry are precisely the messages Ms Nouy has been giving to the financial community.
The unanswered question, of course, is whether the ECB hopes to de-link the banking industry from government debt, and perhaps encourage the birth of a number of bad banks, where the non-performing assets might be dumped.
Two lessons emerge from this episode:
• The first is that countries which failed to put their financial affairs in order during the past years will be under increasing pressure in the future, because banks will be less inclined from now on to buy their bonds.
• The second is that bailouts have not finished, but they will be more selective and connections will matter – for example when an agency must define ‘objective’ bailout criteria. In other words, the winners will be those with good contacts and possibly strong government support. It is not difficult to predict that big business will tread water more easily than most other players.