by Don Alexander, MBA
Associate, RSD Solutions Inc.
The bailout of euro 100 billion of Spanish banks is a temporary stop gap measure to provide market stability, but does little to improve Spain’s market access. The sovereign debt crisis in Europe has gone into a full-fledged banking crisis. The problem for Spain is that insolvent banks could bring down the government. In contrast, an insolvent government in Greece is bringing down the banks. The feedback loop between the solvency of the banking system and the sovereign fiscal position is now a two way process. The risk of full blown debt crisis will have dramatic consequences for companies with euro and European bank exposure.
Spain will be the fourth country to get EU support after Greece, Ireland and Portugal. The procrastination of European politicians have increased the crisis severity and increased the risk of contagion. Already, indicators suggest Spain needs more aid and as bond spreads widen. Italian bond spreads are also widening Daniel Gros & Dirk Schoenmaker, in a VOXEU piece dated June 6th, Cleaning up the mess: Bank resolution in a systemic crisis discuss some of the issues. The authors note that savers in many vulnerable euro members are withdrawing deposits from banks. Unless the banks are recapitalized, this gradual deposit flight will turn into a full-fledged bank run and with costly consequences. Currently, the banks in countries like Spain and Greece have an immediate need for bank capital. This can be best provided by a European institution, such as the European Stability Mechanism (ESM). Clearly, the sovereign governments in a number of countries are not in a position to recapitalize their banks. Once the banks are recapitalized: the ESM, ECB and national central banks should come under control of a new European authority (European Banking Authority “EBA”) governed by the EU. The EBA should be independent of national government influence. In the medium term, the creation of a European Deposit Insurance and Resolution Fund (EDIRF) could help stabilize European banks and make them less vulnerable to contagion. Currently, the banks in Greece and Spain require an immediate solution. This has to be done before a long-term solution is implemented. The European Commission’s (EC) are a case of “too little too late”. The idea of having a pan-European deposit guarantee would help banks with large cross border activities. However, the problem today comes from local banks in Greece, Ireland and Spain where they became heavily involved in real estate lending. The general theme that emerges is the need for a European approach, especially where a number of sovereigns cannot stand behind their banks. A general principle that emerges is the deeper the hole – the greater the need for an EU wide solution. The general principle that emerge is: one, the private must be involved, especially with insolvency via equity haircuts or restructuring; second, the least cost principle should be followed with resolution authority at the least cost; three, swift decision making is essential and not the current procrastination that is pushing losses higher; and four, any resolution requires aligning the interest of management with those of public authorities. The authors suggest that two issues must be addressed: one, Spanish banks should only be recapitalized only after full loss recognition of problem loans and two, a mechanism needs to be established to avoid any further run on Greek bank deposits and to eventually include all of Europe. In the medium-term, a European wide banking regulation is required followed by some form of fiscal union. The lesson for risk management is that prompt action can reduce the cost of resolution and small banks can be as much of a problem as larger multinational banks. However, the longer officials procrastinate the higher the risk and cost of resolution.
For more on this, follow the link: www.voxeu.org/index.php?q=node/8069
