Past a messy Brexit & elections in France and Germany
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
Senior bankers in Spain and Italy can breathe a collective sigh of relief after Europe’s finance and economic ministers decided on Friday to postpone, for at least 18 months, a decision on setting a limit on the government bonds some banks can hold as eligible “risk-free” capital. It was one of four things keeping Spanish senior bankers awake at night. Now, they can sleep a little sounder.
The initiative, initially proposed by the German government and supported by other fiscally hawkish governments such as Finland and the Netherlands, was intended to limit the purchase of public debt by banks, in order to break the vicious cycle of co-dependence that now exists between sovereign and bank risk.
If allowed to happen, the move could have posed a very serious threat to the balance sheets of many banks on the Eurozone periphery. According to European Central Bank data, euro-area sovereign bonds accounted for over 10% of banks’ assets in the Eurozone, or €2.73 trillion ($3 trillion), at the end of 2015 — over €300 billion more than at the end of 2014, on the eve of the ECB’s launch of its negative interest rate policy (NIRP).
This trend is particularly acute in countries like Portugal, Spain, and Italy, where banks’ balance sheets are filled to the gills with bonds of their individual sovereigns — all considered “risk free” for regulatory reporting. Just the merest suggestion of loosening the chains of interdependence between sovereigns and banks was enough to set off shrieks of panic in the halls of government and banking C-suites of Madrid, Rome, and Lisbon.
“Let’s be very careful about translating into practice rules that look nice on paper,” Italian Finance Minister Pier Carlo Padoan warned, adding that any such rules could lead to a sell-off and “instability”. Padoan’s sentiments were echoed by Santiago Fernandez de Liz, the chief economist for financial systems and regulation at Spain’s second biggest lender, BBVA, who cautioned that applying a proposal of this kind in the Eurozone would “reignite the fragmentation” of Europe’s financial markets.
The threats appear to have worked, prompting Ecofin to announce that it would first wait for the findings of the Basil Committee, to be held in 2017, before reaching any definitive decision regarding the regulatory treatment of sovereign debt. None of this should come as a surprise, with the Fed, the Bank of Japan, and the Bank of England all vehemently opposed to Germany’s proposal.
The price to be paid is another 18 months of dysfunctional co-dependence between European banks and sovereigns as well as entrenched inaction on Europe’s decidedly incomplete banking union, which still lacks even the most basic financial security mechanism: a deposit insurance scheme. For that to happen, the Germans continue to demand a decoupling of sovereign and private risk, plans for which have now been scuppered until at least 2018.
But Italy and Spain — two of the countries keenest on securing a cross-continental deposit insurance scheme, not to mention the two biggest recipients of ECB refinancing loans to banks — are in no position to ween their governments or their banks off the bank-sovereign mutual support system.
Italy’s public debt is now a staggering 123% of its GDP, much of which is gathering dust on the cluttered balance sheets of Italy’s banks — banks which are so fragile that Bank of Italy Governor Ignazio Visco recently begged the European Union to backtrack on new bail-in rules aimed at protecting taxpayers from having to prop up ailing banks, warning that it may be impossible to stop contagion in a crisis.
The fact that Eurozone finance ministers have once again caved to concerted pressure from both banks and the Italian and Spanish governments is hardly any surprise. Kicking the can down the road is now an official sport in Brussels. Putting off the decision for another 18 months would allow the EU to avoid any inconvenient clashes with the Brexit referendum, not to mention the French and German elections in 2017.
Once again, short-term political expedience trumps the need for long-term economic prudence. The result, as Ambrose Evans Pritchard writes in The Telegraph (in an article on why he has decided to vote for Brexit), is that six years into the Eurozone crisis, “there is not a flicker of fiscal union”:
No eurobonds, no Hamiltonian redemption fund, no pooling of debt, and no budget transfers. The banking union belies its name. Germany and the creditor states have dug in their heels.
That will be the state of play for at least the next 18 months. According to diplomatic sources cited by the Spanish financial daily Cinco Dias, this was the plan all along. Germany never had any intention of helping set up a cross-continental deposit insurance fund, which would make its taxpayers jointly responsible for the debts of all the banks in the Eurozone; its calls to set a limit on the sovereign bonds that banks can hold as eligible “risk-free” capital were merely a stalling tactic.
True or not, one thing that is abundantly clear is that, Brexit or no Brexit, the Eurozone is destined to languish in economic limbo for at least another year and a half, assuming it lasts that long. Meanwhile, the race is on to get as much sovereign debt as possible off the balance sheets of peripheral banks and onto the ECB’s already bloated books. Take it away, Mario! By Don Quijones, Raging Bull-Shit.
But the broader European banking crisis is getting impatient. Read… Brexit Chaos to Serve as Cover for ECB Bank Bailouts