Editor's choice
An interview with Anders Borg
The big talk in regulation is about forcing bondholders to take a hit when banks collapse. The concern has to be that for all the efforts of Dodd-Frank, the UK Banking Act and the EU Recovery and Resolution Directive, the outcome is unenforceable – in other words, when a major financial institution gets into trouble the fear of spreading panic will prevent governments from forcing a haircut on bondholders.
The thinking in the eurozone illustrates the point. Holders of Irish bank bonds were fully compensated so landing the government with a bail-out bill to the tune of almost 40% of gross domestic product (GDP). The prevailing view is that the needs of eurozone creditors ranked higher than those of Irish taxpayers.
Given this, the recent retreat by Germany and other creditor countries on a plan to use European Stability Mechanism funds to recapitalise battered banks seems particularly harsh.
The latest test case is Cyprus. The main cause of the problem is exposure of the banks to Greece, which had its sovereign debt restructured. Of an estimated €16bn bail out, about €10bn may be accounted for by the banks. Overall, Cyprus’ debt-to-GDP ratio will rise from 90% to an unsustainable 140%. This can only be brought down to a manageable level if bondholders take some pain or other eurozone countries pitch in. The latter is politically challenging while the former risks sending a panic message to bondholders in other countries.
It is difficult to see how this outcome would be different in either the US or the UK if a large bank got into trouble. So far, only Denmark has shown any appetite for forcing write-downs on bondholders of small banks and the country’s resolution scheme has raised funding costs for other Danish banks, something they complain bitterly about.
In an interview with The Banker (above), Sweden’s finance minister, Anders Borg, makes clear his backing, from a practical viewpoint, for national governments underwriting bondholders of troubled banks. If this is the reality, the regulators can stop talking about bail ins.
