We publish below an extract from the hearing in the Senate of Stefano Micossi, General Manager of Assonime, on the Completion of the European Economic and Monetary Union (the so-called “Document of the five Presidents”).
The acute instability that has developed in the main financial markets in recent weeks has found an epicenter in the European banking system, exposing the risks of a half-baked banking union, where both a European deposit insurance system and a public guarantee of last resort in the event of a systemic crisis.
In this context, the first applications of the new BRRD directive on the resolution of failing banks – to four small local banks in Italy and to Banco Espirito Santo in Portugal – have awakened awareness among investors, including retail savers, of the risks associated with holding of subordinated bank bonds potentially convertible into capital upon exceeding (downwards) certain minimum capital thresholds.
In this regard, it can be recalled that over 90 billion of so-called bank bonds circulate in Europe. co.co.s (contingent convertible bonds), mainly issued by German and Swiss banks. All these securities are exposed to the risk of conversion into shares and reduction in value in the event of difficulty of the issuing bank, according to the new rules on state aid for solvent but illiquid banking companies (going concern), according to the rules of the BRRD directive for insolvent banks (gone concern).
This was probably the trigger for the sharp decline in equity and bank bond prices, despite the strengthening of capital and provisions in recent years. But other factors also weigh. The new quantitative easing policies also push interest rates on long maturities towards zero, compromising the traditional business model of the commercial bank based on the transformation of maturities (borrow short, lend long).
Furthermore, negative rates on banks' deposits act as a levy on bank intermediation, as banks dare not pass the cost on to depositors, for fear of a funding meltdown. The poor performance of the economy aggravates this profitability crisis in less dynamic economies (including Italy). Finally, banks' balance sheets are weighed down, in some cases, by large volumes of 'problem' loans, which could only be mobilized quickly at the price of significant capital adjustments; in other cases by toxic activities of uncertain value.
Added to all this is the fact that in some countries investment in government bonds represents a significant portion of assets, reawakening the specter of the vicious circle between the banking crisis and the sovereign debt crisis. Widening spreads between Portuguese, Spanish and Italian government bonds versus German bunds may also reflect these concerns.
Furthermore, the tightening of prudential rules in recent years has led to significant costs for banks. To these must be added the uncertainty on the point of arrival, which continues to be a moving target, given that the definition of the final structure remains open and will probably involve additional capital and liquidity requirements.
Both the rules on state aid to banks and the BRRD directive provide that in the event of a systemic crisis, the competent authority can suspend the rules on the bail-in of creditors and shareholders; then it would be possible, as was already done in Europe in 2008, to provide for a public guarantee for the liabilities of the banks. If the crisis worsens, this would probably be the inevitable way out, but for now the conditions for doing so are not yet met.
However, the absence of a common deposit insurance system and of last resort European fiscal support in the event of a systemic crisis does not sufficiently reassure depositors and bank creditors: it is an incomplete system exposed to considerable instability risks.
In this context, discussions were held in Brussels (Council of the Union), in Frankfurt (Council for Systemic Risk) and in Basel on the hypothesis of limiting the exposure of banks to sovereign risks; the hypothesis of developing mechanisms for the automatic restructuring of the public debt of countries that request assistance from the ESM has also been advanced. The risk that similar mechanisms may make the system more sensitive to risks, but certainly not more stable, is high.
Of course it is true that sovereign debt securities are no longer perceived by investors as risk-free, following the restructuring of the Cypriot and Greek debts, and the ECB already takes this into account in its stress tests. It remains that the smooth functioning of the financial system requires the existence of a risk-free asset, which can only come into existence as a result of a joint decision to issue debt securities jointly guaranteed by the member states of the Eurozone.
We must know, however, that the difficulties and obstacles in the negotiations on the banking union have their origins to an important extent in the fears aroused in our partners by the difficulties we encounter in bringing the public debt under control. If the public debt-to-GDP ratio does not begin to fall this year, those resistances will become stronger.
Attachments: Hearing in the Senate by Stefano Micossi
