The Long and Winding Road: The struggle to secure a bank debt deal

Friday 20 June 2014 18.17

euro

The odds on Ireland securing a full-blooded bank recapitalisation using Europe’s €500bn  ESM bailout fund now appear low.

Time and politics have moved on since the eurozone summit of June 2012, when Taoiseach Enda Kenny secured the promise of help for Irish banks.

But priorities for the Government have changed as well, and officials are insisting that the promise of support can yet deliver something for the Irish banking sector, even if it is not the pile of cash that seemed to be on offer exactly two years ago.

It’s worth recalling the events of June 2012 and the torrid mood that prevailed.

It was the darkest moment of the euro crisis:  the borrowing costs for Spain and Italy were rising to a point at which Europe’s modest rescue funds would not have been sufficient to step in.

A doom-loop had developed between banks and sovereigns, whereby governments were frantically bailing out banks, which in turn were relied upon to buy the sovereign debt of governments.

An attempted bailout of Spanish banks, one which increased the size of Spain’s deficit, had failed spectacularly.  The euro itself was on the edge of collapse.

Against this backdrop was a change of personnel at Europe’s top table.  Mario Monti, who had the backing of US President Barack Obama, was Italy’s respected new prime minister.

François Hollande had just taken over from Nicolas Sarkozy as president of France.

Along with the canny Spanish leader Mariano Rajoy, they hatched a plot to ambush Angela Merkel at the summit, in order to push her into agreeing a bolder and, to the Germans, unacceptable bid to save the euro.

Their demand was that the ESM, and its predecessor the EFSF, be allowed to buy up Italian bonds.  The ESM would also have to be allowed to directly recapitalise banks that were in trouble, but in such a way as not to burden the sovereign.

In short, it was a dramatic bid to break the vicious cycle between banks and sovereigns that was posing an existential threat to the single currency.

As the meeting in Brussels progressed, Rajoy and Monti threatened to upend the summit, and talk of a new growth pact, unless Merkel cast aside decades of German orthodoxy, and agree the roundabout monetary financing of governments.

Under intense pressure the German chancellor buckled – and somewhere in the small hours of the morning, Kenny, who had been in close contact with Rajoy and Monti, secured a dramatic sideline concession for Ireland.

In the statement that followed, it was clear that the 16 eurozone leaders had “got” the necessity to break the link between bank and sovereign debt.

Although Spain and Italy weren’t mentioned by name, everyone knew that they were the two critical countries that had to be dealt with if the euro was to be saved.

But at the end of the statement’s first paragraph, one country was mentioned: “The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme. Similar cases will be treated equally.”

That last sentence was key.  If Spanish banks were getting direct recapitalisation, then Irish ones would too.

Irish officials broke the news at 4am.  Ireland had got its long-awaited deal on bank debt.  The €30 billion or so that had gone into the pillar banks (excluding Anglo Irish), could now be addressed.

Enda Kenny was jubilant and, in no small measure, somewhat surprised at the turn of events.

He told reporters: “Europe is always about patience and about timing. Ireland was one of the first to put forward the measures of direct injections into banks. Issues that at first sight, first indications, seem to be rejected inevitably are left on the table and find a way of becoming a reality later on.”

But two years on that reality has not dawned.

The trouble began when Jens Weidmann, the head of the Bundesbank, disassociated himself from the idea.

Then in Helsinki, just three months after the June summit, Wolfgang Schauble, the German finance minister, issued a statement with his Dutch and Finnish counterparts, which seemed to pour cold water on the Irish prize.

Direct recapitalisation would only come about once there was a new European regulator in place, and once there was a clear commitment that the private sector and national governments would step in first, before there was any pan-European funding available for stricken banks.

Even then, the statement added ominously, recapitalisation could only apply to future problems.  Legacy problems were “a matter for national governments”.

The following month the German chancellor caused a storm when, at a summit in Brussels, she insisted that ESM funding for banks was only for “future cases” and that there would be “no retroactive direct bank recapitalisation” for Spanish banks (and presumably Irish banks as well).

There ensued a furious round of weekend phone calls between Dublin and Berlin, resulting in a joint Kenny-Merkel communiqué to the effect that Ireland was “a special case” and that the June commitment would be kept.

The following day the Taoiseach met President Hollande in Paris and the “special case” notion was repeated.

But the months passed.  Direct bank recapitalisation was now bound up with the tortuous negotiations towards a new European Banking Union.

The basic trade off was that if Germany was going to tolerate ESM funds being used to bailout banks, then a whole new regime was needed to make sure that banks were more strictly supervised (so they wouldn’t need bailing out).

Furthermore, if they did need bailing out the ESM would be a last resort, and in the meantime the private sector – shareholders, bond-holders and depositors – would have to “bail-in” money first.

The Government switched its strategy away from retroactive recapitalisation and on to Anglo and the promissory notes.

When a deal was struck with the European Central Bank in February 2013 on Anglo the Government earned some breathing space.

By now Ireland was eyeing its bailout exit.  But the improvement in the State’s economic situation would prove deleterious to the bank recap aspirations.

With the bailout exit looming, I posed a question to Wolfgang Schauble at a meeting of eurozone finance ministers in Luxembourg on 15 October 2013, about prospects for a retroactive recapitalisation of Irish banks.

Such an option was “not probable,” he said.  “Ireland did what Ireland had to do… now everything is fine.”

His remarks were seized upon by the opposition in Dublin as “proof” – once again – that the Taoiseach had been sold a pup in June 2012, and that Europe was not to be trusted on the issue.

In reality, Schauble’s remarks were simply reflecting the consistent view in Berlin that the promise to break the link between banks and sovereigns, enshrined in the June 2012 statement, was to be read entirely separately from the promise to “examine the situation of the Irish financial sector with the view of further improving the sustainability of the… [bailout] programme”.

The upturn in the Irish economy, as well as the fact that Merkel was now sharing power with the Social Democrats, who were even more averse to German taxpayers’ money going to banks, both meant that opposition to help for Ireland was hardening in Berlin.

In the meantime, the key elements of a new banking union were taking shape.

A raft of new rules were tortuously negotiated between EU member states and the European parliament on how Europe could avoid a situation in the future, where the failure of a systemically important bank – or even a non-systemically important one like Anglo – could be handled without posing a fatal threat to the single currency.

The ECB would become the supervisor of Europe’s most important banks.  Member states would have to harmonise rules on how to ensure banks were capitalised properly, and how to wind them down and recover the parts worth saving if they still faltered.

In time, there would be an over-arching Single Resolution Mechanism (SRM) to supersede the national rule book, and which would work out who took the decision at European level, and when, to wind up a bank if it got into trouble.

A pecking order, applicable across the European banking system, of shareholders, junior bondholders, senior bondholders and depositors was established in terms of who was first in line to take a hit if a bank failed.

The idea of a Single Resolution Fund (SRF) was also established, a pot of money built up through contributions by the financial sector, which would help stabilise a bank collapse.

Throughout this process it was becoming apparent that European taxpayers were to be protected in a way that Irish taxpayers weren’t when the banks got into dreadful trouble in 2009 and 2010.

This seemed to strengthen the government’s key argument:  Ireland stepped in and saved the European bank system by not burning Anglo bondholders in 2009, at a time when the current instruments – including the ESM – were not available.

Now it was only fair that the burden Irish taxpayers took on in relation to the banks was acknowledged retroactively.

This week a senior eurozone official, however, told RTÉ News that it was now “extremely unlikely” that Ireland would get such a recognition.

His argument was that so much had changed politically and technically since 2009/10 that it was “next to impossible” to wind back the clock.

Under pressure from Germany, the ESM was to be used to help banks as a very last resort, and with onerous conditions attached.

The two main conditions – that the private sector be bailed in, and that a bank has been supervised by the ECB beforehand – clearly cannot apply in Ireland’s case, the official reasoned, because Irish banks were bailed out long before the rules were made.

Irish officials beg to differ.

The political agreement on how the ESM could directly recapitalise banks was made in June 2013, one year after the original summit commitment.

On that occasion Ireland’s concerns were catered for, albeit not in a robust way.  Potential retroactive bank recapitalisation, the agreement said, could be considered “on a case-by-case basis,” with the agreement of all 17 eurozone countries required.

On 10 June, after months of work by officials, the detailed guidelines on how direct recapitalisation would work were finally agreed and were sent to eurozone capitals for approval.

As an indication of how sensitive the issue is in Germany, I was given a categorical denial by German officials that “retroactive recap” was included in the detailed guidelines, which will be voted on in September by the Bundestag.

That, however, turned out not to be the case.

Following further enquiries I obtained a copy of the parliamentary guidelines (they have not been made public).

Article 14 refers to “Retroactive application of direct recapitalisation”.

It states:  “This guideline is established without prejudice to existing ESM and EFSF programmes in which financial assistance has been provided to ESM Members who recapitalised their institutions, which could be replaced in part or in full with a retroactive application of direct recapitalisation following a decision by the ESM Board of Governors…”

The second paragraph of Article 14 is the one which gives Irish officials comfort.

It states that the “detailed modalities” for the use of ESM funds for something which happened in the past “shall be established in the relevant ESM Board of Governors decision.”

In other words, if the Government can manage, through negotiation and in advance, to get around the concerns mentioned by the eurozone official, quoted above, then those details will all be contained within one straightforward decision by the ESM board.

That still leaves a lot of room for doubt – the board of the ESM is, after all, in reality just the eurozone finance ministers, including the German, Dutch and Finnish ones.

The other comfort for the Government, however, is the increase in the value of the shares of the banks that were initially bailed out.

Bank of Ireland is now worth €1 billion more than the government put into it.  AIB may also show a significantly increased value since 2010.

The reality is that the Government may not need the ESM to take an equity stake in the pillar banks, the approach long seen as the best way for retroactive recapitalisation to work.

Should the Government convince its eurozone partners in the long term that the ESM could have an explicit option on Irish bank shares, that could provide a solid price floor which could attract other investors.

It all depends on the goodwill of Ireland’s eurozone partners, and on the continuing rise in value of the pillar banks.

It may not be the windfall that seemed to have been promised in the early hours of 29 June 2012.  But it might just give the Government enough cover to ward off Opposition attacks, in the run up to next year’s general election.

 

 

 

 

 

 

 

 

Comments are closed.