On average, the market-to-book value of European banks now is about 0.50 .... This indicates that accountants' estimates of bank capital are far too rosy, and that banks have substantial hidden losses on their books. In a recent speech Klaas Knot (2013), Dutch central bank president and European Central Bank governing council member, noted that restoration of banks’ balance sheets is a crucial requirement for economic recovery. To facilitate this process, Mr Knot states, it is essential to create transparency about losses in the banking sector and to have an orderly resolution of lossmaking assets. Without this, banks will remain restrictive in making new loans. Mr Knot adds that the planned European banking union offers an appropriate opportunity for speeding up the resolution process. [my emphasis]They seem to be under the impression that the 2009 stress test for banks in the US was an appropriately rigorous one, a doubtful premise. But they are addressing a real problem. There needs to be a genuinely rigorous review of the European bank's real financial position, reasonably predictable losses need to be recognized on their books, and the institutions need to be either resolved (put out of business and reorganized) and/or recapitalized.
They put their proposal in the context of the theoretically pending eurozone banking union:
The way in which Europe recapitalises its problem banks now has a direct impact on the design of the future European banking union. If many banks are recapitalised by imposing losses on unsecured creditors, such as holders of subordinated and common debt, this is likely to be reflected in the design of the single resolution mechanism that will determine the extent to which bail-ins are mainstreamed in future bank resolutions in the EU.This is understandable. Creating a banking union is official eurozone policy. And a necessary one if the euro is going to be made into a workable currency for the long run.
A single resolution mechanism along these lines will make it easier to reach agreement on the powers of the envisaged future European resolution authority. Last but not least, the adoption of the principle that unsecured creditors should absorb most of the losses of problem banks implies that only limited residual potential losses will be borne by European taxpayers through the European stability mechanism (ESM) and through any future European resolution fund.
But German Chancellor Angela Merkel is blocking the actual establishment of a banking union. She's opposed to it because it would mean that Germany would be responsible for paying substantial portions of the cost for future bank reorganizations and recapitalizations. She's pursuing a narrow nationalistic policy and domestic politics to match it. So she wants to avoid it, or at least to postpone it as long as possible.
Germany would also presumably have to contribute substantial sums to a eurozone-wide bank recapitalization effort even without a banking union. Particularly given the rigid fiscal restraints by the Fiscal (Suicide) Pact, countries like Spain and Italy likely couldn't handle the recapitalizations on their own. Because in practice, even with stockholders and unsecured creditors taking the first hit, substantial public funds would also probably be needed.
Benick and Huizinga also touch on the effect of the different approach the Troika (read: Germany) took in handling the Cyprus crisis:
The plight of Europe’s banks worsened considerably when Jeroen Dijsselbloem (2013), Dutch finance minister and Eurogroup president, stated that the approach taken in Cyprus of resolving failed institutions without using taxpayer money would in future preferably apply throughout the Eurozone. Consistent with this, Wolfgang Schäuble (2013), German finance minister, recently stated his desire 'to ensure that enrolling taxpayers to rescue banks becomes the exception rather than the rule', and that to achieve this 'we need credible EU bail-in rules as soon as possible'.Tags: angela merkel, cyprus, eu, euro, european union
Banks are already saddled with ample unrecognised losses on their assets, estimated by many observers to be at least several hundreds of billions of euros and mirrored by low share price valuations, and an additional loss of their present funding advantage will be crippling.
Financial markets understood Mr Dijsselbloem’s message, as shown by a subsequent decline in the share prices of many institutions. Very low bank valuations imply that they will find it very difficult to recapitalise themselves by issuing equity or debt that is convertible into shares – in part because share issuance would further dilute the value of implicit state guarantees.
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