Currently in Brussels the leaders of the EU are patting themselves on the back for (nearly) achieving the banking union, or bail-in process. They are making the claim that the banks will be more stable under the new centralised banking authority, and that individual countries are now less at financial risk from the next bank collapse.
“Today is a momentous day for banking union,” EU Financial Markets Commissioner Michel Barnier said, “We are producing revolutionary changes to Europe’s banking system so that taxpayers will not foot the bill in banking crises, ending an era of massive bailouts.”
The Single Resolution Mechanism will step in and take control and then wind down individual banks as they show sufficient signs of weakness, and the depositors will be held liable to make good shortfalls. This is very dangerous as this will make capital nervous and mobile. This was witnessed in Cyprus when Russian money fled the banks before the regulator shut the banks, leaving the smaller depositors disproportionately on the hook. Stable banks showing any weakness will become vulnerable to capital flight, and thus, more banks will go under, and more private deposits will be at risk.
But the real problem is this: banks hold vast quantities of Government debt (bonds) that fund spending programmes all over Europe that serve no economic benefit, and are not held to generally accepted accountancy rules, in other words, to buy votes Governments are writing all kinds of cheques funded by the banks’ willingness to fund them. As soon as the economies slow, the governments write more cheques to cover unemployment payments or ‘infrastructure and stimulus’ programmes. The extra supply of government bonds coming from a shrinking economy reduce the value of the bonds. Once the value of the bonds decreases, the banks have to write down the value of their holdings pushing them closer to the brink. Deliberate government programmes to boost the housing market, such as Help to Buy, have exactly the same effect. The combination of government debt, and retail debt created by government policy are the largest risk elements on banks’ balance sheets.
The solution is really quite simple, the governments need to rein in their appetite to borrow from the market, and they have to desist from generating programmes that create government debt by proxy.