A Spectre Creeps Across Europe

The spectre of bail-in risk across Europe

Moody’s argues that the unprecedented nature of the government’s decision to place taxpayers’ interests above the rights of creditors who had previously benefited from a public sector guarantee indicates that Austrian authorities are now generally more willing to countenance bank resolutions in which losses may also be imposed on senior creditors.
Markets had seemingly been less rational in the run up in assessing Austrian banks’ high emerging market exposures. Loans to borrowers in Central and Eastern Europe account for around 40% of the combined lending of Erste Bank, RBI and Bank Austria. The NPL ratio for these loans is high at 12% and rising by one to two percentage points every year. A substantial slice of this €200 billion of aggregate exposure relates to borrowers from Russia and Ukraine. And there is now a systemic banking crisis unfolding in Bulgaria. Indeed HAA was nationalized in the first place on account of its bad emerging market loans.
Now that is thrown into reverse. Fitch warns that Austrian banks are vulnerable to short-term disruption of access to funding and rising cost. The question is how far spreads on Austrian bank bonds will widen and how far concern will spill over to other European banks’ bonds not just over their exposures to risk from emerging markets to the East but on the imminent move to an era of bail-in.

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 My view:

With the events continuing in Europe that indicate substantial contagion risks (like Ukraine raising interest rates to 30% and several eastern European banks on the edge of insolvency), we need to remain mindful that the governing classes have a plan in place for bank failures.

The primary plan involves the imposition of "haircuts" on bondholders and depositors.  The document that outlines the thinking behind this is put out by the IMF and can be found here.

Under current circumstances, having physical cash outside the banking system is probably a wise idea.  Although depositor protection is offered up to $100,000 in Canada, $250,000 in the United States, and 100,000 Euros in Europe, we need to be aware that the pool of funds for the depositors is quite finite.  It is conceivable in the event that several banks become insolvent at once, that the pool of funds would be inadequate to cover all depositors.  Most likely one would end up with a certain value to bank shares instead of cash.

While a substantial bank run does not appear imminent in much of Europe, North America, or Australia, one risk measurement that suggests risk are rising is the steady march upward of LIBOR.

With the advent of debit cards, cash has become less popular in some countries.  In my view, this is a risky development.  Under a bank run or insolvency scenario, the amount taken out in physical cash or electronic forms is certain to be restricted.  Perhaps one of the few ways to protect one's family is to have access to physical cash that the creeping hand of governments and banks can not easily confiscate.