EU deal to close failed banks won't break "doom loop" -Reuters poll

Fri Jan 3, 2014 9:39am EST

* EU's deal to close failed banks not enough, say economists

* Deal won't break "doom loop" between banks and states

* Governments left with bill while resolution fund being built

* ECB to hold rates, but poll shows downward bias

By Andy Bruce

LONDON, Jan 3 (Reuters) - The European Union's blueprint to close failing banks won't be enough to break the pattern of euro zone states haemorrhaging funds by propping up weak lenders, a Reuters poll showed on Friday.

Hailed as "the final pillar" for a banking union by Germany, last month's deal aims to prevent bank failures from dragging governments to the brink of bankruptcy, as happened in Ireland and Cyprus.

It features a single resolution fund that banks will pay into over the next ten years, giving roughly 55 billion euros ($76 billion). Until then, individual governments would be left holding the bill.

In a Reuters poll this week, 27 of 41 economists said this structure would not break the so-called "doom loop" between banks and states.

"At least for the first years, the agreement doesn't go far enough in terms of risk sharing," said Kristian Toedtmann, economist at DekaBank in Frankfurt.

"If serious problems develop in the banking system, the sovereign will ultimately have to step in, probably with assistance from the European Stability Mechanism," he added, referring to the emergency backstop fund for euro zone states.

Euro zone governments have already spent hundreds of billions of euros trying to stop the rot in the region's financial system, and at a huge social cost.

With harsh austerity a direct result of the financial crisis, the euro zone has struggled to escape the spectre of recession over the last few years, and high unemployment has become endemic.

The banking union project aims to stop citizens taking the hit for the banking sector again.

MORE DOOM?

By setting up a system to shutter troubled lenders, Europe would equip the ECB with the means of dealing with teetering banks. However, the scheme that has emerged, because of efforts to accommodate sceptical countries, is unwieldy.

It requires the ECB to fire the starting shot by declaring a bank as too weak to survive. What follows, however, would involve input from a new agency empowered to shut banks, the European Commission and up to 18 different euro zone countries.

Michel Barnier, the European commissioner in charge of financial regulation, expressed frustration with the watered down deal.

"When I compare it with my original proposal I have regrets," he said. "I would like to have seen things done otherwise."

Some economists were highly critical.

"If anything, the agreement will strengthen the 'doom loop' by making clear national governments' responsibility to recapitalise banks in difficulties before having recourse to supra-national institutions," said Stephen Lewis, chief economist at Monument Securities.

Lena Komileva, economist from consultancy G+ Economics, said the deal ensures that the current drivers of the euro zone's banking and sovereign debt crisis - and the forces of market fragmentation - are here to stay.

A wider poll of more than 50 economists showed the European Central Bank will hold its main refinancing rate at a record low 0.25 percent on Thursday, and through to mid-2015.

But there was a slight bias towards looser monetary policy.

Ten respondents - almost a fifth - predicted a further cut to the main refinancing rate by mid-2015, and some predicted it would hit zero. Only three predicted a hike.

There was a similar pattern in forecasts for the deposit rate, currently at zero. Six economists expect it will be cut to a negative rate, while three said it would be raised. (Additional reporting by John O'Donnell, polling by Sarmista Sen and Sarbani Haldar; Editing by John Stonestreet)

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