FRANKFURT/BRUSSELS May 29 As the euro zone
ponders a possible Greek exit, policymakers have not yet built a
shield robust enough to prevent a bank run in one country
sending others in the bloc deeper into crisis.
A push by the European Central Bank for the euro zone to
stand behind struggling lenders is slowly gaining traction with
government leaders but the bloc has yet to build backstops to
prevent, or cope with, a sudden collapse of confidence in banks.
Last week, European leaders discussed pan-European means of
supporting banks, measures the ECB hopes will include a bank
resolution fund to deal with the fallout from the wind-up or
restructuring of a failing lender.
Such a body would complement the 1 trillion euros of 3-year
credit the ECB has lent in recent months to banks across the
17-country euro zone, which has helped oil the wheels of
Europe's banking system where confidence is so low that most
remain reluctant to lend to one another.
But a wave of withdrawals by depositors - either for fear
that their government is too weak to stand behind its banks or
that their country will exit the euro and switch their savings
into a vastly devalued national currency - would represent a
whole different scale of crisis.
Such pressure on Ireland's banking system prompted a
national bailout by the International Monetary Fund and European
Now investors are worried about the contagion effect a Greek
exit from the euro zone could have on savers in other countries.
"Preventing bank runs in Italy, Spain and Portugal should be
the top priority," said Berenberg Bank economist Holger
Schmieding. "Policymakers need to make sure that the potential
Greek precedent of a forced conversion of domestic euro deposits
into a weak new currency would not spark a run on banks ...
The ECB is pressing the euro zone to set up a fund that
would prevent this dangerous ripple effect, a message reinforced
by ECB policymaker Joerg Asmussen last week.
"The recapitalisation of a troubled bank by its government
may lead to a deterioration of the government's fiscal
position," Asmussen said. "The deteriorating fiscal position in
turn further weakens banks' balance sheets, through their
holdings of sovereign bonds.
"This feedback loop has to be stopped ... A European bank
resolution authority and a European deposit insurance scheme are
two elements that could be used to address the nexus between
sovereigns and banks."
Any pan-euro zone deposit guarantee scheme would need to be
large in order to stem ebbing confidence.
The typical national guarantee in Europe now covers the
first 100,000 euros on deposit, something that would do little
to reassure corporate investors with millions.
It was the decision by companies in Ireland to withdraw
deposits that accelerated its banking crisis.
The question of how to shut down or restructure teetering
banks has risen to the top of European policymakers' agenda as
concerns grow about the impact if Greece were to leave the euro
zone, and as problems deepen in Spain's large banking sector,
which is laden with bad property debts.
But policymakers are far from setting up a backup fund, not
least because European paymaster Germany, who does not want to
support laggard banks in Spain, is reluctant to finance it.
WAITING FOR DRAGHI
In the absence of a resolution fund or insurance scheme to
deal with a bank collapsing, many investors expect the ECB would
act to head off a bank run or a similar systemic threat.
ECB President Mario Draghi has said the 1 trillion euros the
bank released into the financial system with twin 3-year,
ultra-cheap lending operations - or LTROs - in December and
February avoided a major credit crunch.
In the case of Greece, the belief is that the ECB would act
again to contain a bank run, said Clemens Fuest, a professor at
Oxford University and a member of the academic advisory board of
the German Federal Ministry of Finance.
"The expectation seems to be that the ECB will prevent it by
providing whatever liquidity is needed," he said, adding that
this could either be from the ECB directly or as emergency
funding from the Bank of Greece with the ECB's backing.
Greece's four largest banks received some help this week,
with the country's bank stability fund approving an 18 billion
euro injection of bailout money to rescue them.
If this proves insufficient and contagion spreads to other
countries' banking sectors, policymakers may rapidly have to
dust off plans to provide guarantees to weaker banks or inject
further capital - scenarios discussed in the past but on which
there has been no agreement.
The banking environment has steadily deteriorated, according
to statistics from the Bank for International Settlements, which
chart the flight of capital from the euro zone's weakest
Figures from December last year show a sharp decline in
deposits from abroad held in banks in Greece from $160 billion
in late 2009 to less than $80 billion.
Ireland's bank deposits from abroad fell from $905 billion
to $471 billion over that time and a similarly sharp fall was
seen in Portugal.
Households and companies have almost 11 trillion euros on
deposit with banks in the euro zone, with over 3 trillion in
Germany alone, according to ECB statistics.
One way to reinforce banks would be to allow the euro zone's
rescue scheme, the European Stability Mechanism (ESM), to inject
capital directly into lenders - an idea which Spanish Prime
Minister Mariano Rajoy is pressing but which Berlin opposes.
Under Europe's existing arrangements, countries like Spain -
should they require assistance with their banks - must apply
for a sovereign bailout programme, a humiliation too far.
"Taking on the risk of a bank failure at a European level
through the ESM is far preferable to the much greater risk of a
sovereign default," said John Fitzgerald, of the Economic and
Social Research Institute, a Dublin-based think-tank.
In the absence of that, Berenberg's Schmieding said were
Greece to leave the euro zone, Spain should apply to Europe's
bailout funds for aid to recapitalise its banks.
The ECB could cut interest rates and - together with
national central banks - supply banks with liquidity, he said,
possibly with new long-term loans.
Some ECB policymakers are open to considering a further
LTRO, sources close to the bank say, but they face resistance
from orthodox policymakers already worried by the balance sheet
risks the ECB has taken on with the first two operations.
Germany's Bundesbank has already said the ECB should not
significantly increase the risks associated with providing
liquidity to Greece, and believes the impact of a Greek exit
from the euro zone would be substantial but "manageable".
Easing the requirements on the collateral banks need to put
up to access ECB funds is another way the central bank could
help lenders short of liquidity - but such a technical step will
not help if they become insolvent and a systemic risk.
Draghi is pressing governments rather than the ECB to take
the decisive action and delivered a stark message last Thursday,
saying: "We have reached a point in which the process of
European integration needs a courageous leap of political
imagination in order to survive."