Equity and debt markets are deeply skeptical of the European Bank Resolution & Recovery Directive, with recent tests in Spain and Italy not serving as examples that the system is working, an equity and a debt analyst said Sept. 19.
The BRRD took full effect at the start of 2016 and sets out a framework for dealing with failed and failing European banks, requiring among other elements that bondholders bear a share of the costs of any resolution.
But a wide divergence in national insolvency laws and a lack of clear rules about when a financial institution can be declared as "failing or likely to fail" leaves room for a lot of flexibility to bend the BRRD rules, the analysts said during a round-table discussion at the Centre of the Study of Financial Innovation in London. That leaves the mechanism for bank resolution exposed to political machinations and causes market participants to doubt its effectiveness.
Italian interventions fuel equity market doubts
The rescue of Veneto Banca SpA and Banca Popolare di Vicenza SpA, rather than their placement into resolution, as well as the state backing provided to struggling Banca Monte dei Paschi di Siena SpA at the end of 2016, exacerbated equity market doubts in the BRRD, said Simon Samuels, founding partner of independent financial sector advisory Veritum Partners and a former head of European bank equity research at Barclays and Citigroup.
Meanwhile, the recent shuttering and sale of Banco Popular Español SA was sufficiently straightforward that it became "kind of an irrelevant example" for equity markets and did nothing to enhance confidence that the BRRD could be used to resolve a larger failing institution, Samuels added.
If Barclays were to fail tomorrow "there isn't a single person in the industry who believes that the response of the U.K. government would be, 'We are not going to let taxpayers pay for the rescue of Barclays,'" he said.
And given that neither Veneto Banca nor Popolare di Vicenza was unique in the way that a failing Barclays or Deutsche Bank would be, the use of extraordinary measures for their rescue served only to further raise eyebrows, Samuels said.
"They were not big banks failing in the depths of a crisis — they were pretty small banks failing in the middle of economic stability, and the fact that the punchline to those failures was not a perfect, text-book execution of what the BRRD is meant to be, has added to the market skepticism," he said.
Loopholes worry debt markets
For debt capital markets, meanwhile, the main concern is about the loopholes allowed in each of the different cases in Spain and Italy, said Leland Goss, managing director and general counsel at the International Capital Market Association.
"I think the view is that there is too much room for politics to intervene with too many variables," he said.
He pointed to the so-called point of nonviability, when regulators decide that a bank is no longer able to function and should have its debt "bailed in" to fund resolution. However, if retail investors are poised to be wiped out, as was the case with the Italian banks, this is "a huge problem" given that the bail-in procedure is meant to protect taxpayers, Goss said.
"That completely eviscerates the system," he added.
The Italian cases also demonstrated that "systemically important" is defined differently depending on the circumstance, since an institution may not be relevant on a global scale while being so at national or even regional level. The rescue of Popolare di Vicenza and Veneto Banca, for example, was justified by their systemic importance in the northeast of Italy.
"And if you [allow] politics and politicians to intervene and to play around with these variables, then this system is just not going to work," he concluded.
Samuels also gave a gloomy outlook for the BRRD.
"I don't think that capital markets believe the BRRD is going to work, and ultimately I think capital markets think that there would not be a huge amount of change come the next crisis," he said. Bank debt is still significantly cheaper than corporate debt in the bond markets, as it was before the crisis, demonstrating that investors still assume that bank debt is ultimately government-backstopped, he added.