The Free Exchange blog has a useful entry here.
Month: December 2011
Available here.
There is a new ECB legal paper on bank resolution regimes. In discussing the January 2011 European Commission working document, the paper states :
Under the statutory or comprehensive approach, a statutory power would be conferred on the resolution authority ‘to write down by a discretionary amount or convert to an equity claim, all senior debt deemed necessary to ensure the credit institution is returned to solvency’.
… .
Key factors in determining the success of such a bail-in regime will include its compliance with the principles of human rights law governing peaceful enjoyment of property and the predictability of its outcome and, hence, its alignment with the expectations of market participants. However, it would appear that the Commission is considering the possibility to accord resolution authorities the power to discriminate.
Discrimination between equally ranked creditors is highly problematic both from the perspective of human rights and predictability. Discriminatory treatment defined as treating essentially identical cases differently or essentially different cases the same is per se not justified by objective differences and, therefore, unduly infringes property rights.
However, the situation could arise where a differentiated treatment of creditors of the same class may be necessary to achieve an optimal result during reorganisation. In such a scenario, the overall outcome in resolution is optimised by not respecting the pari passu principle within a class of creditors. In order to achieve the intended positive consequences of such differentiated treatment, it is important that it follows transparent principles and safeguards and that the differentiation is justified by objective criteria. In those circumstances, it will not be discriminatory. In other words, any exceptional deviation from the pari passu principle cannot be allowed to build on discriminatory treatment and, in any case, it must be ensured that the principle that creditors cannot be worse off than they would be in immediate liquidation is respected. This differentiated approach shows that the principle of no worse-off than in liquidation functions as a bottom line in the system of creditor safeguards and has to be respected in all cases, while the pari passu principle allows for exceptions, provided these are objectively justified and, therefore, non-discriminatory.
The latest attempt by the ECB to get a grip on the Eurozone crisis might work. It has the potential both to push sovereign market yields toward sustainable rates, and to block self-fulfilling institutional bank runs in which corporate deposits move to stronger Eurozone countries, draining weaker member banking systems of liquidity and credit.
Colm McCarthy was keen on a “reverse tap” in which the ECB enforces a maximum yield (minimum market price) on Italian/Spanish/etc sovereign bonds using its money-creation potential to back up this policy. The problem with his plan, in my view, was the lack of a surveillance mechanism to ensure the funded countries were continuing their needed restructuring. Germany would not accept that solution. My own preference was for the IMF to serve as conduit for sovereign funding via official IMF programs backed by ECB-funded bonds. Colm criticized this as an unnecessary intermediation by the IMF in a problem that needed to be solved by Europe.
The new ECB unlimited-three-year bank funding strategy uses the banks themselves as the monitor for sovereign discipline. It also provides direct bank liquidity so that the slow-motion institutional bank run phenomenon is less likely to lead to the negative feedback loop (corporate depositors distrust the PIIGS banks, PIIGS banks lose liquidity and restrict credit flow to their national economies, PIIGS national economies slow down due to shortage of credit, PIIGS banks suffer due to national economic slowdowns). Actually the “G” does not belong in this acronym anymore since it is a separate case. Perhaps PISI? Commercial banks in the PISI who lose corporate deposits to Germany or elsewhere can replace them with even cheaper funding from the ECB.
Might the new ECB strategy work?
The IMF report on Ireland provides a menu of the different ways in which Ireland can be assisted by its European partners (point 42 on pages 26-27). The IMF points out that such help would additionally benefit the wider eurozone by “enhancing the robustness of Ireland’s program, these and other potential steps would also provide a firewall protecting the euro area against potential shocks.”
I have enumerated the menu below. While I imagine all of these are under discussion, I invite the readership to rank these options in order of importance.
1. Underpinning growth and job creation
1A. Enhanced support for appropriate public investment
1B. Enhanced support for SME lending
2. Banks: regaining market access and return to private ownership
2A. Guarantees for term funding
2B. conversion of short-term Eurosystem liquidity support into medium-term funding
2C. capital support for vehicles designed to reduce deleveraging costs and spillovers
2D. temporary equity participation in banks by European partners
3. Debt Sustainability
3A. see 2D
3B. refinancing prior recapitalization of banks
3C. enhanced EFSF flexibility to facilitate Ireland regaining market access at reasonable cost