Who will pay for banking losses?

The WSJ has a really good piece by Gabriele Steinhauser and Matina Stevis on the core story of the Eurogroup meeting, which seems to have slipped past the domestic media somewhat. Yes, yes, they’ll get to Ireland’s debt in September/October. Grand. The key issue of just who pays for any losses within the ESM is not settled, nor is it likely to be any time soon. From the piece:

Germany’s finance minister said that even once the euro zone’s bailout fund has been authorized to directly recapitalize struggling banks, the lenders’ host government should retain final liability for any losses.

Wolfgang Schäuble’s statement early Tuesday indicated disagreements on how far the currency union needs to go to protect countries from expensive bank failures. His declaration, which followed more than nine hours of talks between euro-zone finance ministers here, clashed with those of other officials, who insisted that banks’ host states wouldn’t have to guarantee any support from the bailout fund.

The issue is hugely important for Spain, which risks being locked out of financial markets amid concerns over how a European bailout for its banks will affect Madrid’s ability to repay investors.

Fun times ahead.

By Stephen Kinsella

Senior Lecturer in Economics at the University of Limerick.

24 replies on “Who will pay for banking losses?”

Seems there is a little problem of communication. Wolfgang doesn’t agree with the generally accepted interpretation of the summit proposals…
From Der Spiegal …
“This fundamental dispute overshadowed the meeting of finance ministers. Schäuble said there had been some misunderstandings in communication following the EU summit. As a result, the various partners had to reassure each other that they meant the same thing. “It must be made clear that nothing is going to happen quickly,” Schäuble said. Those individuals who claimed that banks could have direct access to the ESM within a few months were awakening false expectations on the financial markets, he said. That was not good, he added.”

It seems nobody is bothered by the question posed! Bloomberg have a gushing article today which would lead you to believe that the Spanish crisis is solved and the markets are reacting as if it is fact with Spanish yield down to 6.83 on 10 year bonds.

So who pays? Perhaps the German Constitutional Court will provide guidance.

To borrow from Yogi Berra, “It’s déjà vu all over again!”

We had 3 or more threads on this issue last week.

The ESM fund of €500bn is insufficient to support the banks of up to 6 troubled economies and it is not likely that it would be topped up this side of a German general election.

The Eurogroup statement in respect of Ireland could be read two ways: “The Eurogroup will consider the issue again at its meeting in September. Similar cases will be treated equally, taking into account changed circumstances.”

Does it mean that all countries will be treated like Spain in retroactive funding from the ESM or does it mean that existing cases such as Portugal Ireland, and Greece will be treated the same?

Schäuble’s comment on ultimate liability remaining with states matters.


1: If I print my own money (I am a very clever fellow!) and it is so good that it is indistinguishable from the actual, and I ‘lend’ some of my new money to a mate (who has no inkling of my mastery in the art of forgery); can I now make the Lockean claim that ‘that money’ was my private property and I will demand repayment, or else!

2: Is the ‘electronic printing’ of money the creation of a physical entity? That is if I conjure up something from nothing – can I now claim Lockean ownership of something whose origin has no claim on any prior physical entity? This appears to be a very good definition of the Creation.

@ All

I posted this link to the important recent report by the German Counncil of Economic Experts (which carries, or should carry, a greater weight than Professor Sinn). An English version is promised by the end of the month. It devotes considerable space to the case of Spain and is rather elliptical, if I understand the German correctly, as to who will ultimately carry the bank losses.


I posted what Schaeuble actually said on the KOR thread (according to the WSJ).

“We expect that the final liability of the state will remain” even once the banking supervisor is up and running, he told journalists. He added that what mattered was that the bank support wouldn’t add to a country’s debt—something that he said would be possible even under a scenario where the government retained liability for potential losses”.

While being no expert in the area, what he seems to me to be saying is that there will be some form of “comfort letter”, through the EFSF and ultimately the ESM, which will improve market sentiment and lower borrowing costs for the affected states by not impacting on their overall debt levels. The markets seem to have understood it this way.

The Council of Economic Experts are also very strong on the conditionality aspect, including the posting of collateral – cash or gold reserves – in the context of its proposal for dealing with the enormous stock of outstanding debt.

There is, sadly, no such thing as a free lunch.

What, you mean there is no Santa Claus, and that someone (including Ireland at 1.5%) has to fund the ESM?

We’re not going to get debt-writedowns – in the sense that ordinary people would understand the term – even with accepting more oversight or conditionality from our creditors. With a debt:GDP of “only” 120%, and our Dept of Finance and the IMF saying this is “sustainable”, creditors would need be mad to give us a debt-writedown.

They might pay market prices for our shares in the banks, and they might extend the period for funding the Anglo promissory notes. But we don’t need a Santa Claus for either action.

@ All

I find Schauble’s comments alarming.
There was a summit after all. There was a communique issued that explained that imperative of breaking the link between banks and sovereigns. At least that is what I recall reading. So what is going on.

Have Germany signed a summit communique that is worth less a latter day Munich Agreement.
Europe should simply stop and reflect at this point.
Either Germany has the capacity to sign an agreement or its does not.
It appears that it does not.

Alarming comments indeed.

What is the net difference between the sovereign bailing out the bank directly and the sovereign fufilling any future losses the ESM incurs from recapitalising the bank?

Horrible feeling of being back to square one..

And Wolfgang’s comments fly in the face of the other part of the Statement

“We affirm that it is imperative to break the vicious circle between banks and sovereigns”.

At this morning’s press conference Matina Stevis continued on this theme. Here is the question she asked and the answers received. It can be viewed from 29:45 in this video.

Matina Stevis, Wall Street Journal

“Can you please tell us in no uncertain terms, are you in a position to say today, that the ESM will not request any guarantee in any form from sovereigns when it injects capital and receives equity in rescued banks? Will it request some guarantees or full guarantees for this equity share that it will take on its balance sheet or will the risk be shared with the sovereign somehow?”

Klaus Regling, CEO of the EFSF and incoming MD of the ESM Board

“Well the first point, as you know, the ESM is not operational so we are planning now everything for the bank recapitalisation in the case of Spain via the EFSF and that was discussed today.”

Ollie Rehn, VP of the Commission in charge of Economic and Monetary Affaird

“On the ESM and direct bank recapitalisation. I think the word and concept “direct” is a very clear concept. This direct bank recapitalisation, not indirect through the sovereign, but there is a very clear and necessary condition. It is that there has to be an effective and well-functioning single supervisory mechanism of banks that are part of this arrangement of direct bank recapitalisation.”

Thomas Wieser, President of the Eurogroup Working Group

“Just to complete what was said by the two previous speakers. And then there will be no sovereign guarantee required.”

@ Tim

Karl Whelan’s take on the situation is simplistic in the extreme. Germany has taken on enormous contingent liabilities already and these have not shown up in its national debt; yet! But it cannot be seen as simply an accounting trick.

Qualifying my remarks with the statement that I lay no claim to expertise in this area, we have a very topical example in the news domestically as to what several and joint liability means. The Germans are not going to accept it and neither woud we were we in their shoes. The best that can be expected is limited form of joint liability with clear limits for each participating country.

It is up to the politicians in those countries to take the actions necessary to convince markets of their ultimate viability. This is the lesson that Rajoy is slowly and painfully learning. Whether it has been learned in Ireland is open to doubt.


It’s interesting that last year when people were advocating writedowns of domestic mortgages, there was no apparent interest from the same individuals in paying extra tax themselves.

Hadn’t Blackrock provided the necessary buffer to cover it?

The current tug of war (or perhaps – turning on of the bath taps while simultaneously pulling out the plug 😉 ) is all about whether Spain will be required to issue the equivalent of put options to the ESM when the ESM buys shares in its banks.

You can think of the puts as the contingent liabilities that people like me are too dim to focus on.

How dim? Contingent liabilities are routinely ignored in press reporting and debt sustainability analysis. Ireland has probably somewhere between 100 and 130 bn in pension liabilities for example.

If you assume the puts are eventually held to be non-invisible and therefore ridiculous, you have the current version of ESM Article 20 (pricing) requiring investment at or close to market value. If some of Spain’s banks are insolvent, then the ESM can only recapitalise them by invoking item 3 of Article 20.

Given current German attitudes (see puts above) it is difficult to imagine this occurring post an EZ-wide regulatory system having declared such banks to be bust. This, it seems to me, is the interesting bit with regard to IBRC and AIB.

If the Germans get their puts, then Spain might get some of its bust banks recapped via the tried and tested method of pretending they aren’t bust. If there are no puts, then they will probably have to be declared Anglo-equivalent.

At that point the ‘equivalent’ question could become favourable to Ireland if, note, if, the difference of recaps hapenning before as opposed to after, the EZ-wide regulator is in place could be navigated.

From Seamus’ post

So, until there is “an effective and well-functioning single supervisory mechanism of banks” sovereigns are on the hook for taking any equity stakes in banks and conditionality and MOU’s will be the order of the day. In the short term, nothing has changed, in the longer term something may change.

Next question how long is it going to take to establish this well-functioning supervisory mechanism?

Seeing as we are going round in circles may I propose my original solution to the problem

Shoot one banker for every billion lost.

and one regulator for every 100 billion lost.


The document also says that holders of hybrid capital and subordinated debt in state-rescued banks will have to take a haircut on their investments in order to minimize the cost to taxpayers of the restructuring.

Hundreds of thousands of small shareholders who bought instruments such as preference shares are likely to be affected.

The first injection of capital into banks not already rescued by the state and unable to raise capital by themselves can be expected by October, after reviews by the Spanish government and the European Commission.

De Guindos said he hoped some of the bank aid could be given directly to banks, rather than through the Spanish government, once an ECB-led supervisor for euro zone banks is operational, sometime during next year.

“The issue of a direct recapitalization is open, because in the memorandum, there will be a reference to the (euro zone leaders’ June 28/29) summit conclusions where it was established that with a single banking supervisor, direct recapitalization will be possible,” he said.

As recently as last February, Mr Schauble was wondering about Greece’s willingness and ability to stand by its agreements:

“When you look at the internal political discussions in Greece and the opinion polls, then you have to ask who will really guarantee after the elections that Greece will stand by what we are now agreeing with Greece,” German Finance Minister Wolfgang Schaeuble said on February 15.

These remarks were the last straw for President Karolos Papoulias, 82, an elder statesman and moderate former foreign minister, who responded by wondering aloud at a meeting with the Greek general army staff: “Who is this Mr Schaeuble to insult my country? Who are the Dutch, the Finns?”

Following the latest comments by Mr Schauble ,backsliding on the summit deal, the question can be rephrased:
‘When you look at the internal political discussions in Germany and the opinion polls, then you have to ask who will really guarantee that Germany will stand by what we are now agreeing with Germany’

Are the Yanks and the Asians going to stand aside and watch the Euro collapse ?
Or even the Swiss, FFS.

@ All

The situation gets curioser and curioser with this FT editorial this morning;



“More importantly, the eurozone affirmed that, once a common bank regulator is created, the Spanish government will not be liable for the aid.”

If this affirmation is in the statement of the Eurogroup, it is well disguised.


@ All

Article 8.5 of te ESM is interesting in this context.

“The liability of each ESM Member shall be limited, in all circumstances, to its portion of the authorised capital stock at its issue price. No ESM Member shall be liable, by reason of its membership, for obligations of the ESM. The obligations of ESM Members to contribute to the authorised capital stock in accordance with this Treaty are not affected if any such ESM Member becomes eligible for, or is receiving, financial assistance from the ESM.”

Ireland will not get a significant write down of its debts unless Spain and Italy, and the rest, are also benefitting. It may get an adjustment to interest rates or repayment periods, but a whopping discount won’t arrive.

For some irrational reason or other, a sense of entitlement to a discount seems to pervade the Irish consciousness on this thorny matter.

If Noonan & Co. really believed it achievable they should have pressed the button when Greek debt holders were compelled by and large to take a discount.

I read this morning the ‘adjustments’ being imposed by the Spanish Prime Minister. They can only flatten the economy in the medium term and there is no certainty of growth. How long will it be before Spain goes down the Greek line into default?

John McHale on a different thread mentions his concerns for the euro after a conference in Berlin. To a layperson like myself, it is baffling how it can hold together with the same set of levers being applied repeatedly.

Membership of the euro will figure prominently in the next Italian general election. Up to recently I would have considered a return to the Lira most improbable.

Beppe Grillo’s Five Star political front has exiting the euro top of its list. It is unlikely Five Star will ever come remotely close to forming a government (being part of one can’t be ruled out) nonetheless there are winning local elections and the message is resonating with ordinary people and businesses.

If Spain and Italy made common cause for a debt discount, what could the rest of the eurozone do to prevent them taking relevant actions? Probably very little without forcing them out of the euro.

A counterfactual question I would like the economists to address is what would be the response now if Greece was pushing for a second bailout and debt discount? Could it be the case that the decision on the latter was taken hastily in the expectation that conditions would improve or at least not deteriorate in the other big southern economies? If so you would wonder who reads the tealeaves in the EU/ECB.

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