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Monday, 4 April 2011

Let’s get rid of the concept ‘System Bank”: every bank should have the possibility to fail.

The European countries Greece, Ireland, Spain and Portugal are fighting for their (financial) existence and membership of the Euro zone
·     Greece reported a staggering deficit of 10.4% over 2010.
·     Ireland’s banks immediately need an additional €24 bln to keep head above water, while the whole country is already drowning from debt.
·     Portugal needs soon to roll-over various national loans against deteriorating interest rates, as rating agencies Moody’s, S&P and Fitch lowered the rating of Portugal.
·         Spain suffers from:
o    high unemployment;
o    an enormous, but currently deflating bubble in residential and commercial real estate, with devastating results for the Spanish financial world.

These facts would be big, but not at all fatal problems when:
·    not the whole financial world in Europe and abroad was interconnected through the large, internationally operating banks
·    the largest European banks would not have enormous exposure to risky investments, like Greek and Irish sovereigns, large quantities of derivatives and commercial and residential real estate in Spain, Great Britain, Ireland and Portugal
·    some of these largest European banks were not called “system banks”.

Everybody in their right mind agrees that the only way to solve the problems of the PIIGS-countries is: 1. To allow these countries to restructure their debt. 2. To put these countries under a kind of legal restraint by the other euro zone countries to clean up the financial mess in a matter of 5 – 10 years. And 3. To let the bondholders of the sovereign bonds of these countries take a haircut: shared burden.

But this does not happen: the countries of the Euro zone create emergency funds for current use and for 2013 to “rescue” the PIIGS, by handing out more debt to them. In no case until now, the bondholders are sharing the burden by getting a haircut on their bonds.

Even Stevie Wonder can see that the amount of money in the emergency funds will not be big enough to bail out Spain alone. Not to mention the other countries from the PIIGS zone. But still this is the path that the Euro zone wants to follow until the last taxpayer falls down.

Why? The reasons for this are the so-called “system banks”.

Who are these system banks? You should think of:
·    UK: HSBS Bank, Barclays, Royal Bank of Scotland
·    The Netherlands: ING Bank, Rabobank, ABN AMRO
·    Germany: Deutsche Bank, CommerzBank, Deutsche Postbank
·    Spain: Banco Santander, BBVA-Banco Bilbao Vizcaya
·    France: BNP Paribas, Société Generale, Credit Agricole
·    Italy: UniCredito, Intesa Sanpaolo, Banca MPS
·    Belgium: Dexia, KBC Group

These system banks are extremely large, measured by assets and they are very important on their home markets, but also for international trade (bank guarantees, Letters of Credit). They keep the money coming from savers, companies and pension funds and submit loans to large corporations, small and medium enterprise and private persons for mortgages and private loans. They exchange money for national and international business deals. They also render services for stock trading and IPO’s for companies.

In 2008 governments all over the world decided that these system banks could not fail, as this would bring down the whole global financial system, like a house of cards. As example of the havoc that would be created when the system banks would fail, people pointed to failed banks like Lehman Brothers and Washington Mutual in the USA, ABN AMRO in The Netherlands and Northern Rock in the UK. This should be prevented at all cost.

Therefore no system bank has failed since 2008 and the European and US governments make sure that the system banks remain fully operational.
But this “cannot fail”-principle for the system banks created enormous risk for moral hazard:
·    System banks didn’t feel the need to restructure their credit and write-off radically on their risky investments (PIIGS-sovereigns, CRE and Residential RE, derivative investments), as they knew the European governments would always foot the bill in case of future events.
o   Instead the banks acted like all assets on their balance sheet were “pure gold”, although everybody knew they were not.
o   They used the concept of “heads: we win, tails: you lose”.
·         Knowing the shaky assets on their own balance sheet, it led to mistrust of the creditworthiness of other banks, continuing to this day.
·         Banks on the other hand became arrogant again, as they knew they would always be saved by the governments of their domiciles.
o   The customer was put in the center only by words, but not by deeds.
o   There is a  renewed fondness for large bonuses in especially the UK and the USA.
o   CEO’s of system banks in The Netherlands were very indignant about being refused their bonuses by the Dutch government.
o   Barclays and HSBC even threatened the UK government to flee the London City as their domicile, in case of stricter banking legislation.

The result of keeping these system banks alive is that the European system banks are still extremely vulnerable to sovereign defaults and to restructuring of sovereign debt. As a consequence the European community is held hostage by these banks, as the default risks are in fact transferred from the large banks to the European countries: now only for the PIIGS-countries, but in due course to all European countries .

And now the taxpayers in all European countries are left holding the baby, knowing they should keep footing the bill. 

If Europe and the US don't want to remain paying for the system banks until the last taxpayer falls down, they should leave the concept of the system bank. When no bank is too large to fail, countries can write scenarios for what happens when a bank fails. We had some experience with it in 2008, so this is not all new.

The most important thing when a large bank fails, is damage control:
·    Keeping the healthy parts of the failed bank alive and making sure that day-to-day business can carry on.
·    Making sure that all corporate and private debtors pay back the money they borrowed, by continuing their term loans, mortgages and overdraft loans.
·    Bringing down all unhealthy parts of the failed bank at the cost of stock and bondholders.
·    Terminating all irrecoverable loans.
·    Bring back the trimmed-down bank to the financial market as soon as possible.
·    Remunerate the savers that lost money up to the state-guaranteed amount, when a bank cannot be saved anymore

But we should stop sponsoring banks that don’t deserve to be sponsored. The worst thing that could happen is that all system banks fail at the same time.
But if this happens, this would mean that these banks already have failed, but nobody dares to say it. And the price of this "don't ask, don't tell"-behavior is getting larger and larger.

For me it is certainly not worth it to shipwreck the whole European Union to save these system banks. So please, let them fail, if that is what should happen, to save the EU.

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