4th Mar 2024

Brussels wants bondholders to help pay for bank failures

  • Citizens have not been pleased with being saddled with the burden of bailing out failed banks (Photo: William Murphy)

The public would be spared from further pain in bailing out banks in the future, with bondholders instead footing more of the bill under plans unveiled on Thursday (6 January) by the European Commission to give EU national regulators more powers to intervene ahead of any crisis.

The EU executive outlined a series of ideas up for discussion that suggest bondholders should be forced to accept a 'haircut' on their investments in a troubled bank or convert their bonds into equity.

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Reacting to high-profile banking failures during the economic crisis from Belgium's Fortis, to the crash of US investment house Lehman Brothers, to Icelandic banks and Ireland's debt-engorged Anglo Irish Bank, EU member states have chosen to bail out their banking sector, with private debt being shifted wholesale over to the public sector.

Governments support for banks has amounted to 13 percent of GDP, according to commission figures.

Capitals have since used the opportunity to impose sweeping austerity measures as a way to pay for the tab, moves that have proved massively unpopular amongst citizens who complain that they are paying the price of a crisis they did not create.

"The impact on taxpayers is obvious," the EU executive said in a statement, adding that the existing arrangements covering how to deal with such crises retained "serious shortcomings."

"We must put in place a system which ensures that Europe is well prepared to deal with bank failures in an orderly manner - without taxpayers being called on again to pay the costs," said internal market commissioner Michel Barnier.

Under the proposals, which would see a so-called bail-in from investors, national authorities would be given the power to write down or convert debt into equity in the failing bank.

However, out of fear of setting off fresh panic in the markets, the commission stresses that such measures would only affect future debt, with existing bondholders spared any such pain.

"It is not envisaged that such a power would apply to existing debt that is currently in issue, as that could be disruptive," it explained.

Under the outlined proposals, national regulators would be given powers to react to brewing banking failures earlier on, including the ability to impose a replacement of management, force a bank to stop engaging in excessively risky activities, or require the bank to implement a recovery plan.

Regulators could also be able to appoint a 'special manager', a 'Mr Fix-It' parachuted in for a short period to run the firm.

The commission also hopes to see the development of a framework for EU cross-border co-ordination in the event of future banking failures. During the crisis, cross-border responses to banking disasters have been ad-hoc, the EU executive worries.

In the future, national authorities would co-ordinate their responses to ensure financial stability in all affected member states in order to achieve an outcome that best benefits the EU "as a whole".

The proposals are currently at the consultation stage, with fleshed out legislative initiatives not expected before the summer. They also focus only on banks. Similar measures focusing on insurance firms and other types of financial institutions are to be unveiled before the end of the year.

However, markets were quick to react to Brussels' call on them to pay up, with interest rates on Portuguese and Spanish government bonds jumping.

After Lisbon announced it was to attempt a sale of between €750 million and €1.24 billion in bonds next Wednesday, yield spreads between Portuguese debt and German bonds climbed to 4.14 percentage points.

Belgian rates also climbed to 4.05 percent for ten-year bonds, although analysts regard this as more of a reaction to the latest episode in the ongoing failure of the countries' Flemish and francophone parties failure to form a government.

Johan Vande Lanotte, a mediator appointed by the king resigned, declaring: "You can take a horse to water but you can't make him drink."

A government coalition has yet to form since the general election, which tool place on 13 June last year.

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