June 27, 2013

EU Finance Ministers Cooking Up a Storm

This week's ECOFIN meeting has confirmed fears that Cyprus-style 'bail-ins' will be the new normal when dealing with future bank restructures.

For the long-term traders out there with a more macro view, today’s events in Europe should be intriguing. Also, those of you with more than 100,000 EUR in your bank accounts at European banks, this update is a must read.

Following a whole day of talks at the ECOFIN meeting, EU finance ministers came to a broad consensus on rules/guidelines that shall be used to decide all future ‘bail-ins’ within the EU. Finance ministers have essentially sketched out a template of how they will deal with future bank failures and/or sovereign default crises. As a rule of thumb, the ECB/EU is planning to designate anyone with a bank balance higher than 100,000 EUR as a viable tap for a haircut. Shareholders, bondholders and depositors will share the burden of saving a bank. Rules stipulate that the European Stability Mechanism (ESM) can also be used to support troubled banks within the Eurozone. The rules also state that countries are obliged to disburse losses up to the equivalent of 8% of the bank’s liabilities before taxpayers or bailout funds can be used. Although the rules agreed by EU ministers will only become formal policy in 2018, they will nevertheless be a benchmark as early as next week, should some kind of credit crisis unravel itself within the Eurozone prior to 2018. Today’s agreement is now likely to pave the way for EU leaders to ratify the EU’s highly controversial banking union on Friday.

To call today's development ominous is an understatement. What this agreement means is that the EU/ECB will now be able to use anyone's Euro-based bank deposits to plug any capital shortfalls they deem to be necessary. Cyprus was a case study and it seems ECB officials and EU finance ministers have found the results to be satisfactory. As a throwback to 2008, losses are once again being nationalised and profits will no doubt continue to be privatised.

Market reaction

European bond markets have found some support in early European trade today, partly helped by dovish ECB comments and also by tempered expectations of the Fed’s departure as a blanket buyer of US bonds. A downward revision to Q1 GDP (1.7% vs. 2.5% exp.) has encouraged bond bulls to re-enter the market on speculation that central bank support isn’t over yet. Shorter dated debt (<3yrs) has also benefitted from PBOC comments as China tries to calm the burgeoning panic arising from its squeeze on speculative banking practises in China.

Commissioned by Think Forex