Tuesday, 26 March 2013

The Dutch cap set to create another financial crisis

The Dutch have made a few decisive contributions to the global financial system since the debacle of the Tulip-mania the first recorded financial bubble,  of 1636-1637.  An episode in which tulip bulb prices were propelled by speculators to incredible heights before collapsing and plunging the Dutch economy into a severe crisis that lasted for many years.  

This 'glorious' history did not appear to hold back Jeroen Dijsselbloem,  chairman of the eurozone finance ministers. who has led the charge on Cyprus.  The final deal is that Mr Anastasiades (Cyprus's PM) agreed to the closure of Laiki, the island’s second-largest bank, and the radical restructuring of Bank of Cyprus, the country’s biggest. In both banks, large uninsured deposits of more than €100,000 will be used to pay for the bailout; in Laiki, senior bondholders will also be “bailed-in”.

The Euro fell on global markets after Jeroen Dijsselbloem, announced that the heavy losses inflicted on depositors in Cyprus would be the template for future banking crises across Europe.  "If there is a risk in a bank, our first question should be 'Okay, what are you in the bank going to do about that? What can you do to recapitalise yourself?'," he said.  Now in full flow he went on to say "If the bank can't do it, then we'll talk to the shareholders and the bondholders, we'll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders."

These parting shots made by Mr Dijsselbloem, following the conclusion of the Cyprus bail-out deal should send a cold shiver down the spine of every saver and investor in Europe.  Prior to 2008 investors had the tacit understanding of the risk reward  equation;  but the game changed with the collapse of Lehman Brothers and the subsequent central banking guarantees that effectively insured depositors against losses.  The decision to step away from this principle in Cyprus would be fine if we lived in a world where the banks were well capitalised against a low risk loan and investment portfolios.  Sadly this is not the case.  Specifically in Europe our major banks are still in a very fragile state, being both short of capital and over leveraged to low grade loans / investments. 

The European Stability Mechanism (ESM) was initially designed to have the fire power to deal with both government and bank restructures, it seems that the terms have now changed.  Mr Dijsselbloem confirmed  that the European Stability Mechanism, the eurozone’s €500bn rescue fund would be unlikely to be used to recapitalise struggling banks, a complete about face on 12 months ago. “We should aim at a situation where we will never need to even consider direct recap,”  Asked how this might effect other countries with under-capitalised banks Mr Dijsselbloem added helpfully “It means: deal with it before you get in trouble. Strengthen your banks, fix your balance sheets, and realise if a bank gets in trouble, the response will no longer automatically be: we’ll come and take away your problems.”

Whether Mr Dijsselbloem cares or not he has now set in motion a hugely risky redistribution of assets and deposits as wealthy Europeans look to spread their risk and reduce their asset concentration in any one bank.  This capital migration will undoubtedly see a number of European banks severely weakened and the end game could be very messy.

More at http://www.ft.com/cms/s/0/6943b3fe-963a-11e2-b8dd-00144feabdc0.html#axzz2Og1jStW6

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