European officials – including Eurogroup President Jeroen Dijsselbloem – have been making comments in the wake of the Cyprus bailout deal that have been more than a little unsettling for investors in European banks.
Dijsselbloem sparked a controversy this week when he suggested in an interview with Reuters and the FT that the way banks were bailed out in Cyprus – specifically, the haircut to uninsured deposits as part of the restructuring process – could be the new way that the euro zone handles bank bailouts in the future.
That would mark a radical departure from what has been the predominant approach in Europe since the start of the financial crisis – authorities ensuring depositors that they won’t be at risk, and that their money is safe in banks across the currency area.
BofA Merrill Lynch analyst Hans Mikkelsen thinks Dijsselbloem has given us a glimpse of the “end game” in the euro area – the eventual transfer of risk back from the taxpayer – which has been shouldering most of the weight of bailout efforts so far – back to those who loan money to the banks in question, through purchases of bank bonds and deposits in bank accounts.
Mikkelsen says that because of this, at BofA, they “embrace a view that banks will never look the same post-Cyprus.”
After all, according to Mikkelsen, “it is not reasonable to expect depositors to be able to distinguish between banks with strong and weak capital ratios but also – and perhaps more importantly – to be able to anticipate whom policymakers will deem worthy of rescue and who not.”
So, what happens next?
Mikkelsen, who has been a big proponent of the idea of a “Great Rotation” out of investor money out of fixed income funds and into equity funds in the United States, envisions something a little different going down in Europe.
Mikkelsen writes in a note to clients:
Yet large depositors have clearly been put on notice that they should be careful where they invest. In our view, this could push larger sums out of the banking system into managed funds, e.g. money market funds or fixed income funds, and will likely spread deposits across a country’s banking sector at the insured level (which may be positive for risk assets).
For the banks themselves, it underlines the work that they still have to do in terms of building capital buffers that will satisfy bondholders (and depositors) of the remoteness of the risk of their suffering any capital loss. This should mean more subordinated issuance over the next few years, in our view.
However, Mikkelsen is not so negative on the prospects for euro zone banks.
“In terms of investible Eurozone banks,” he says, “we reiterate our view that Greece, Portugal, Ireland and Spain have already been recapitalised and are already in programs which we doubt will be revisited any time soon.”
With those four banking systems addressed, Mikkelsen flags Italy as the most relevant risk – but he says that “even our worst estimates” of how much Italian banks might need in a bailout amounts to only 5 per cent of Italian GDP. Furthermore, since Italian banks have a lot of bondholders, Mikkelsen doesn’t see a scenario in which depositors would have to take a haircut, because there are enough bondholders to cushion the blow in a restructuring.
There is, of course, Slovenia, which seems to be teetering on the edge of needing to ask for a bailout, and Mikkelsen thinks that situation could cause a further deterioration in investor sentiment in the short term, “but this is Cyprus-like in its specificity and has little read-across arguably to the mainstream European banks,” he writes.
So, it’s a different world now. Especially for depositors. The market has reacted pretty negatively to this realisation so far, as European bank stocks have tumbled this week.
Whether investors continue to dump them en masse or decide that the risks aren’t as great as this week’s selloff suggests remains to be seen.
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