EU Banking Resolution – far reaching implications for depositors

Little attention has been paid to Europe’s new agreement on bail-ins for troubled banks. Yet the implications are far reaching. Major differences in accounting for derivatives – US GAAP versus IFRS – have been resolved in favour of the European IFRS approach. This has a big impact on reported leverage for the major US banks. And depositors might also realise that they will be much more exposed in future. There may be less flexibility to follow approaches like that of the UK’s Co-op Bank where penalties will be applied selectively to different creditors. The proposal for that bail-in does not follow the conventional credit ranking .

Derivatives

Currently, American banks under US GAAP can net off derivative assets against derivative liabilities and report the lower figure. European banks report the higher gross amount, making their total leverage look much higher. Of course actual capital ratios are typically weaker in Europe, and so the change just brings the apparent strength a little closer. And neither approach actually shows the full economic exposure – the face value of the related underlying securities – which is much higher than the stated derivative values.

But a comparison of US, EU and other comparable global banks can be seen in the FDIC analysis based on data at end 2011, which ranks more than 30 of the biggest on a basis that reflects IFRS and genuinely loss absorbing capital. European banks still look weaker, even before any allowance is made for likely hidden losses.

UK and Eurozone/Switzerland

The good news for UK banks is that Continental European banks fare better than many of their peers in the Eurozone and Switzerland As might be expected, HSBC and Standard Chartered are top quartile and the other largest UK banks avoid the bottom quartile. Most of the bottom quartile is reserved for some large names in Continental Europe. Despite the scale of the UK’s credit bubble, it is more likely that yet-to-be realised lending losses lie within the weaker Eurozone region.

Although the new accounting approach is 5 years from implementation, banking analysts may start to make comparison much earlier. Commonality of approach is needed if global banks are to be bailed-in, as the US taxpayer is unlikely to be as generous as it was in 2008 if international banks with US operations run into trouble.

Deposits

Agreement in outline on bail-ins will set a more standard pattern for sharing pain between equity holders, bond holders, depositors, state and EU. It would not contemplate arrangements like Ireland’s 2008 to March 2013 deposit guarantee. Not it is clear that bail-ins like the UK Co-op Bank’s proposal would be permitted. Moody’s has now given the Co-op Bank a short term sub-prime rating for its deposits; in future this would get more attention from depositors above £85000 and the other depositors big enough to be excluded from the guarantee. Is is intended that all creditors in future, above the €100,000 insured level that protects the unsophisticated , will need to play a part in controlling big banks and pricing their business model and leverage correctly. Much more education of depositors should be done.

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