FT Alphaville " The bail-in Spain - ECB edition Banking crisis U-turn of the year? From the WSJ's Gabriele Steinhauser and Brian Blackstone: The European Central Bank, in a sharp turnaround, advocated imposing losses on holders of senior bonds issued by the most severely damaged Spanish savings banks - though finance ministers have for now rejected the approach, according to people familiar with discussions. The ECB's new position was made clear by its president, Mario Draghi, at a meeting of euro-zone finance ministers discussing a rescue for Spain's struggling local lenders in Brussels the evening of July 9... In the July 9 meeting, Mr. Draghi argued in favor of including senior bank creditors in burden-sharing between taxpayers and investors in the case of Spain, three people familiar with the discussions said. Two said Mr. Draghi favored forcing losses on senior bondholders only when a bank was pushed into liquidation. That's the central bank "arguing in favour" of what is still a highly rare event in markets - and an unheard-of event in the eurozone - which the ECB itself once feared would wreck financial stability. A few thoughts... This condition of "only when a bank was pushed into liquidation." That's about where the policy-maker consensus is, though resolution isn't quite bankruptcy law. The reason it's been so rare for the holders of senior unsecured bank debt to take losses is that normally they've ranked pari passu with a bank's depositors in bankruptcy. Governments have tried to pick their way around that problem. Amagerbanken, a Danish bank, imposed a 41 per cent loss on senior bondholders last year, under a government wind-down of assets. But even with the liquidation rider - for the ECB to advocate senior burden-sharing as a central bank, right now in the crisis, and in Spain, would be remarkable. Liquidity and liquidation of Spanish banks. The July 9 meeting was about Spain. If Draghi was talking about taking bail-ins all the way up to senior unsecured debt, that's a sign that the ECB is ready for some banks to be declared "non-viable." As last week's draft bailout MoU already stated: Banks that are deemed to be non-viable will be resolved in an orderly manner... Orderly resolution plans should be compatible with the goals of maintaining financial stability, in particular by protecting customer deposits, of minimising the burden of the resolution on the taxpayer and of allowing healthy banks to acquire assets and liabilities in the context of a competitive process. Incidentally, it's intriguing to re-read this now and note that senior creditors weren't mentioned as protected alongside depositors... It would be quite a grasping of the nettle. After all, the ECB must know very well that some Spanish banks have likely been continuous borrowers from its crisis liquidity ops since they started in 2007. One problem with a bank's liquidation would be managing down this liquidity. Another might be ensuring that other (stronger) banks don't remain long-term borrowers because the bail-in precedent drives up the cost of private funding. The ECB would also be talking about senior bail-ins in resolution long before 2018. That's when formal EU powers to impose senior burden-sharing are supposed to come into force, and not before, as per rules unveiled just one week before Spain first asked for a bank bailout. So, 2018 isn't set in stone. We sort of knew this already, and wondered about it during Spain's initial bailout request. We pointed to these official guidelines for bank recaps by the EFSF, for whom 2018 wasn't set in stone either: Where appropriate, additional conditionality could draw from the future EU bank crisis resolution framework, which will be proposed by the Commission after summer. In particular, such a conditionality could include requirements to enhance the supervisory toolbox in the three crucial phases of crisis management identified (preparation, early intervention and resolution) such as recovery and resolution plans, early intervention tools for supervisory authorities, asset separation tools, bail-in tools. At that time, we were being told how silly we were for believing that the losses of Spanish banks would be big enough to need any bail-in, even of junior bank debt. Well, the sub-debt burden-sharing arrived, as did the "asset separation tools," a bad bank. While finance ministers rejected senior bail-ins "for now" as the WSJ puts it - it all looks more malleable than ever. Not least, the ECB is leading on senior debt bail-ins just as it might become the eurozone-wide bank supervisor. As the WSJ also mentions, governments might come round to full burden-sharing the more they see it as a way to minimise the loss they'd face on holding equity in direct ESM bank recaps. There's been some loose talk of "resolution" as a condition for these direct recaps, when they come into force in 2013 or 2014 (the timeline really isn't clear). ECB advocacy of senior bail-in narrows it down a bit, again well before 2018. It's also worth remembering what Draghi said about "democratic accountability" for the ECB, if it takes up the supervisor role. Senior bank bond bail-ins would mean accountability to taxpayers who'd otherwise bear banks" risk, we suppose... Finally - Ireland, the ghost at the table. From the WSJ story, on the finance ministers" rejection of the ECB: Forcing senior creditors to take losses in Spain would have raised more questions in Ireland about why taxpayers were forced by the EU to take on the huge burden of repaying high-ranked bondholders. Well, as P O Neill has already pointed out, path dependence isn't a policy. Though it might show why retroactive change to Ireland's bank bailout is tricky. Ireland also seems to be cursed special because the government backstopped so much senior unsecured bank debt (in the Eligible Liabilities Guarantee scheme). So what about all that Spanish (or Italian) government guaranteed bank debt? Related links: Credit distortion de crise - FT Alphaville The problem with Europe's bail-ins - FT Alphaville Senior creditors rarely get haircuts - WSJ This entry was posted by Joseph Cotterill on Monday, July 16th, 2012 at 9:01 and is filed under Capital markets. Tagged with bank bonds, bank resolution, burdensharing, ecb, ireland, senior debt, Spain, spanish banks.