Tuesday, July 17, 2012

Confirmation that the ECB and EU is moving towards adoption of the Swedish model for handling a bank solvency led financial crisis

Confirming your humble blogger's post earlier this week, Macrobusiness blog carried an interesting post explaining why it too thinks the ECB and EU is moving towards adoption of the Swedish model for handling the EU's bank solvency led financial crisis.

Regular readers know that under the Swedish model banks are required to recognize all the losses on and off their balance sheets today.  Subsequently, they rebuild their bank book capital levels through retention of 100% of pre-banker bonus earnings and, where possible, equity offerings.

As part of its explanation, the post also offered the following history.

Eventually, after much fumbling and politicking, the Swedish government was forced into finding a resolution for the banking system and, as I said above, you may well notice some similarities to last week’s document: 
Banks that turned to the Bankstödsnämnd were dealt with in a way that minimised the moral hazard problem. In short, the aim was to save the banks – not the owners of the banks. By forcing owners of banks to absorb losses, public acceptance of the bank resolution was fostered. In this way, taxpayers were likely to feel that the policy was fair and just. 
The general strategy was to divide the banks into three categories, depending on whether the statutory capital adequacy ratio would be breached and, if so, whether this breach was temporary: The first category included those banks that might deteriorate towards the capital adequacy limit, but would subsequently be able to achieve enhanced solvency on their own; the second category covered those that may fall below the limit for a time, but would eventually recover; and the third category was for those that were beyond hope. 
Each of these three categories was treated differently by the Bankstödsnämnd. 
Category 1. The Bankstödsnämnd encouraged these institutions to find private sector solutions and to avoid public involvement as far as possible.13 Shareholders were requested to inject additional capital where such an option was feasible. To facilitate this process, theBankstödsnämnd was prepared to grant a temporary “capital adequacy” guarantee. Only one bank, Handelsbanken, turned out not to need an injection of capital. Another bank,Skandinaviska Enskilda Banken, chose to reinforce its capital base through a share issue aimed at its current shareholders, without having to apply for any public guarantees. 
Category 2. This category covered a bank with short-term problems, but with a good prospect of future profits that could be expected to restore solvency. In such cases, where private solutions may not be available, the Bankstödsnämnd was prepared to deploy more extensive support, including capital contributions or loans, in addition to the guarantee mentioned in category 1.Föreningsbanken was dealt with under this category, receiving a guarantee that the State would contribute share capital in case the capital adequacy ratio fell below 9 per cent. This guarantee proved not to be needed. 
Category 3. This category embraced banks that were not expected to become profitable; their equity would gradually erode and ultimately become negative. This category required active State involvement, ultimately in the form of orderly liquidation of the ailing institution. However, if a more favourable result could be achieved with other methods, the Bankstödsnämnd was entitled to apply those as well, for instance by selling bad assets and consolidating the remainder of the bank, either on its own or through a merger with other banks. Such an approach was adopted in the case of two major insolvent banks, Nordbanken and Gotabanken. 
Two bank asset management corporations (AMCs), Securum for Nordbanken and Retriva forGotabanken, were set up to manage the bad debt (non-performing loans) of these two financial institutions as part of the resolution policy – as had been the case in other countries. 
A novel approach was adopted which involved splitting the assets of an ailing bank into “good” and “bad” assets, and then transferring the “bad” assets to the asset management corporation, principally to Securum. In addition, when assets were placed under the administration of Securum and Retriva, they were assigned low market values in the due diligence process, effectively setting a floor for asset values. Because market participants did not expect prices to fall below this level, trading was maintained. 
That looks quite similar to sections 14 through 21 of last week’s draft MoU [for dealing with the Spanish banks]. 
There are obviously quite a few components missing, most importantly a blanket guarantee of bank deposits and liabilities and an open ended funding commitment, but I think there are enough similarities to pose the question. 
Is the Eurozone, and more explicitly the ECB, suddenly running the Swedish playbook ?

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