Monday, March 25, 2013

Back to debt/equity swaps?

The worst thing which can happen to a bank's creditor (be that a lender or depositor) is that his claims are 'shaved' as part of a haircut. Why? Because he gets nothing in return.

In a previous post, I have argued why a debt/equity swap (which was insinuated in the first proposal for Cyprus) could really be a good idea. Obviously, if the equity one gets in exchange for loans/deposits is worthless, the idea is not much better than getting 'shaved' right away. But who is to tell that equity which appears worthless today will never regain some value?

It seems that debt/equity swaps are now indeed part of the current proposal, and that is good!

Not knowing their balance sheets, I cannot tell why one would restructure the largest bank through debt/equity swaps and not the second largest. Some creditors who will lose money with the latter are certainly going to ask that question in court.

The other question which I cannot answer without knowing the banks' balance sheets is why it should not be possible to transform the short-term risk of a bank run on the part of large depositors into an organized and orchestrated process to reduce bank assets in order to pay out depositors. Given the magnitude of the large deposits, it can't be that the banks used them all to fund loans. We know that a lot of them were used to fund the investment in now illiquid Greek bonds but I have to assume that the banks also invested in other, more solid and liquid asset categories. When an investment fund is called upon to pay out investors, it doesn't borrow money for that. Instead, it sells assets.

No particular praise is in order for doing away with the charge on deposits under 100 TEUR. First, there was no choice but to do this and, secondly, the long-term damage of having originally proposed it is irreparable.

To essentially close the second largest bank may be a good idea, or may not be. That would depend on how large the good bank would be after the bad bank is carved out. The most important point, though, is equitable treatment of risk takers in similar categories. The more inequitable it may turn out to be, the higher the risk of endless law suits.

Obviously, if one's intent is to shrink the Cypriot banking sector, there is no faster way to do it than to close the second-largest bank...

1 comment:

  1. There's a lot of scaremongering going on. The mainstream newspapers are making hay with this because it sells. When push comes to shove, banking runs need a lot more than "just a feeling because of Cyprus". There needs another dynamic too, and that is far harder to judge - look at Northern Rock! Most people do not come to decisions easily, and would rather leave things just as they are.

    The issue of Cyprus was dealt with badly, not least by the Cypriot government! It will level itself out somehow and those who have lost money will get used to the idea that it isn't there any longer.