by Business Editor David Murphy

The rule book regarding what a euro zone country is permitted to do to fix its banks has been entirely rewritten

Critics have argued Europe has been making up the answers to the banking crisis as it went along in an amateurish fashion.

The evidence to back up that criticism is getting stronger by the day.

The rule book regarding what a country is permitted to do to fix its banks has been entirely rewritten. That raises deep questions about the €62 billion pumped into Irish banks and about future recapitalisations which are on the cards.

In the case of the Cypriot calamity, bank bondholders were wiped out and depositors with over €100,000 in two of the island’s banks are now facing losses of between 60% and 100%.

Initially, EU officials said the draconian solution was a “once off” event to address the symptoms of Nicosia’s casino banking system which was allegedly bulging with hot Russian money.

The head of the euro zone’s finance ministers group, the gaff-prone Jeroen Dijsselbloem, subsequently said Cyprus was a “template” for future banking solutions.

Under Ireland’s presidency of the EU, Finance Minister Michael Noonan is trying to agree a formal process for dealing with failing banks by next month.

ECB board member Joerg Asmussen said: “We want to establish a clear pecking order. First shareholders have to be burned, then all junior bank bondholders, then unsecured senior bank bondholders and uninsured depositors at the very end.”

Not all countries are in agreement, however, and the debate regarding hitting depositors would mean people with savings over €100,000 could be in the line of fire. For over borrowed countries with weak banks (ie: Ireland) this is particularly worrying because there is nothing to stop a flight of large depositors.

While Ireland was told in 2011 that it could not wipe out senior bondholders by the ECB, now Mr Asmussen says this is acceptable. This marks an enormous policy change.
In Ireland most of the bank recapitalisation has already happened. The Central Bank says in the medium term new accountancy rules may mean banks would need more capital.

Others argue that a requirement for new funds could happen sooner as a result of the continuing mortgage crisis. Another stress test, which is likely later this year, will give a reliable answer to that question.

But where will the money come from? Ireland has bailed out bondholders, which the ECB now says it is acceptable to burn. When the blanket bank guarantee was introduced in 2008 there were unsecured bonds of €85 billion in the financial system now there is less than €1 billion of senior unsecured and unguaranteed debt. That means there are no more bondholders upon which losses can be imposed.

Deposits of large corporations have left the system and don’t show any sign of returning. There is €155 billion of deposits in the banks. Of that, €54 billion are savers with sums in excess of €100,000. That means those depositors could feel under threat if amounts over €100,000 can be burned in the euro zone.

Last June the European Council raised the possibility of the European Stability Mechanism being used to recapitalise banks. Germany and some other countries have been trying to back out of this promise.

But now that Europe is making up policies to fix banking problems as it goes along, Ireland has an opportunity to ensure it can use the ESM to recapitalise the banks. The horrible alternative is to tap the taxpayer once again or hit depositors over €100,000.

Not to worry though. Europe will have a plan.