In early June, the failure of the Spanish bank Banco Popular seemed to work smoothly under the new European resolution rules. The relatively new Banking Union seemed to work in achieving its goal to limit moral hazard. Losses were imposed upon junior bondholders and shareholders whereas Spanish taxpayers did not pay a dime. Although there are many defects with the new resolution framework, it seemed to be a step in the right direction. This impression was short lived and died when the Italian government agreed to use 17 billion of taxpayer’s money for two failed banks, Veneto Banca and Banca Popolare di Vicenza, in late June. Thus, Italian senior bondholders will be protected despite the philosophy of the new bail-in framework according which bondholders shoulder losses if a bank fails. Consequently, the two banks’ senior bond prices rose by more than 15% on Monday.
What is the Banking Union? After the 2007 financial crisis and during the 2010 – 2012 debt crisis, the European banking sector was weakened to a considerable extent. Consequently, the European Central Bank (ECB) and national governments made an extensive use of bail-outs to stabilize the banking sector. As an unintended consequence, the liquidity and capital provided to banks meant that the financial position of both the monetary authorities and the national governments deteriorated and the incentives for banks to act prudently were distorted.
This post was published at Ludwig von Mises Institute on July 4, 2017.
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