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Those numbers could increase if European regulators apply different risk weightings than banks when assessing the riskiness of their balance sheets or enforce higher leverage requirements.
One senior London based banker describes the EU’s single resolution mechanism (SRM) as “the elephant in the room”. “The SRM and, specifically, the implementation of the ‘bail-in tool’ has great potential to move spreads", says Emil Petrov, head of capital solutions at Nomura. “I don’t think that the risk of senior unsecured debt bail-in has been fully priced by the market yet and I expect the spread between senior debt and Tier 2 debt to tighten as implementation becomes imminent.”
If banks struggle to raise funding in markets, they must first impose losses on subordinated creditors under EU state aid rules, then potentially tap their home Member State. If the sovereign is unable to afford this, it can call on the eurozone’s €500 billion bailout fund, the European Stability Mechanism, for loans with strict conditions.
After 2016, tougher bail-in rules will kick in that bring senior creditors into the firing line during any bank resolution. The law is complex and gives authorities some discretion, but in general creditors amounting to 8 per cent of liabilities would need to be bailed-in before state support or resolution funds can be offered.
“Sooner or later you will see some impact on as senior creditors look at the risks they’re running and work out the likelihood that they will face a writedown", says Tim Skeet, a managing director at Royal Bank of Scotland. “They’re being asked to take on quite a lot of capital risk without a lot of capital upside – coupons are pretty thin.”
For the time being, a bank’s sovereign remains largely responsible – and on the hook – in the event that a bank hits serious difficulties. Critics argue this strengthens the link between sovereigns and banks, one of the things a union was intended to dilute.
“A union was meant to lessen the difference between putting your money into a Spanish as opposed to a German bank", says Matt Spick, head of banks research at Deutsche Bank. “Investors will look for a strong sovereign because they have greater discretion about which bondholders they will bail in and bail out.”
Analysts point out such concerns may not matter much so long as eurozone growth ticks along and investor outlook remains positive. In the short term, stronger economic fundamentals and investors’ hunt for yield will be the determining factors in banks’ funding costs, especially in periphery countries.
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