What is a precautionary recapitalisation? October 21, 2013 at 8:29 am

Mario Draghi’s letter to Commissioner Almunia on European Union bail-in rules (the whole text of which, interestingly, I cannot find on-line), has been making the news. Reuters reports that he suggests that

Banks that are still viable but need state aid to boost their capital base should be allowed to receive help without inflicting losses on their junior bondholders,

The situation under discussion here is where the

bank had a viable business model and its capital was above the minimum threshold, but its supervisor still required it to raise additional funds.

Hmmm. This suggests that we really can tell whether a stressed bank’s capital is above the minimum, which in turn implies that we know what its assets are worth. In reality supervisors will often be requiring banks to raise additional funds precisely because they distrust a bank’s provisioning. In this case the bank is ‘really’ not well capitalised, and the market doesn’t want to buy the new equity precisely because it suspects this is the case without having good information to know for sure. So, Mario, how can we tell if a recapitalisation is ‘precautionary’ or not without a more robust framework for assessing European bank solvency?

One Response to “What is a precautionary recapitalisation?”

  1. Basically this is all about Spanish cajas, which are currently adequately capitalised, but where the ECB wants to make them fail the stress test in order to establish the “credibility” of the exercise. But a lot of the reason why the cajas’ capital is OK is that they have (mis)sold a hell of a lot of AT1 over the counter to retail customers. So Super Mario wants a little bit of wriggle room to let capital injections go in from the FROB without causing the amazing political sh*tstorm that would result from bailing in the AT1.

    Also add a substantial glug of the simple fact that like all banking supervisors, the ECB wants the competition regulator to get the hell off its turf.