IMF asks Europe to decide on bank resolutions and the Greek Gordian knot

Reza Moghadam, Director of the IMF’s European Department, briefs the news media on the economic outlook for Europe, Friday October 11, 2013, during the IMF World Bank annual meetings at the IMF in Washington, D.C. (IMF Photo/Cliff Owen).

In view of the fast deteriorating relations between the European Union and the International Monetary Fund over the needed measures to confront the Greek Gordian knot and Eurozone’s banking sector problems, a culmination is expected in a few days. The exchanges between the two sides, recorded this week are indicative of the worsening climate over the North Atlantic.

IMF general manager Christine Lagarde asked Greece’s partners in Eurozone last Thursday, “to honour their engagement towards Athens”, as if those 16 Eurozone member states, and more so Germany, needed IMF’s fillip of their obligations. The answer came from Jörg Asmussen, a German economist and politician, member of the executive board of the European Central Bank, who commented that “IMF is being generous with other people’s money”.

It’s always Greece

As things stand now, the Brussels EU directory and the German government would have preferred the IMF to disappear from Europe. The problem, though, is that, back in 2010, the German Bunsdestag had voted for IMF to participate in Greece’s financial rescue, putting in it money and expertise. Subsequently, the then formed lenders’ troika of EU-ECB-IMF undertook also the rescue of Portugal and Ireland, and more recently the reshuffling of the Spanish banking system.

At present, the IMF seems adamant that Greece’s Eurozone partners, prominent among them Germany, to forfeit a large part of the Greek debt they hold, in order to cut down the country’s financial obligations to sustainable levels. Obviously, the Fund refers to the October 2012 agreement between Athens and the troika of EU-ECB-IMF. At that time creditors conditioned their second package of loans on the achievement of a fiscal surplus in 2013 and they also undertook the obligation to forgive a part of Greece’s debts, if this condition is met. Now the IMF says Greece has produced a surplus, and consequently demands that Germany ‘honours’ its obligation for a haircut of loans. The Eurozone answers that interest rate reductions and loan maturity extensions already accorded together with those to follow are tantamount of a generous reduction of the present value of loans.

What about Eurozone’s banks

It’s not only Greece however that haunts the EU-IMF relations. The Fund also insists that that Brussels and Berlin must take care of the precarious situation in Eurozone banks. It is common knowledge that the major European banks are in urgent need of capital increases, to cover the devaluation of their assets, writing off a good part of them. Eurozone banks are running presently an oversized asset side in their balance sheets, a large part of which must be degraded because an equally disproportionate percentage of loans and other ‘investments’ have gone sour.

According to optimist estimates, Eurozone banks need at least €70 billion in new capital increases to counter those problems. It must be reminded that according to official announcements, “between October 2008 and October 2011, the European Commission approved €4.5 trillion (equivalent to 37% of EU GDP) of state aid measures to financial institutions”. The EU’s executive arm observes that “This averted massive banking failure and economic disruption, but has burdened taxpayers with deteriorating public finances and failed to settle the question of how to deal with large cross-border banks in trouble”.

How bad is it?

There is no doubt that Eurozone’s banking sector is in bad shape. In view of that, the Union has agreed to introduce the Bank recovery and resolution Directive (BRRD), which provides that taxpayers would not be any more burdened by failing banks. From 2015 onwards this cost will be borne by the bank’s creditors and unsecured deposits. This directive, together with ECB’s supervision on Eurozone’s banking system as from April next year, are two giant steps towards the consolidation of Europe’s financial sector.

Bank resolutions unresolved

It remains, however, to be determined who will decide and undertake the task of resolving or recovering bankrupt or in danger of bankruptcy banks. Only after this last issue is settled, the much-advertised European Banking Union will be in place. Of course Germany again wants that everything is done its own way. Berlin is quite reluctant to let anybody else to decide to resolve a German bank. Berlin also opposes the idea of spreading obligations which may stem from a resolution of a non-German bank over the entire Eurozone.

On the other side of the fence, the European Commission has proposed that eventual bank resolutions should be conducted centrally, by an authority under its own Brussels roof, with money coming from all the Eurozone (Single Resolution Mechanism-SRM). Mario Draghi, the President of the European Central Bank, has offered an in between solution, keeping the central character of the resolution, with the money however coming mainly from the member state or states, where the bank operates. As for the IMF, the Fund exerts strong pressures for this controversy to be resolved ‘now’, because the Western financial system is to soon undergo a major crash test. This will occur after the US is to pull back the trillions of low-cost loans the American banks have spread all over the globe. The Greek Gordian knot is a major key in this respect also.

As things stand now, the ball is in Europe’s court. The US and the IMF expect the Union to answer promptly to all those questions. Presumably these issues will be dealt with in the Economic and Finance Ministers Council (ECOFIN) meeting in Luxembourg on 15 October. Whatever compromises are expected to be produced there have to be submitted for final approval by the European Council of 24-25 October. In short, Europe is expected during the next two weeks to come up with solutions on both accounts; Eurozone bank resolutions and the Greek Gordian knot.

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