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INVESTORS WARNED In fairness to the SRB and the European Banking Union other key players, the reforms process worked differently in the earlier test of the system, involving Spain’s Banco Popular that was wound down earlier in June this year. In that deal, the ECB was quick in declaring Banco Popular as being troubled, or, in terminology of ECB “failing or likely to fail”. The SRB promptly took control, wiping out Banco Popular’s shareholders and haircutting junior bondholders before another Spanish bank, Santander, was asked to raise its own funds to finance the buyout of Popular’s assets. However, despite the accolades from the analysts and politicians, the Banco Popular’s winding down was a superficially easy test of the system, as it required no haircuts of senior bondholders and Santander faced no difficulty raising own finance. This is not what the resolution mechanism was designed to test.

Bank of England warned at the end of June that the U.K. financial system is heading in a worrying direction and that banks are “forgetting the lessons” of the financial crisis. Last year, the IMF warned that the Euro area continues to experience “market pressures” within the banking sector. The Fund estimated the some €900 billion of non-performing loans remain on the books of Eurozone lenders. In July 2017, the IMF issued a warning to the world’s 20 largest economies, the G20, stating that the current markets conditions present growing risks to global growth, and that financial systems vulnerabilities “present an immediate concern”. In June this year, Bank for International Settlements defined four non-political risks that are underpinning rising threat of a new economic crisis. Risks number two and three: financial stress as financial cycle matures across the advanced economies, and global debt levels continued upward trend.

Instead, the Banking Union infrastructure was developed explicitly to handle tough cases, like the Italian banking system that still holds €300 billion worth of bad assets, based on Banca d’Italia estimates, of which roughly €170 billion are officially non-performing. To-date, resolution of Banca Monte dei Paschi di Siena (BMPS), and Popolare di Vicenza and Veneto Banca, have cut only about €49 billion of rotten assets from the system. In the case of the BMPS, the end cost to the taxpayers of recapitalisation was in the region of €5.4 billion. The gross cost to the taxpayers of resolving less than €50 billion of defaulting assets has been around €23 billion, counting direct bailouts, plus costs. If the trend continues, Italian taxpayers can be looking at writing more cheques in years ahead.

In this environment, Irish banks are sitting ducks for risk and uncertainty associated with the fortunes of the international financial system. While the banking sector in Ireland has undergone significant deleveraging, profit margins across sector remain relatively weak, despite the banks pumping out some of the highest cost lending in the Euro area. And bad loans remain a stubborn legacy of the crisis, placing the Irish banking sector as the third worst in the Euro area by this metric some nine years after the crisis peak, behind only Greece and Cyprus. Deleveraging across the domestic Irish lenders since 2013 has cut non-performing loans loads from an average of 27 percent to just over 14.2 percent as at the end of 2016, and to an estimated 13 percent at the end of 1H 2017. However, this figure remains more than double the 5.3 percent Euro area average. Meanwhile, recent rights issuances and significant Contingent Convertible bonds placements by the Irish banks, in all likelihood, have nearly exhausted the room for near-future market funding through these sources. This means that Irish banks are still walking on thin ice and any exogenous shock can trigger a new wave of contagion into Irish financial system. Given the latest track record of the European Banking Union reforms, such a shock will most likely lead to a re-nationalisation of at least the weaker Irish lenders.

From the Irish investors perspective, the de facto failure of the European banking reforms implies higher risk over the longer term horizon. Research from the Bank for International Settlements shows clearly that the financial crises are becoming both more frequent and more severe. Last month, the ex-Chairman of the U.S. Fed, Alan Greenspan warned that the current conditions in the bonds markets the bread-and-butter of the banks’ capital reserves - can be characterised as an ‘‘irrational exuberance’’ type moment.

Dr Constantin Gurdgiev is the Adjunct Assistant Professor of Finance with Trinity College, Dublin and serves as a co-founder and a Director of the Irish Mortgage Holders Organisation Ltd and the Chairman of Ireland Russia Business Association. He holds a non-executive appointment on the Investment Committee of Heniz Global Asset Management, LLC (US). In the past, Dr Constantin Gurdgiev served as the Head of Research with St Columbanus AG (Switzerland), the Head of Macroeconomics with the Institute for Business Value, IBM, Director of Research with NCB Stockbrokers Ltd and Group Editor and Director of Business and Finance Publications. He also held a non-executive appointment on the Investment Committee of GoldCore Ltd (Ireland) and Sierra Nevada College (US). Born in Moscow, Russian, Dr. Gurdgiev was educated in the University of California, Los Angeles, University of Chicago, John Hopkins University and Trinity College, Dublin.

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Manning Financial Autumn 2017  
Manning Financial Autumn 2017