never seems to come

Europe's stricken banks wait for a rescue that never seems to come

5/19/2012 by Heather Stewart

There are four weeks to go before the Greek elections – and, it seems, even longer to wait before a German change of heart on bailing out lenders. But fearful markets, and hard-pressed electorates, may not be patient much longer

For battle weary euro politicians, four long, tough weeks lie ahead between now and the next round of Greek elections, which could see recession-hit voters restating their determination to reject the savage austerity measures that are the price of Greece's latest €130bn (£105bn) bailout.

But over the past two years, events have repeatedly been taken out of the hands of Europe's leaders by the markets or a furious public – and analysts warn that the crisis could spiral beyond their control even before the Greeks get the chance to go to the polls.

As another frenzied week in euroland drew to a close, Spanish banks became the latest focus of anxiety as ratings agency Moody's downgraded 16 of them – including Santander's UK arm – on Thursday night.

In all the eurozone's struggling peripheral economies – Italy, Greece, Portugal and Spain – governments and banks are locked together in what Sony Kapoor, of Brussels-based thinktank Re-Define, calls a "dance of death".

The weaker each economy becomes, the more bad debts its banks are forced to declare; and the more likely it is that their governments will be forced to set aside fresh resources to recapitalise them.

At the same time, much of the banks' capital base – their safest assets – are made up of the bonds of their home country's government, which become shakier investments as the governments are forced to stand behind their banks.

Madrid announced last week that Spanish banks were sitting on €148bn of bad loans in March. It was also forced to deny that one bailed-out lender, Bankia, was facing a dramatic run on its deposits. Bankia's share price at one point plunged by more than a quarter.

A bank run of the sort that helped bring down Northern Rock in the UK is one of the greatest fears facing Europe's leaders, because once panic-stricken savers take matters into their own hands, their fears can quickly become self-fulfilling. If a "Grexit" did materialise, businesses and consumers could respond by pulling their money out of financial institutions, not just in Greece but also Spain, Italy, Portugal and even Ireland, as they contemplated the possibility that others could follow Athens out of the single currency. Megan Greene, director of European economics at Roubini Global Economics, says: "The biggest risk over the next month is from a bank run."

There may not have been queues outside branches, but already deposits in Greek banks are down by almost a third since before the crisis, and central bank governor George Provopoulos said that withdrawals had hit €700m in a single week. "We're seeing a 'bank jog' in Greece already," Greene says.

"People have been withdrawing deposits right, left and centre," agrees Neil Mellor of BNY Mellon.

Greene believes European politicians could assuage savers' concerns in the coming days by declaring a Europe-wide deposit protection scheme; but that would fall foul of Germany's opposition to offering blanket support to struggling states. "No one is going to feel very calmed by the Greek government saying 'We're going to backstop all your deposits,'" she says.

Danny Gabay, director of City consultancy Fathom, says what Europe faces is fundamentally a banking crisis. "It's not who borrowed: it's who lent," he says. "That's the problem. The people in their tents outside St Paul's were not complaining about the person who borrowed six times their income; they were complaining about the banks, which should have known better."

It was severe strains in Europe's banks, and the risk of a full-blown credit crunch, that prompted Mario Draghi, president of the European Central Bank, to pump €1 trillion worth of cheap loans into the financial sector late last year, though analysts immediately warned that the drastic emergency measure would merely buy time.

As the Greek elections approach, European leaders are walking a tightrope. They must try to convince Greek voters that even brutal austerity is better than the dire consequences of being chucked out of the euro, while reassuring the markets and anxious voters in other countries that they could handle a "Grexit".

With the latest gathering of EU leaders taking place this Wednesday, the outline is already emerging of a package of pro-growth measures, centred on an expansion of lending to infrastructure projects and small to medium-sized businesses by the EU-backed European Investment Bank (EIB).

Greene says that these proposals may provide a modest boost to growth over the medium term, and allow Germany's Angela Merkel and France's François Hollande to adopt a more united political front, but that they do not tackle the underlying problem: that Greece – and, she believes, ultimately Spain – are in an unsustainable financial position. "It's not like Europe is in need of infrastructure," she says.

Mellor says: "If they do something with the EIB, the market will be content to give it the benefit of the doubt; but it just buys more time."

As the storm rages, the keepers of the euro flame have lined up to offer radical ways to rewrite the single currency's rules to make the project more viable in the long term. Jean-Claude Trichet, who stood down as president of the European Central Bank last autumn, made a speech on Thursday night in which he argued that eurozone states should be able to declare fellow members bankrupt, and take over their tax and spending policy – an idea that the economist Nouriel Roubini rapidly dismissed as "totally undermining national sovereignty".

The European Stability Mechanism – the €500bn rescue fund that will be able to pay out to help states in distress – comes into operation at the beginning of July, and the International Monetary Fund has also boosted its resources in readiness to come to Europe's aid.

But ultimately, most analysts believe whatever Greece decides in a month's time, the crisis is unlikely to be cauterised until politicians make what Mellor calls a "monumental, megalithic decision": to allow the ECB to freely lend cash-strapped banks as much as they need to stay afloat; and to allow eurozone governments to stand behind each other, come what may.

That would mean tackling Germany's deep-seated political opposition to offering open-ended bailouts to countries it believes have behaved irresponsibly – something that still looks highly unlikely, despite growing evidence of a change of mood in other European countries.

Meanwhile, the Bank of England and the Treasury in the UK, and hundreds of firms across Europe, will continue hurriedly drawing up contingency plans as they watch the euro "tearing itself apart," as Sir Mervyn King put it last week.

EU trade commissioner Karel de Gucht caused a flurry of excitement in the markets on Friday by apparently admitting in an interview with Belgian newspaper De Standaard that the commission itself was working on contingency plans for Greece leaving the euro. A spokesman for commission president José-Manuel Barroso later denied it, but most experts believe it would be irresponsible for Europe's institutions not to be preparing for the worst.

While Alexis Tsipras, the leader of Greece's anti-austerity Syriza party, talks tough in the runup to the election, some senior EU figures seem to have begun to comfort themselves with idea that they could contain the consequences of a "Grexit"; but Gabay says the term itself gives the misleading impression that the crisis would centre on Athens.

"The Greeks already have a word for exit: it's Exodus. And the point about Exodus was the consequences were pretty damned painful. I'm not saying there are going to be rivers of blood or 40 days in the wilderness, but it's very dangerous to think this is just about Greece."