Business & Finance, News

EU rules on bank bonds causes insurers severe concern

October 27th, 2009
Author: Jeff Taylor

The EU is demanding that nationalised UK banks effectively default on all or part of their issued bonds in order that the money be used to pay back the taxpayer first. This takes the bail out repayment responsibility down the risk chain through 'ownership' into 'loanership' territory (dividends on nationalised banks shares have not been paid since 2008).

The EU

The EU

The problem is that many of these bonds are held by life insurance and pension companies and if these coupon payments are not made to them the repercussions could be extremely severe for us all.

The markets have been expecting such a move and related bonds such as RBS and Lloyds are already trading at a discount. Should this come about many funds may be forced to ditch these bonds in the hunt for income bearing securities.

In response, another type of financial instrument has been invented. It is a 'contingent capital' instrument that has been dubbed, wait for it, the 'Death Spiral Covertible'. This is a convertible bond that will pay a high coupon interest rate in return for bearing the risk of converting to an equity if the bank fails. Lloyds is planning to use these to shore up its capital position. What it says to me is that banks are still high risk.

Several banks and holdings such as Northern Rock, Independent News & Media, Bradford & Bingley and Anglo Irish have already reduced some payments.

It seems that the taxpayer cannot get its money back without costing, well, the taxpayer in the form of  pension and investment growth.

Also strange that a nationalised organisation would default on a bond, surely these should be the next best thing to a Gilt?

Worse still, the way the banks think to use to get out of it is another financial instrument ………….

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7 Responses to “EU rules on bank bonds causes insurers severe concern”

  1. Brian English says:

    I thought the bail out money was a combination of loans and equity. Equity would certainly have a low ranking in liquidation and it seems wrong that repaying a bail out loan instead of a bond (or is it just the interest on the bonds?) could be allowed. Surely the bond holder should have legal redress and the bail out is unsecured?

  2. Jeff Taylor says:

    This is the sort of tack I was taking with this Brian. The EU wants the coupon on the corporate bonds to be diverted to the taxpayer. So that the bank can pay the taxpayer back more quickly so EU competition rules aren't broken for too long.

    Maybe a more efficient way to do this would be for HMG to buy all the bonds at today's depressed prices, then sell at a profit when it's all sorted out?

  3. Jeff Taylor says:

    A somewhat idealistic view James? But surely some debt and fractional reserve banking is needed to keep the cogs oiled?

  4. A gold standard that backs up our currency would be nice……

  5. Brian English says:

    "A gold standard that backs up our currency would be nice……"

    I think it has already been established that bankers can't be trusted with gold. They always end up issuing too many "receipts" against it. Best solution is revert to gold and silver as hard currency. Who needs a world reserve currency when gold is always exchangeable?

  6. @Brian English
    What about a gold standard for the national currency and allow banks to print their own money which they are responsible for? I remember Ian Parker-Jones (Libertarian party leader) telling me a little about the concept…he could answer the questions on that far more eloquently than I can…but it made the Banks responsible for their own actions and if they failed…they just failed.

  7. Jeff Taylor says:

    .. "but it made the Banks responsible for their own actions and if they failed…they just failed"

    Yes, but they take their clients' money with them when they do fail.