To bail-out or bail-in – Portuguese taxpayers yet again “bail out” senior unsecured creditors

Portugal spent €11.8 billion of taxpayer money (nearly 7% of 2014 GDP) bailing out its banks between 2008 and 2014. This added to the already precarious state of government finances and has caused considerable problems for the country. Much of this money went to support the €4.9 billion support package for Banco Espirito Santo (BES). The bank was split into a bad bank and good bank with the idea of selling off the good bank (Novo Banco). This task is far from complete with bids coming far below the cost of hitherto injected funds thus the Bank Resolution Fund faces further losses.

The new EU Banking Recovery and Resolution Directive (BRRD) which has to come into force January 1st 2016 is supposed to draw a line under taxpayer bailouts. However, the Portuguese government has just approved a bailout of Banco Internacional de Funchal (Banif), which could cost a further €3 billion. Banif is a small Madeira-based lender which is hardly systemically risky given that it is only the country’s 8th largest bank (albeit the largest bank in the Canary Islands).

The bailout of Banif followed a similar pattern to that of BES. After the European Central Bank in effect cut off Banif’s access to emergency liquidity funding, the Bank of Portugal intervened on December 20th 2015, splitting the bank into good and bad banks. The good assets were sold to Santander and the bad assets were placed into a special vehicle. Shareholders and subordinated debt holders were left with the bad bank and face full write downs. Senior creditors have, however, been protected.

Governments are understandably reluctant to face up to big problems in the banking system which could lead to further contagion. However, we can only truly say we have learned the lessons of the Global Financial and Eurozone crises when bank losses are no longer socialised and bank creditors impose discipline on risky institutions.

The diagram below demonstrates the challenges facing regulators when resolving a failed bank and ensuring a fair allocation of losses.