Lessons to be learnt from Kazakhstan04.06.2010 / Published in Financial Times on June 4, 2010, http://m.ft.com/cms/s/0/050d003a-6f4a-11df-9f43-00144feabdc0.html
Ever since the film Borat was released, the word “Kazakh” has tended to provoke sneers on western bank trading floors. Right now, however, it merits more respect – at least as far as the issue of financial restructuring is concerned.
A few days ago, Kazakhstan announced that it had completed the restructuring of BTA, one of the largest Kazakh banks, by imposing severe haircuts on investors holding BTA bonds and loans. These creditors, which include ABN Amro, Commerzbank, Standard Chartered, ING, KfW, and funds DE Shaw and Fortis Investment Management, have effectively had to swallow some $6.8bn of write-downs to enable the bank to cuts its debt burden from $12.2bn to $4.4bn.
The news has attracted little outside interest. After all, with the eurozone in turmoil and American politicians fighting over financial reform, traders and policy makers have had plenty else on their mind. But what has just occurred on the Kazakh steppes is looking surprisingly relevant to this hand-wringing about European banks and US reform. Until recently it was generally assumed in the emerging market world that when a bank ran into problems it would either be bailed out by the government (or, more likely, the International Monetary Fund) or go spectacularly bust and close its doors.
And indeed, when BTA, along with several other Kazakh banks, first started to collapse almost two years ago, that was what most western investors assumed would occur.
Hence, some of the powerful western creditors who held the debt of BTA and other banks started pushing for a furtive state rescue, of sorts – and warned that if this did not occur Kazakh-style financial Armageddon would occur. However, to its credit, the Kazakh government faced down some of the more aggressive western banks by insisting on something rarely seen anywhere in the world: an orderly restructuring, with creditor haircuts, of a still-functioning bank.
Now, it would be naive to think that this process could be easily transposed on to the west. Kazakh banks are much smaller than American or European banks and their operations do not straddle numerous different borders or bankruptcy regimes.
Nevertheless, the core principle of the BTA story is thought provoking. By a happy coincidence a couple of days before the Kazakh news Michel Barnier, Europe’s financial services commissioner, announced plans to create a new European resolution fund to deal with failing banks, funded by a bank levy. In some respects this is encouraging news, since the sooner that Europe starts thinking about this problem, the better. But in other respects, Mr Barnier’s proposal is riddled with problems. For even if the Commission could persuade all the European governments to impose a bank levy for such a fund, it is unlikely to become big enough in size, fast enough, to absorb all the potential losses if a big bank went down.
However, another option, as demonstrated in Kazakhstan, is to demand that creditors absorb all, or part, of the losses, even as the bank remains a going concern. And indeed, this is precisely the idea that is now starting to gain traction in some regulatory quarters.
In Europe, for example, Paul Tucker, deputy governor of the Bank of England, is one of those who is now championing this idea of creditor haircuts as a way to deal with the “too big to fail” issue.
In America, there is every chance that the future financial reform bill will contain some features that would impose creditor losses in the future (though it remains a point of fierce dispute whether this would be imposed by a central, third-party body or the law courts.)
Unsurprisingly, the concept remains very controversial. Many investment groups hate the concept, since bond holders have generally been protected from losses until now. Many European bankers are also opposed, since they fear it could raise funding costs. Some international lawyers are also wary, since it would be challenging to thrash out any deal with creditors operating in different bankruptcy regimes.
But, notwithstanding those (big) drawbacks, to my mind this seems the least bad option. After all, the concept has one big merit: namely it spares taxpayers. There is another: the prospect of haircuts could prod creditors to exercise more badly-needed oversight in the future. After all, it is evident from the last bubble that equity investors are lousy at this, partly because they are incentivised to cheer revenue growth. But if bondholders thought they might face haircuts in the future, they would have a real incentive to impose discipline on banks – and perhaps make them more transparent in the future.
This would be better than the alternative: building a system based on ever tighter bank rules and implicit taxpayer bail-outs. Which, unfortunately, is where Europe is heading.