Fool me once
European banks are treating their retail customers like muppets. Lenders in Spain and elsewhere have flogged increasing volumes of their own bonds to unsophisticated retail customers. Such investments look ill-advised, at the very least. It also complicates government efforts to impose pain on creditors, rather than taxpayers.
Spain’s banks have long boasted about their ability to sell a wide range of financial products to retail customers. But the relationship has become too cosy. Banks have pushed billions of euros worth of bonds and hybrid instruments that are now illiquid or underwater. Of the 65 billion euros in outstanding subordinated debt issued by the country’s lenders, 62 percent is owned by retail clients, according to Barclays Capital. Likewise, Italian and French banks have long flogged unsecured bonds to retail investors.
The wheeze allows banks to boost capital and meet funding needs at a time when markets are largely closed to them. High coupons, which look attractive when compared to deposit accounts, ensure they sell like hot cakes.
But the practice has several flaws. First, it doesn’t expand the pool of funding available to banks: cash flowing into bonds tends to come from deposit accounts. Second, the investments are looking increasingly shaky: some Spanish banks have converted preference shares into ordinary equity – admittedly on friendly terms – or have stopped paying coupons. The Spanish bank consumer association, Adicae, is taking 28 banks to court for “abusing preference shares”.
But the biggest problem is that mixing retail depositors with bondholders makes it harder for governments to impose losses on private-sector investors. Take BFA/Bankia, which is receiving a 19 billion euro bailout from taxpayers. Converting the Spanish bank’s 4 billion euros of outstanding preference shares into ordinary equity would have helped to reduce the bill. But management has refused, for fear of upsetting the depositors who bought the securities.
It is unrealistic to expect retail customers to distinguish between government-insured deposits and potentially risky bank securities. It is also unrealistic to think that banks can navigate the conflicts of interest that arise from offering the two side by side. Rather than trying to regulate the sale of bank bonds to retail customers, governments should simply ban it.