Don't start from here

At least the ATMs still pay out in full

AS IRELAND grapples with its banking crisis, distant Kazakhstan, which dealt with its own blow-up in February 2009, offers an interesting lesson. The Kazakh restructuring, completed in September this year, is unusual because instead of getting a state guarantee, the majority of the creditors of BTA Bank, the biggest problem, shared the pain. Even senior bondholders, who are high in the pecking order, were hit. In most other countries—including Ireland, so far—they have been wrapped in cotton wool, at taxpayers' expense.

Most BTA creditors were offered a menu of options which included a haircut on their assets, various combinations of senior and subordinated debt, and a small stake in the bank's equity to keep them interested in its future. The government faced down those who warned that, if senior bondholders and trade creditors were included, the market would ostracise Kazakhstan for years. Around $12 billion of bonds and commercial debt was reduced to $4 billion. The external debt of the Kazakh banking sector, which was 26% of GDP when the crisis struck, has been roughly halved.

The Irish government recently dared to force holders of subordinated debt of Anglo Irish Bank, its worst lender, to take a haircut. The holders of €1.6 billion ($2.2 billion) of these bonds, which are at the bottom of the creditors' hierarchy, were asked to sacrifice 80% of principal. But the government has hesitated to extend the pain to senior bondholders.

There are good grounds not to: first, if they face losses then depositors, who in theory have the same seniority, might start a run. Second, senior bank bonds from other euro-zone countries, especially Greece, Portugal and perhaps Spain, might suffer contagion. Third, other Irish banks are thought to be big holders of Anglo Irish Bank senior bonds, so they would suffer further losses. And fourth, the European Central Bank would take losses on its reserves of Irish bank bonds and those that it is holding as collateral.

Across Europe and in America, changes in banking law are being put in place which will make it easier to force bank creditors to share the pain of a failure next time. Germany is working on a restructuring framework and Britain's Banking Act, passed last year, created a new “special resolution regime”. The new rules in America envisage imposing losses on all creditors (but not depositors).

Yet the worry remains that if all creditors face the risk of loss in a crisis, they will start a run, creating a self-fulfilling prophesy. Students of the Kazakh example argue that a firm voice at the start of a crisis, insisting that the burden will be shared, works wonders for market expectations. The Irish did the opposite, giving blanket bank guarantees in September 2008 which have recently been extended to the end of June at least.

The alternative, which some regulators prefer, is to create a specific layer of debt that would bear losses if a bank fails, without (it is hoped) triggering a run of all creditors. Switzerland has already chosen one version of this approach by forcing its two big banks to issue new contingent convertible (“CoCo”) bonds that turn into equity if necessary. Whatever the method they choose, the message for all countries being held to ransom by their banks' senior debtholders is clear: don't start from here.