Portugal’s Novo Banco: Fixing the Central Bank’s Mistake

The Bank of Portugal made a serious mistake in the structure of the €2 billion recapitalization of Novo Banco. It chose five specific senior unsecured bonds out of 40 bonds of equal rank to absorb the losses required to recapitalize Novo Banco. The justification was protection of small investors because the five bonds are held entirely by large investors. Bondholders of equal rank receive unequal treatment. The result is legal challenges, claims of discrimination and of arbitrary action by bank regulators, and uncertainty for investors in Eurozone bank bonds.

An alternative structure based upon the treatment of depositors in a bank restructuring will generate the necessary €2 billion of Novo Banco capital while providing full protection of small investors and equal treatment for bondholders of equal rank. A clear set of predictable rules will be established.

Under the Bank of Portugal plan, all holders of the five selected bonds will see 100 percent of their holdings transferred to the bad bank and incur large losses. Under the equal treatment structure, even after full protection of small investors, less than 50 percent of large investor bonds will be transferred to the bad bank where losses will be imposed.

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