By James Saft
(Reuters) – An unlikely Marine Le Pen victory in French presidential elections could set off a bank funding crisis that would have more power to torpedo the euro project than she might posses once in office.
National Front nativist and anti-euro candidate Le Pen may well not make it through to the second round on May 7 after Sunday’s vote, and is likely to lose to whomever she meets if she does.
If she does capture the Elysee Palace, she will almost certainly face a fractured and intransigent Parliament after June elections, particularly once the legions of French savers work out what a redenomination into new francs will do to their wealth. Le Pen’s ability to pull France out of the euro and re-negotiate its relationship with the European Union would be severely crimped by constitutional and practical hurdles, which make it highly unlikely.
But markets, particularly those that advance money to French banks, may not find this truth reassuring. Funding for French banks is likely to be curtailed if she wins on Sunday, and dangerously so if she actually takes office.
“While it will be difficult for Le Pen to implement her campaign promises even if she wins the election in May, it is the expectation of major Eurozone upheaval, rather than the reality itself, which makes the scenario of a Le Pen victory significantly more complicated and dangerous for risky assets than was the case after the Trump and Brexit surprises,” Salman Ahmed, chief investment strategist at Lombard Odier Investment Managers, wrote in a note to clients.
It may well be that a victory by leftwing candidate Jean-Luc Melenchon carries similar, if lower risks.
Should funds begin to leave the French banking system, not just in panic, but out of an abundance of caution, the European Central Bank has tools that would allow French banks over to access liquidity. It could also tilt asset purchases toward French bonds, thus delivering more cash to French banks.
But this is not a frictionless course of action.
The result will be a build-up of imbalances in the Trans-European Automated Real-time Gross settlement Express Transfer, or Target 2, system, which handles the banking system credits and debts within the euro zone across national borders.
As it stands, France is barely a debtor in Target 2, with Germany the main creditor, and mostly to peripheral and weaker euro zone countries like Spain and Italy.
Within a normal euro zone framework the accumulation of Target 2 balances is normal, and a helpful means for capital to find its uses. At the point at which Germany begins to doubt whether the money it is owed ultimately will be settled in euros, or under what set of protocols, it will become politically very difficult for Germany to allow the ECB, and for the ECB itself, to build a massive Target 2 imbalance.
“Political questions will certainly be asked before Germany decides to increase its credit to other Eurozone countries if it is clear that one of those countries, France, intends to leave the eurosystem, potentially leaving Germany with a significant fiscal loss on its claims,” Ahmed wrote.
“Were Germany to freeze the Target 2 system, the single currency union would cease to exist even before a referendum on France’s membership takes place – highlighting the importance of expectations in this situation.”
In March, Deutsche Bank (DE:) estimated that the French banking system has some 2.7 trillion euros, or 68 percent of the total, of its funding that is vulnerable, either because it is from outside the euro zone or because it is short-term, having a repayment date of one year or less.
Remember, too, that while it is sensible to expect the French banking system to come under the most intense pressure in the event of a strong Le Pen showing, it is not impossible for a euro zone bank funding crunch to start elsewhere and spread. All that matters, ultimately, is that intra-euro zone liabilities grow at a rate alarming to the creditors at a time when there are valid questions about the future of the single currency.
Again, all of this is unlikely. Le Pen may not win, and if she does, once in office may see sense in stepping back from a policy that would beggar a substantial number of French citizens.
A small bank run may do the trick, and the ECB and German authorities may play along for a while to see if it does.
Small bank runs, however, are nobody’s idea of a good way to keep the euro project together.
Politics over the past year, however, have been extraordinarily unpredictable in prospect, and grimly predictable in retrospect. France may be no different.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.
You can email him at email@example.com and find more columns at http://blogs.reuters.com/james-saft)