Econintersect: Dexia, the large Franco-Belgian Bank that recently was partially taken over by the French, Luxembourg and Belgian governments, used unorthodox (legal at the time, but now illegal) financial maneuvers to enhance the appearance of its capitalization. The maneuver was legal at the time because the bank used a subsidiary to make a transaction that would have been illegal if the parent itself had done it. New laws now cover subsidiaries. This is a classic case study of control fraud, a term coined by William K. Black, professor at the University of Missouri, Kansas City.The deal involved about €1.5 billion in loans by Dexia to its two largest institutional shareholders, part of which (certainly more than half based on statements in Pignal’s FT article), were used by the investors to buy more shares of Dexia. The security pledged by the borrowers? Existing shares of Dexia stock were the security. Thus the capital position of Dexia was made to appear stronger by borrowing money from itself to finance a capital increase, an obvious case of “double dip” accounting.
From the FT article by Stanley Pignal:
“Auto-financing is illegal under Belgian law, even if in this case, strictly speaking it was a subsidiary which was providing the loan to the shareholders,” said a spokesman for the Belgian Financial Services and Markets Authority. The Belgian National Bank said it could not comment on a specific institution but that it was aware of the loans.
Earlier this week The Wall Street Journal reported the completion of the nationalization by Belgium of the domestic retail banking unit of Dexia at a cost of €4 billion ($5.5 billion). Belgium, Luxembourg and France have agreed to jointly guarantee €90 billion in funding for the remainder of Dexia for the next ten years.
In addition to the nationalized portion of the bank, Dexia is seeking to sell other parts of its business, including its business in Luxembourg, its public finance unit in France and the Turkish unit, Denizbank.
What precipitated the demise of Dexia? According to The WSJ it was inability to get short-term funding in the interbank funding market. Apparently it was not action by regulators that closed the bank down, although the Pignal FT article recounts a number of issues that regulators raised over the past three years. In the final analysis it appears that this is another poster child for ineffective regulation.
Sources: Financial Times (Stanley Pignal, October 20) and The Wall Street Journal