Ireland provides the answer to what happens to deposits when all banks are insolvent

Regular readers know that this blog has been documenting the on-going run on the Irish banks.  This documentation has provided a number of interesting insights.

For example, as predicted on this blog, the documentation showed that the stress tests run by BlackRock and the subsequent reconfiguration of the Irish banking system did not restore depositor confidence.  Deposits continued to flow out of the Irish banking system.

In the last couple of months, this documentation has also picked up something else of interest.  The issue that this documentation has picked up is the increased concern about the solvency of the other banks in the Eurozone.

Specifically, the concern over sovereign debt restructuring (think Greece, Italy, Portugal and Spain) and the question of which Irish and foreign banks are solvent and which are not.

Prior to questions being raised about the solvency of the foreign banks doing business in Ireland, Irish depositors were taking their money out of the Irish based banks and putting it into the branches of the foreign banks.

Now however, with the increased worries about the solvency of the foreign banks, Irish depositors faced a new problem:  where to put their deposits when all major banks in the Eurozone financial system are apparently insolvent and there is no place to run?

Other than paying a higher interest rate, every major Eurozone bank offers depositors a commodity product.  Deposits for each bank are government guaranteed and presumably easily accessed as the banks themselves have access to almost unlimited liquidity from central banks through their ability to pledge their assets (see expansion of ECB's eligible collateral to include loans).

Faced with this choice or putting their money in a mattress, Irish depositors elected to keep their money with the Irish-based banks.  As a result, deposits grew modestly in December.

This observation provides insight into a question that has existed since the beginning of the financial crisis: would there be a bank run when it is disclosed that all major banks in a financial system are insolvent and there is no place to run to?

Based on the Irish experience, the answer is no.

This finding has major implications for banks recognizing all the losses hidden in the financial system and providing ultra transparency.

It shows that there is no reason to fear a run by depositors if banks recognize the hidden losses and provide ultra transparency.