Europe banks fear run on deposits

In an article confirming much of what your humble blogger has discussed, the Wall Street Journal looks at the ongoing run on the banks occurring in the EU.

The specter of funding problems is once again haunting Europe's banks.... 

the Continent's financial system remains vulnerable to the prospect that stampedes of customers could yank their deposits from institutions perceived as shaky. 

That threat was shoved into the spotlight last week when customers withdrew more than €700 million from Greek banks in a single day. The deposit flight, in response to the rising odds that Greece will leave the euro zone, represented a dramatic escalation of two years of a slow but steady flow of deposits fleeing the country's crippled banking system. 

A deposit flight that EU policymakers inspired with their comments about Greece leaving the euro zone and replacing the euro with the drachma.  This gave depositors an incentive to pull their funds rather than risk a loss of money should their deposits be converted from euros to drachmas.

Now the concern among a growing number of policy makers, investors and analysts is that banking systems elsewhere in Europe's periphery are susceptible to similar crises. 

If that happens, policy makers and central bankers would likely again have to rush to the rescue. 

If Greece leaves the euro zone, it will almost certainly restrict bank customers from moving their money out of the country. 

That could prompt depositors in struggling countries like Spain and Portugal to think, "If it could happen in Greece, it could happen here," said Philippe Bodereau, head of European credit research at bond-fund manager Pimco. 

They then might preemptively transfer their funds out of their countries in order to avoid having their savings converted into rapidly devalued Spanish pesetas and Portuguese escudos. 

"That's what markets are starting to worry about," Mr. Bodereau said. "It takes you to a whole different level of liquidity crisis."

A whole different level of liquidity crisis that could be prevented.

Last week, rumors of an exodus of customers from a large Spanish bank prompted government and industry officials into the uncomfortable position of having to deny that they were experiencing a bank run. 

Meanwhile, British customers withdrew about £200 million ($316.4 million) from the U.K. arm of Spain's Banco Santander SA on Friday following a downgrade of the bank's credit rating and amid worries about its vulnerability to Spain's problems, according to a senior executive. The withdrawals represent only 0.2% of Santander U.K. PLC's total deposits. 

As recently as two months ago, the European banking system seemed safe from the threat of liquidity problems. The ECB's huge loan program, implemented late last year to prevent banks from running out of money, stuffed banks with enough money to refinance their maturing bonds for all of 2012. 

But the combination of new fears that Greece will leave the euro and the increasing fragility of Spain's banking system has quickly ended that honeymoon. 

After a three-month market thaw, European banks once again are largely locked out of public funding markets. Thanks to the ECB loans, the banks can weather such a shutdown. But they are less prepared for mass withdrawals of deposits, analysts and investors say. 

Seeking to defuse that threat, some European Union officials have been considering the introduction of a pan-EU plan to guarantee bank customers' deposits, say people familiar with the matter. Such a plan would complement national guarantees already in place. It is unclear how developed such plans are.

Your humble blogger has been recommending this for months.  It is nice that the EU officials are now considering it.

One reason investors and analysts are worried is because large portions of bank deposits in Spain, Portugal and Italy can be withdrawn at virtually a moment's notice. There is little to stop anxious customers from transferring their savings from a bank in one EU country to a bank elsewhere in the 27-country bloc. 

In Spain, whose banks are sagging under the weight of a devastating real-estate bust, about 30% of the country's total domestic household and commercial deposits are held on an overnight basis, meaning they can be taken out at a customer's whim, according to the Bank of Spain. 

In Italy, about 48% of domestic deposits can be withdrawn quickly, as can 21% of the deposits of Portuguese individuals, according to data from their central banks. 

Citigroup analyst Stefan Nedialkov last week estimated that banks in Ireland, Italy, Portugal and Spain could quickly lose a total of €90 billion to €340 billion of deposits if Greece leaves the euro zone, with Spain bleeding between €38 billion and €130 billion. His estimates are based partly on the deposit exodus from Argentina's banks in its financial crisis in the early 2000s. 

Those figures represent nearly 10% of the countries' deposit base, the rapid withdrawal of which would normally have disastrous consequences. Some banks would run out of money and collapse. Even the strongest would have to sharply curtail lending and dump assets in order to conserve scarce funds. 

But Mr. Nedialkov reckons that such a deposit flight wouldn't necessarily be a catastrophe. He saidthe ECB would likely come to the rescue with a new installment of cheap bank loans, via a so-called long-term refinancing operation, or LTRO. 

Such a move would be controversial, fanning fears that Europe's banking system will become permanently addicted to central-bank lifelines and unable to stand on its own. But given that the alternative could be financial mayhem, "I think most people would prefer the LTRO route," Mr. Nedialkov said. 

Of course, all of this could be avoided by the EU adopting the Swedish model and implementing my blueprint for saving the financial system.

Aside from anecdotal evidence, it is hard to tell what is actually happening with deposits. Europe's central banks report data on deposit flows only weeks after the fact. In Greece, for example, the magnitude of last week's withdrawals won't be clear until the Greek central bank discloses monthly data at the end of June.

With ultra transparency, everyone would know what is happening with deposits as banks would report this on an ongoing basis.