Once established, this policy will apply to banks in Spain, Italy, France ... and the EU-wide run on the banks will be on as a) no one can tell if any EU bank is solvent and b) there is plenty of anecdotal evidence that none of the EU banks is solvent.
European policymakers are split over how to handle a bailout of Cyprus, with Germany and some other countries pushing for bank depositors to bear part of the cost and many other member states worried such a move will cause a bank run.
Euro zone officials say momentum has built in recent days behind the idea of "bailing-in" Cypriot bank shareholders and depositors, although the specifics of how such an operation would be carried out have not been pinned down....
Germany, Finland and the Netherlands are among those who say taxpayers cannot be expected to go on financing euro zone bailouts, saying it is time for owners and depositors in risk-laden banks to accept losses on investments.
The concern is that announcing such a move will provoke the immediate, large-scale withdrawal of deposits from all Cypriot banks, where a large number of international investors, including many Russian and British companies, hold accounts....
While Cyprus is the euro zone's third smallest economy with annual GDP of only around 18 billion euros, a bank run could have repercussions across the single currency bloc and re-ignite the debt crisis, officials warn.
"We have to consider that risk," said one euro zone officials whose country is undecided about whether a bail-in of depositors is the right course of action. "It's a real option but some countries don't want it."I happen to agree that unsecured bank debt and equity holders should bear losses.
However, the necessary condition for these investors to hold losses is that the banks provide ultra transparency and disclose their current global asset, liability and off-balance sheet exposure details.
With this information, investors can assess the risk and solvency of a bank and can adjust both the amount and price of their exposure to a bank to reflect this assessment. As a result of having the information on which to make an informed investment decision, the investor is responsible for all losses on their exposure.
Unfortunately, this is not the case. As the Bank of England's Andrew Haldane says, current bank disclosure leaves them resembling 'black boxes'.
If they were only black boxes, then losses could be imposed on the gamblers who buy the unsecured debt and equity of these black boxes.
Banks are not just black boxes. Banks are black boxes where the bank regulators have been making public comments about the content of these black boxes. Specifically, bank regulators have been saying that they are solvent.
Oops. How can you impose a solvency related loss on an investor who relied on the bank regulators' statements that the bank was solvent?
The simple solution is to realize that banks are designed to operate with low or negative book capital levels and to not bail out the banks.
By requiring the banks to provide ultra transparence, the market can exert discipline so that the bankers do not gamble on redemption as they retain future earnings to rebuild their book capital levels.