Saturday, March 16, 2013

EU establishes principle of imposing losses on insured depositors

As reported by Bloomberg, EU policymakers are establishing the principle of imposing losses on insured bank deposits.

By doing so, in a single stroke, they have undermined the whole concept of deposit insurance and created massive instability in the financial system.  Deposit insurance is suppose to be an ironclad guarantee by the sovereign that up to a specified level, all money put into a bank is protected from the financial performance of the bank.

The EU policymakers have decided to unilaterally end this guarantee.

At a minimum, for countries like Greece, Spain, Portugal, Italy and France, this should accelerate the run on their banks.

Why should depositors take the risk of losing money when there is no way of knowing if the banks are solvent?

This is a global issue.  Just this past week, the Fed effectively said that JP Morgan was insolvent by calling into question its fortress balance sheet (I know JP Morgan passed a stress test, but banks around the world, see Dexia and banks in Ireland, have been nationalized shortly after passing a stress test).

In the absence of ultra transparency where banks disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, there is no reason to believe that a bank is solvent and that depositing money in the bank is nothing more than a chance to have a high risk of loss for zero return.

With the EU policymakers ending trust in the sanctity of the deposit insurance guarantee, the only way to re-stabilize the financial system is by requiring the banks to provide ultra transparency.

With this information, market participants can independently determine which, if any, banks are solvent and therefore safe to put money into.

Euro-area finance ministers agreed to an unprecedented tax on Cypriot bank deposits as officials unveiled a 10 billion-euro ($13 billion) rescue plan for the country, the fifth since Europe’s debt crisis broke out in 2009. 
Cyprus will impose a levy of 6.75 percent on deposits of less than 100,000 euros -- the ceiling for European Union account insurance -- and 9.9 percent above that....
A tax is just another name for a loss.
Officials have struggled to find an agreement that would rescue Cyprus, which accounts for just half of a percent of the euro region’s economy, without unsettling investors in larger countries and sparking a new round of market contagion....
The European Central Bank will use its existing facilities to make funds available to Cypriot banks as needed to counter potential bank runs. Depositors will receive bank equity as compensation. 
Finance Minister Michael Sarris said the plan was the “least onerous” of the options Cyprus faced to stay afloat....
Actually, there was a far less onerous option that I have been talking about since the beginning of the financial crisis:  Let the banks recognize their losses and rebuild their book capital levels out of future earnings.

There was absolute zero reason to impose losses on depositors other than the EU policymakers are trying to bailout banks in countries like Germany that invested in the Cyprus banks.

The option chosen by the EU policymakers was the absolutely worse option available.
While the tax on deposits will hurt wealthy Russians with money in Cypriot banks, it will also sting ordinary citizens. 
Some ATMs in the country have run out of cash, Erotokritos Chlorakiotis, general manager of the Cooperative Central Bank, told state-run CYBC.
A run on the banks that will not be limited to Cyprus.
Funds to pay the levy were frozen in accounts immediately, ECB Executive Board Member Joerg Asmussen said. The levy will be assessed before Cypriot banks reopen on March 19 after a March 18 national holiday.... 
“As it is a contribution to the financial stability of Cyprus, it seems just to ask a contribution of all deposit holders,” Dijsselbloem said... 
Asmussen said tapping deposit holders was needed to expand Cyprus’s tax base. 
European Union Economic and Monetary Affairs Commissioner Olli Rehn called the assessment a strictly fiscal measure. Rehn had warned against so-called haircuts on depositors to avoid setting a destabilizing precedent. 
When asked if a deposit assessment could be ruled out for future rescues, Rehn said in an interview: “It can and there is no concrete case where it should be considered.”
Mr. Rehn's comment that losses will not be imposed on depositors in other countries is completely unbelievable.  As Mr. Asmussen said, it was necessary to impose losses on the depositors in order to be able to recapitalize the banks today.
“This kind of stability fee is clearly a much better choice from the point of view of financial stability and Cypriot citizens than a full-scale bail-in, which would have led to very chaotic consequences in the Cypriot economy,” he said.
This stability fee is a loss assessed on depositors.

From the standpoint of Cypriot taxpayers, it would have been far better to have the banks recognize their losses today and let the banks slowly recapitalize themselves through retained earnings.

This was possible to do as the banks have deposit insurance and access to central bank funding.  The deposit insurance effectively made the taxpayers the Cypriot banks' silent equity partners until the banks had rebuilt their capital.

The lesson of the stability fee will not be missed by bank depositors globally.


Anonymous said...

Hands up! Europe.

Richard Field said...

It would be really nice if rather than confiscating depositor funds, policy makers actually allowed the banking system to absorb losses as it is designed to do.

i realize that this would mean putting society ahead of banker bonuses, but sometimes sacrifices have to be made.