Cyprus Model for bank bailouts

The following collection of posts address what your humble blogger refers to as the Cyprus Model for bank bailouts.

My model differs slightly from how the EU implemented the bailouts of the Cyprus banks.

My model starts with banks providing ultra transparency and disclosing on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants including depositors and investors can assess the risk of the bank and adjust their exposure to the bank accordingly.  With the ability to assess risk, comes responsibility for absorbing losses.

Please note that banks do not currently provide this level of disclosure.

Instead, investors are relying on representations, like a bank passing a solvency focused stress test, made by financial regulators.  These representations create a moral obligation to bailout depositors and investors who reasonably relied on the representations in making their investment.

It is shocking, as in the case of Cyprus, when governments turn around and renege on this moral obligation. [An obligation that would go away if there banks provided ultra transparency as market participants could test the solvency of the banks for themselves.]

My model goes on to observe that bank solvency or insolvency is not necessarily a permanent condition.  In fact, banks are designed to operate when they have low or negative book capital levels.  This lets banks absorb the losses on the excess debt in the financial system and protect the real economy and the social contract.

Hierarchy for resolving insolvent bank
Slovenia to make banks pay for existing losses using future earnings

The math behind why banks designed to absorb losses without needing bailouts
Banks absorbing losses saves real economy
Germany's policy:  banking sector must pay to recapitalize banks

Transparency is missing ingredient for bank investors to participate in bail-ins


Astana said...

The Cypriots think that the Germans are running the EU for their own benefit. Do you think they will allow or provide transparency on all of their transactions? There are some rumors spreading out that the President of Cyprus actually warned close friends about what was going to happen and told them to get their money out Cyprus

Unknown said...

Both the Cypriot government and the Germans have a reason for not providing transaction level transparency.

For the Cypriot government, this transparency will expose any crony capitalism. So if the President of Cyprus did in fact warn close friends, this would be revealed.

From my perspective, one of the benefits of transparency is that going forward it ends crony capitalism. Sunlight is the best disinfectant.

For the Germans, transparency would show the exposure of their banks at the beginning of the year and at the time when the EU insisted that the banks be recapitalized by seizing uninsured depositor funds. A significant decline would suggest the German banks knew something.