Eurozone: How safe are our deposits? Which banks will survive?

From right to left: Jeroen Dijsselbloem, President of the Eurogroup; Olli Rehn, Vice President of the European Commission, (Council of the European Union photographic library).

The Ecofin Council, the EU body that regroups the 27 Ministers of Finance, probably the most powerful institution of the European Union, is to conduct its regular meeting this Monday and Tuesday 13 and 14 May. On its agenda the main item will be a Commission’s proposal for a crucial Directive, establishing a framework for bank recovery and resolution to clear failing or about to fail banks.

This text contains the principles which were applied in the case of the resolution of the Popular (Laiki) Bank of Cyprus and the recovery of the Cyprus Bank, the first and the second biggest bank of the divided by the Turks in 1974 and tormented by the Eurogroup on 2012 island. The European Sting published a relevant article on 31 March under the title “EU Directive makes haircut on uncovered deposits a standard in bank bail-ins”, informing the world that in the European Union deposits will be used from now on in banks’ resolutions and recoveries.

The issue attracted a lot of publicity all over the world because the haircut inflicted on the uncovered deposits (above the benchmark of €100,000) reached 80% in the case of Popular Bank of Cyprus and around 35% in Cyprus Bank. This was the plan B drafted by the Eurogroup to resolve the Cyprus issue.

Which deposits are insured?

The interesting thing however is that the plan A, which was rejected by the Cypriot Parliament, contained a haircut of around 10% also for the deposits below this theoretically insured and inalienable benchmark of €100,000. Yet the never applied plan A, was drafted by the Eurogroup and the Nicosia government. Both of them stating that deposits below €100,000 are safe. How was that possible? The only logical answer is that this insured deposits benchmark of €100,000 is an illusion.

Given that in the European Union there is a constellation of deposit insurance schemes, the Commission wants with this proposal for a Directive to create some common principles in this fragmented market. The fact will remain however that it won’t be a pan European deposit guarantee scheme. Obviously the banks in the core Eurozone countries will secure in this way an advantage in relation with southerner institutions. There is more discriminatory provisions in this new Directive.

Deposit guarantees

The Commission’s proposal goes like this: “The directive would require member states to set up ex-ante resolution funds to ensure that the resolution tools can be applied effectively. Under the presidency’s latest compromise proposal, these national funds would have to reach, within 10 years, a target level of at least 0.5% of covered deposits of all the credit institutions authorised in their country. To reach the target level, institutions would have to make annual contributions based on their liabilities, excluding own funds, and adjusted for risk. Member states would be free to choose whether to merge or keep separate their funds for resolution and deposit guarantee schemes (DGSs). In both cases, the combined target level would be the same. The Council’s general approach on a proposed directive on DGSs, agreed in June 2011, sets its target level at 0.5% of covered deposits. Lending between national resolution funds would be possible on a voluntary basis”.

In reality the Commission wants those Deposit Guarantee Schemes to act along the same lines as the national funds for the resolution and the recovery of banks in all member states. This makes sense because in the event of the resolution of a failing or about to fail bank, the DGSs and the resolution funds will have the same task; to liquidate the assets of the bank and pay the claimants. This brings us the core of next week’s discussion in the Ecofin, which is nothing less than the line of those claimants.

Who will be paid and by whom?

Under this light let’s return back to Cyprus. In the case of the two failed Cypriot lenders, the theoretical and widely advertised guarantee of deposits of up to €100,000 proved to be a fallacy. If there was such a guarantee, then how the Eurogroup and the Cypriot government in their first intervention package, agreed on a haircut of deposits below this benchmark of €100,000? Simply there was not such a possibility in the case of Cyprus or in any other country of the world if a bank run gets hot. This brings us to the other major fallacy of our times, the security of deposits in today’s banking universe where derivatives are thought to have reached $600 – 700 trillion.

Deposits under the axe

In any case almost all deposits in Cyprus Popular Bank and the Bank of Cyprus above the €100,000 benchmark were given a very deep haircut of up to 80% in an operation called bail-in. Bail-in means that the intervening authorities are using all the assets of the institution to pay the claimants. If this is not enough, they turn to creditors and at the end they give a haircut to deposits. They use first the unsecured deposits to pay the secured ones, and if the unsecured cannot do the job the secured deposits simply get a haircut. This is what happened in Cyprus and will constitute the platform or the template from now on. According to an announcement by the Council on this issue, “The presidency will focus the (Ecofin’s) Council discussion on the design of the bail-in tool. This tool would enable resolution authorities to write down or convert into equity the claims of the shareholders and creditors of institutions which are failing or likely to fail”.

Some lines below the announcement say: “The presidency has identified three main approaches, with possible variations, to the design of the bail-in tool:
* Harmonised approach: A limited number of defined exclusions from bail-in and insured depositor preference (i.e. DGSs would be bailed in after other senior unsecured creditors). Uninsured deposits (i.e. deposits above EUR 100,000) would be automatically bailed in.
* Discretionary approach: With limited flexibility for national resolution authorities to exclude liabilities for financial stability reasons or to ensure continuity of banks’ critical functions. Discretionary exclusions could apply to uninsured deposits, in particular those held by individuals or SMEs, and to short-term debt as well as to liabilities arising from derivatives or from participation in payment, clearing and settlement systems with a remaining maturity of less than one month.
* Mixed approach: Uninsured depositor preference (i.e. they would be bailed in, but after other senior unsecured creditors) and a combination of defined and discretionary exclusions”.

The sequence of losses

All that can be translated as it follows. Shareholders don’t stand a chance, the same is true for uninsured creditors and depositors. When all that money is not enough to cover the insured deposits, the DGSs will be called in to cover the deposits of up to €100,000. What if the DGSs resources are not enough for that? The Directive doesn’t say anything about that but it is obvious that the insured deposits have only a “preference”. If there is no money, the insured depositors will also suffer losses. The possibility of the national DGSs to lend money to each other is for the good times. When it rains, everybody needs their umbrellas! In other words, during the next crisis the banks will surely lead the world be prepared and keep money in the pillow!

There is something else though. What will happen until all those DGSs are in place? The Presidency’s announcement says that the Ecofin will discuss that too: “Bail-in start date: Under the current proposal, member states would have to introduce the bail-in instrument by January 2018. However, some member states have suggested bringing the date for ward to January 2015”.

Those dates coincide with the creation of the banking union where the European Central Bank will be supervising a round number of 200 major banks and indirectly guaranteeing their prudence and ultimately their solvency. Obviously those 200 financial firms will be enjoying a very special advantage having the ECB to guarantee their creditworthiness. Towards the same time the national DGSs will be ready to guarantee to every bank depositor those €100,000.

Now imagine a situation where a German bank is included in the 200 supervised by the ECB and its depositors are guaranteed their first €100,000 by the German DGS. On the other side of the street, there is a Greek bank not included in the 200 and its depositors are protected by the Greek DGS. Where would you put not only €100,000 in deposits but as much as you have? No answer needed, it’s a rhetoric question.
This major disadvantage for the Greek or Spanish or Italian bank will deprive it not only from customers but it will increase its cost to attract money. Consequently the Greek bank will not be able to offer competitive loans and probably it will be driven to the ‘butchers’ for a bail-in and a probable resolution.

There is no question that as long as the banks are free to play with our money in the $600-700 trillion derivatives market, nobody can guarantee our deposits. In a crisis, the ECB will probably act as ultimate lender, but only to those 200 banks it oversees. What about the rest? God knows! European banks are reportedly exposed to derivatives with $150 trillion. Which government or central bank can rescue them in a crisis?

Seemingly what will be very vividly discussed next week in Brussels will be the agreement on which are the 200 banks that the ECB is to take aboard. As for the bail-in authorities and the DGSs, nobody believes that in a new credit crisis any of those ‘creatures’ will survive. Only the 200 will be saved by the printing machine of the ECB. But this is the ultimate discrimination.

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