Banks and implicit guarantees: the lesson from Cyprus

by George Hatjoullis

National Savings and Investments

National Savings and Investments (Photo credit: Wikipedia)

The Daily Telegraph has an interesting graphic which needs to be highlighted ( Under British banks, it advises that deposits over £85k have an implicit guarantee. Implied by whom or what? This is simply wrong. The DT is conflating ‘assumed’ with ‘implicit’. There is no guarantee implicit or otherwise. The Cypriots also made this assumption at devastating cost.

The uninsured deposits of a bank rank pari passu with the senior bondholders. Neither are guaranteed but neither are normally touched in a bank restructuring. The reason is that governments fear systemic risk and the economic shock. If all depositors of RBS holding above 85k had been wiped out what would have been the consequences? A run on all suspect banks would have ensued and also on some not so suspect. Moreover, the economic shock of wiping out a huge chunk of liquid wealth overnight would have plunged the UK economy into a nuclear winter from which it would still be emerging.

The UK government of the day chose not to penalize any depositors during the financial crisis of 2008/2010. The banks were recapitalized, in effect, from general taxation. The result has still been a grim economic period but far less so than might have been. The witch-hunters claimed tax-payer money was being used to bail out banker bonuses. The reality is that it was senior bond holders and uninsured depositors that were being bailed out (However, let not the facts get in the way of a good story). It is the habitual bail out of uninsured depositors and senior bond holders that lends credence to the myth of the implicit guarantee.

The Cyprus debacle thus has lessons for all. If you have more than the insured amount in a bank deposit it is at risk. Moreover, it is at risk even if it is just parked there temporarily in order to cover some large transaction. If people start to act on these risks there could be serious economic consequences. I have argued in an earlier blog that governments need to introduce insured transactions accounts to help alleviate some of these potential consequences. You cannot check the credit standing of every bank merely to conduct normal business.

With respect to parking liquid wealth, the UK only has a few options. Either Gilts or NS&I accounts. Both have a government guarantee and outside of the eurozone that is worth something because the UK has other options rather than default on its nominal debt (quantitative easing). Within the eurozone member state governments can only ask for help from the ESM and we have seen how this might turn out. A government guarantee within the eurozone is only as good as the eurogroup will allow and as we have seen this may be as consistent as a premier league referee.