Uninsured bank deposits in the eurozone are unequivocally at risk.

by George Hatjoullis


Gestalt7 (Photo credit: Wikipedia)

The title of this blog is uncharacteristically blunt and also somewhat odd. By definition an uninsured deposit is at risk. It is uninsured. It is like exhorting people to take care because fire can burn. However, past government behaviour has insulated uninsured depositors such that depositors have forgotten that their uninsured deposits are, well, uninsured. Depositors in failing banks have typically been bailed out by the taxpayer. Indeed, with all the vitriol spouted out about taxpayers bailing out bankers bonuses, neither politicians, the press nor the general public has grasped that the taxpayer had primarily bailed out senior bond holders and uninsured depositors. Until that is, Cyprus.

The Cyprus bail in of senior bond holders and uninsured depositors is a precedent. It is clear that the possibility of bail in of uninsured depositors will figure prominently in the structure of the eventual banking union. This is what Jeroen Dijsselbloem was indicating and others have confirmed. In principle it has always been the case that uninsured depositors could be bailed in. The reason it has not been acted on often is because of the fear of triggering a systemic banking crisis. The proposed banking union will seek to limit the possibility of bank failure as the first line of defence. However, accidents happen and a resolution mechanism will be constructed to both handle the crisis and avoid systemic outcomes. In the last analysis if a bank failure manages to present itself that does have systemic implications, one assumes that it will be bailed out. The details of any banking union structure will make interesting reading.

What can be said before we know these details? First, one needs to ask why would anyone hold an uninsured deposit in a eurozone bank unless adequately compensated? The banking union structure would presumably offer some strong assurance that the supervision of eurozone banks was such that failure had a very low probability. Nevertheless one would still expect some tiering in deposit interest rates across banks and by size of deposit. The same tiering would be evident in the interbank market. Eurozone residents with excess cash might congregate at large, seemingly well capitalised, eurozone banks and only be tempted by smaller or less well capitalised banks if rewarded. Over time, the absence of crisis might blur such behaviour; until there is a crisis.

The second question is why would non-eurozone residents choose to bank within the eurozone banking union if they have the option. It may be that the banking union structure creates confidence in the system and makes it appear safer than other banking jurisdictions. This will certainly be the objective of the eurozone authorities. It may also be that global players channel banking activities through a jurisdiction that offers an implicit guarantee of the too-big-to-fail variety that has blurred the vulnerability of uninsured deposits in the past. The devil will be in the detail.

The banking union is still in the process of being constructed. One major problem in its construction will be the now ever-present two-tier structure of the european project. Is it to be a eurozone or EU banking union? If the former how will eurozone and EU banks interlink? If the latter how does the banking authority interact with banks in non-euro EU member states? These are non trivial issues with big political implications and may not be easily resolved. The banking union is coming but no one is sure when and what it will actually look like.

In the meantime, banking support is provided at the national level and the legacy system problems remain. The ESM will provide support to member states at a price and the price, it seems, is not constant across all member states. Until the banking union is in place, the location of banking activity within the eurozone carries some risk, which may or may not be adequately compensated. It is logical for all to relocate their banking services to jurisdictions that offer the most security. The implication is obvious.

In Cyprus the horse has bolted. One anecdotal observation is that people with insured deposits are still withdrawing funds and holding cash. The more sophisticated are moving what they are allowed from insured deposits to banking jurisdictions outside of the Republic of Cyprus. If the Republic is to remain within the eurozone this behaviour is illogical. Insured deposits are not at risk. However, if the Republic leaves the eurozone then such behaviour is entirely logical. Cash euros will still be euros but euro deposits in Republic banks will then cease to be euros. The government has reassured the people that the Republic will not be leaving the eurozone. The problem is that it has reassured the people of many things which have proved not to be valid. The Republic banking system is not yet stabilised.