EU bank bail-in directive: how would Cyprus have fared?
by George Hatjoullis
A press release ( http://bit.ly/1e7qWYC) from the european parliament. The bank bail-in directive comes into force on 1 January 2015 and the bail-in system on 1 January 2016 (why a one year delay?). The directive provides some clarity (but not much) to the situation following the Cyprus bank bail-in. The intention is to place the taxpayer last in the bail-in process. Details are a little vague but the basic outline and intention is clear.
Each EU state is to establish a resolution fund from levies on the banking industry and by 2025 the fund should equal 1% of relevant national deposits (not that much really). However, before any public money is touched, a banking jurisdiction must bail-in up to 8% of shareholders and creditors. This means shareholders, junior bond holders, senior bond holders and unsecured depositors, and in this order. This is where it gets a bit vague. The unsecured depositors are not only last but also may come after the resolution fund has been activated and contributed up to 5% for a bail-out. Then just to make matters as confusing as possible the press release notes that smaller (unsecured?) depositors would be excluded from any bail-in [see postscript below for update 19/04/2014]. Public precautionary and emergency capitalizations (in case of systemic risk) would be possible but tightly framed and subject to EC oversight.
Despite the lack of detail it is clear that Cyprus depositors might have fared a little better under this directive than they actually did but not much. All unsecured depositors were bailed-in whilst under this directive small (how small?) unsecured depositors might have been exempt[see postscript]. Moreover, given the systemic importance of Laiki and the Bank of Cyprus there would have been a case for emergency state capitalisation. The problem is that the state in this case was broke and subject to whatever terms the creditor nations represented by the Troika would have exacted. One suspects the tribute exacted would have been much as it was. Still some small unsecured depositors might have escaped with potentially substantial significance for the Cyprus economy.
The press release is also self-contradictory. The intention is to make the taxpayer last but the taxpayer is not last. The small unsecured depositor seems to be last. It would make more sense to just raise the level of insured deposits or have a special category of insured deposits ( e.g transaction deposits) that achieves whatever is trying to be achieved by this vague exception. However, without such nonsense it would not be the European Commission that we have come to admire.
The final details of the Banking Union are yet to be published and a general assessment will be attempted once all details are agreed and available. The latest press release (http://bit.ly/QuBpTn) published 28/03/2014 does include some clarification on points of confusion raised above in relation to ‘Bail-In’. Specifically;
Deposits under € 100 000 would never be touched: they are entirely protected at all times.
Deposits of natural persons and SMEs above € 100 000 1) would benefit from preferential treatment (“depositor preference”) ensuring that they did not suffer any loss before other unsecured creditors (so they are at the very bottom of the bail-in hierarchy) and 2) Member States could choose to use certain flexibility to exclude them fully.
In the context of Cyprus this may have not altered the outcome for ‘natural persons’ given the extent of the bail-in, that the state could not choose to use flexibility and was entirely at the mercy of the troika. The latter chose not to spare natural persons and SMEs of all whom were treated the same as larger corporations. This paragraph serves to emphasise the exceptional and harsh treatment of Cyprus bank depositors. It also serves to emphasise that unsecured depositors might, in extremis, be bailed-in for any member state going forward. The detail to look for is what flexibility the member state has to exclude them fully. Note if it chooses to use such flexibility the member state taxpayer is destined to foot the bill.