The Greek tragedy is now being played out in Cyprus with a new twist
There seems to be a new central bank bail-in template that is here to stay, from what can be inferred from the recent statements by G7 central banks and from the crisis resolution in Cyprus. To give a quick download on the Cypriot crisis, the sequence of events were: exposure of Cypriot banks to Greek debt, downgrading of Cypriot economy to junk status by international rating agencies, the consequential inability by its banks to refinance themselves in the international money market and the reluctance of the Cypriot government to restructure the troubled financial sector. Recently, a euro 10-billion bailout was announced in return for Cyprus agreeing to close its second-largest bank, the Cyprus Popular Bank, levying all uninsured deposits there, and possibly around 40% of uninsured deposits in the country?s largest commercial bank, the Bank of Cyprus.
The template is new and different because earlier when a large bank was in trouble, the central bank used to ask itself what it could do to help the bank, and how it could recapitalise the troubled bank, and how it could ensure that all depositors? money, insured or not, is safe. This time around the central bank was saying: Okay, what are you#the bank going to do about it? What can you do to recapitalise yourself? If you cannot do it, then we are going to ask your shareholders and bondholders to contribute to recapitalise your balance sheet. And, if necessary, we will ask the uninsured deposit holders about what they can do in order to save their own deposits and how much of a hair-cut they would have to take?
What Cyprus makes clear is the realisation that there is not enough money or goodwill in the world to bail out the banks. There was no transfer of risk from over-levered banks to the taxpayers. The risk was pushed back onto the banks. Their equity was wiped out. Their bondholders were mopped out. Their uninsured depositors saw their accounts raided for additional liquidity. It wasn?t just that the rules of the game have changed, the game itself has changed. By raiding the depositors? accounts, a major central bank has gone where they would not previously have dared. The proverbial Rubicon has now been crossed. Going forward, this is expected to be the ?new template? for dealing with risky, over-levered banks and the countries which support them.
For the first time since the crisis began, we are faced with a new paradigm, or a ?new template?, for how a major central bank will address weakness in the financial sector. While the old template involved bailing out through transfer of risk from the corporate sector to the taxpayer, the new template calls for bailing in, whereby the risk is contained within the affected institution at the expense of equity holders, bond holders and finally the depositors.
Governments around the world are finally beginning to realise the gravity of the risk that exists in their banking sectors. Data from IMF indicates that much of the external debt by G7 countries is owed by banks. All G7 countries have banking systems that have become larger and, in some cases, dwarfed their respective economies. The EU has decided to build upon the new template of the ?bail-in? regime. Other countries may follow suit. For instance, a reading of the Canada?s Economic Action Plan 2013 (http://www.cbc.ca/news/pdf/budget 2013-eng.pdf) or a joint paper published by the FDIC and the Bank of England (www.fdic.gov/about/srac/2012/gsifi.pdf), puts the onus squarely upon the depositor. The depositor is a lender to the financial institution that he banks with. However, most depositors naively assume that their deposits are 100% safe in their banks and trust them to safeguard their savings. Under the new template, all lenders (including depositors) to the bank can be forced to ?bail-in? their respective banks. Several G7 countries already have provisions that allow troubled banks to be bailed in using depositor accounts.
The Greek tragedy is now being played out in Cyprus with a new twist as depositors have been unwillingly turned into sacrificial lambs. Given the size of the banking sector in most G7 countries and the burgeoning government debts, the ability of the governments to bail out their banks is severely constrained, especially considering the political headwinds that exist today. A lesson that we all can learn is that no bank is truly safe nor is the depositor?s money in the bank beyond the deposit insurance amount. My intention is not to be alarmist here, but merely to say caveat depositor. Recent central bank statements and actions clearly seem to suggest that.
The author is a post-doctoral fellow and visiting faculty at Santa Clara University, California