Danger in bank accounts

It has been obvious for some time that banks in many jurisdictions are insolvent and that they are simply too big for governments to rescue. Furthermore, while some governments feel they have a reasonable chance of muddling through, they are all aware that a crisis in one major nation, such as Spain or Italy would most probably lead to a chain of defaults beyond anyone’s control. It should come as no surprise that central bankers have been considering how to deal with this problem and that they have resolved a solution.

That solution, as we saw clumsily applied in Cyprus, is for central banks to use creditors’ funds to rescue banks in difficulty, which includes uninsured deposits, instead of taxpayers’ money. What this means is that if you have deposits greater than the level guaranteed by your government, the unguaranteed portion (in the eurozone, over €100,000) is free to be used to recapitalise the bank.

This is a major departure from past assumptions, that central banks would do their utmost to rescue banks without raiding any deposits. As many ordinary savers in Cyprus found to their cost, this is no longer true. The new approach has been agreed at the highest levels, at the Bank for International Settlements, the central bankers’ central bank. It has been a topic under consideration since the publication by the Financial Stability Board (a BIS committee) of a paper, Key Attributes of Effective Resolution Regimes for Financial Institutions in October 2011, which was endorsed at the Cannes G20 summit the following month. This was followed by a consultative document in November 2012, Recovery and Resolution Planning: Making the Key Attributes Requirements Operational. In this latter document it is stated in the introduction that “Reforms are now underway in many jurisdictions to align national resolution frameworks more closely with the Key Attributes (i.e. the October 2011 paper). In other words any changes to law have been or are being made.

This confirms that G20 members are ensuring that they can legally override the rights of creditors, including uninsured depositors. This outcome is not difficult to achieve when the alternative in almost all cases of bank failure is for uninsured deposits to be wiped out completely.

The status of deposits

It is commonly assumed that money on deposit belongs to the depositor. This is not true, because the depositor lends his money to the bank, so the money becomes the bank’s property and merely owes it to the depositor. The depositor is usually the most senior class of unsecured creditor. There are however three broad classes of deposit to consider:

  • Insured deposits, guaranteed by a government or government agency. These protect smaller deposits up to a limit set by government;
  • Uninsured deposits owed to non-monetary and non-financial institutions (non-MFIs); and
  • Wholesale deposits owed to monetary and financial institutions (MFIs).

The BIS proposals being enacted throughout the G20 allow for different treatment for these deposit classes in a bank rescue. The government or its agency is going to have to pay out for insured deposits anyway, so it makes sense for them to remain untouched. Wholesale deposits, which are not the focus of the BIS proposal, are unlikely to be touched except in the case of very small bank failures, because of the risks spreading to other banks and financial institutions. This leaves the full burden of depositor contributions to a bank rescue falling on the shoulders of uninsured non-MFIs. In other words any deposit in excess of the insured amount owned by individuals, companies, trusts, pension funds and other savings vehicles, and any segregated client accounts operated by business lawyers and brokers acting as agents for its customers is likely to be raided where there is a risk of bank failure. Any business receiving payments into its bank account in excess of the insured limit is similarly at risk.

Anyone in this position is simply being negligent if he or she assumes deposits are safe. The smaller a bank’s uninsured non-MFI depositor base is relative to the other depositor classes the greater the amount these depositors will lose in a bank rescue. Therefore non-insured deposits are particularly vulnerable in retail and high street banks targeting small savers, such as mortgage and savings banks, as well as banks with a large element of wholesale funding.

What are the alternatives?

Uninsured non-MFI depositors have three broad choices.

  • They can move their deposits to a bank they feel is safe. This may reduce a specific risk, but does not eliminate depositor risk, bearing in mind that all G20 jurisdictions will substitute uninsured non-MFI deposits for tax-payers funds in a bank rescue.
  • They can spread their deposits between several unrelated banks so that each one is insured. This may be a practical solution for deposits up to two or three times the insured level.
  • They can reduce their deposits by acquiring something else.

The first two options need little further comment, but the third must be explored further. Physical cash is an option but impractical except for relatively small amounts, because most governments have moved to restrict its use by the imposition of anti-money laundering and other rules. The two further alternatives are to invest in securitised alternatives, such as government bonds and other instruments, or in precious metals. And in the case of precious metals, there are mining shares, ETFs and possession of physical metal.

The case for precious metals

The fact that the BIS feels it has been necessary to co-ordinate G20 nations into a common approach to bank rescues using uninsured non-MFI deposits is evidence that bank failures capable of threatening the global financial system are definitely an ongoing risk. The central banks will have calculated that raiding this category of deposits is a matter of expediency, and any run on deposits out of vulnerable banks can be contained by central banks acting as lender of last resort. This is based on the simple fact that either deposits are moved around the system, or when they are drawn down in favour of something else, the money released remains in the banking system. However, raiding these deposits is only an interim solution, because the underlying assumption is that the financial condition of the whole banking system does not deteriorate further.

It is not the intention of this article to argue for or against this assumption, beyond pointing out that the BIS approach is merely a stop-gap solution that does not deal with underlying economic and financial problems. The difficulties governments face cannot be resolved by just applying sticking plaster on insolvent banks.

Depositors are learning that governments, acting in the name of the tax-payer, will do anything for their own survival, debasing savings to cover state spending and now raiding deposits to maintain the status quo. Many depositors take the view that holding short-dated government bonds and similar assets priced on interest rates is risky, which is why they have money on deposit. It is therefore very likely that deposit money will flow into precious metals.

A version of this article was previously published at GoldMoney.com.

11 Comments

  • Mr Ed says:

    Q: How many Cypriots does it take to change a light bulb?

    A: None can, because they can’t get the old bulb that they put in out again.

  • mrg says:

    A good, informative article, though I’m concerned by some of the emotive language …

    “central banks would do their utmost to rescue banks without raiding any deposits …”
    “… raiding deposits to maintain the status quo”

    Is it really fair to describe this as a ‘raid’? As you yourself point out, “the alternative in almost all cases of bank failure is for uninsured deposits to be wiped out completely”.

    It is of course wrong for G20 members to “legally override the rights of creditors, including uninsured depositors”. The normal rules of bankruptcy should apply.

    I was also a bit confused by this statement:

    “non-insured deposits are particularly vulnerable in retail and high street banks targeting small savers”

    Surely ‘small savers’ have only insured deposits. Anyone with more than a hundred thousand in the bank wouldn’t count as a ‘small saver’ in my book (though plenty of ordinary people might get caught at the wrong moment, e.g. after selling a house and before buying).

    Although I object to the term ‘raided’, you’re right to highlight the risks of losses to uninsured deposits, which could have severe knock-on effects:

    “any deposit in excess of the insured amount owned by individuals, companies, trusts, pension funds and other savings vehicles, and any segregated client accounts operated by business lawyers and brokers acting as agents for its customers is likely to be raided where there is a risk of bank failure”

    I work for a small company that has a couple of million in the bank, enough to pay salaries for a few months. If that buffer were wiped out, and we went through a dry spell in sales, people would lose their jobs.

    This is not to say that the status quo is preferable. Shareholders and uninsured depositors have no legal or moral right to a taxpayer bailout, and it would be better if deposit insurance had never existed, since it has contributed (along with extraordinary bailouts) to unwarranted faith in our banking system.

  • Mr Ed says:

    mrg: In a sense, you are right, it is not a ‘raid’ as the money simply isn’t there in the first place, and putting money in a bank is not like depositing it in a warehouse. The money belongs to the bank and you become a creditor. It might be a better world if every intelligent adult putting money into a bank appreciated the consequences of that, and adjusted their behaviour accordingly.

    However, the term ‘raid’ is quite apt. Imagine if a bank raider, instead of demanding fungible cash, demanded that money from a particular account be withdrawn and handed to him, that is what has happened on a large scale through governmental diktat, although it only reflects the underlying reality that the money is not there. The ‘raids’ in Cyprus are done with the intention of saving the banks in the long run, and although it is arbitrary and harsh, it does illustrate the reality of the situation.

  • George Thompson says:

    I prefer ‘liquid’ assets such as those bottled by Wild Turkey, Bushmills, Glenfiddich and Highland Park. The U.S. government has already proven its willingness to ‘raid’ its citizens’ privately held precious metals. There is nothing to prevent their so doing again, excepting the right of its people to keep and bear arms. Even that is insufficient against what not that long ago was the greatest military force ever. So when the soft brown stuff finally hits the whirlybird wizard’s chopper blades, I expect the value of my favorite assets to more than quadruple. If I’m wrong, I can always drink my troubles away.

  • Mr Ed says:

    The best case of hiding gold was in WW2 in Occupied Denmark, Hungarian Jewish scientist George de Hevsey, who himself was to win a Nobel Prize for Chemistry in 1943, hid two exiled German colleagues’ Nobel Prize medals from the Germans by dissolving the medals in aqua regia (an acid mix). A thorough search of the institute failed to find the medals, dissolved in a jar. The gold was recovered at the end of the war and the medals rest ruck.

    I cherish the thought of Gestapo thugs being outwitted by a Nobel Prize winning chemist. See the article below, the paragraph below the red box.

    http://www.nobelprize.org/nobel_prizes/about/medals/

  • A possibility for those seeking safety for relatively large amounts of money in the UK – a possibility no mentioned by Alasdair Macleod – is National Savings and Investments. NSI guarantees depositors’ money up to £1m per head, I think.

    But of course given that we cannot be sure where governments now stand on deposit guarantees, presumably even money deposited at NSI is no longer 100% safe.

  • Paul Marks says:

    The word “deposit” should be dropped – it is wildly misleading. The money is NOT deposited – it is loaned to the bank who then lend it out to other borrowers (plus a vast amount of credit the create, on top of the cash, by “creative accounting”).

    People should be asked “do you wish to lend money to these bankers, knowing you may lose it?”.

    NOT “do you wish to deposit money in this bank?” (which is not what happens at all).

    It is quite possible that some people might choose to risk their money by lending it to bankers.

    But certainly not at these interest rates.

    If if was not for the LIE that money is “deposited” in banks – then (at these rates of interest) the whole system would collapse in a single day.

    Sadly the alternative offered to putting money in the bank, investing in the stock market, is also a Central Bank generated bubble.

  • A Milligan says:

    Depositors actually have a fourth option which is not mentioned in this article, namely investing in a money market fund. That would not be subject to a ‘raid’ on deposits as it is a unit trust managed by a fund manager. The other option has already been mentioned in the comments to this article, namely National Savings certificates of one form or another. One must assume that they would be safe except in the most dire catastrophe for the UK.

  • waramess says:

    Rise above the argument and you can see that solvency is not the real issue for banks; liquidity is everything and any bank that is able to focus on attracting sufficient deposits to cover its assets is fireproof.

    As money needs to go to the banks or under the matress the insolvent but liquid banks are for the time being safe.

    So long as the governments hold their collective nerve and banks continue to receive deposits sufficient to pay their interest costs then all will be well.

    This will change and when it does the niceties of insured deposits and uninsured deposits will vanish. Governments will be unable to support the banks and governments will have no option to renegade on their undertakings.

    We are living through the greatest bubble ever constructed which can be seen clearly by the fact that the stock exchange prices are at a higher level than in 2007 and still rising.

    Everything will change when events result in interest rates increasing and that time is not far off.

  • Paul Marks says:

    Solvency “not the real issue” – liquidity is “everything”.

    We heard a lot of that in 2007-8 – as long as Alan Greenspan kept pumping in more money (as he had done for so many years) all would be well….. accept it was not.

    Sorry but the banks being insolvent IS the issue – and no amount of funny money “liquidity” is going to save this corrupt system. A system where “assets” are something that needs to be “covered” (then they are not really “assets” – and the basic structure of bank balance sheets [with loans treated as “assets”] is a farce).

    However, I agree that the time is not far off when the crash comes.

  • Paul Marks says:

    By the way “investing” in government debt (“National Savings”) is “investing” in the government printing press.

    Which is the only way the United Kingdom government debt is going to get paid.

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