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.