June 26, 2013 7:44 am
Flexibility decided by states is a wrong move for Europe’s Banks
Uncertainty about losses will be made worse when a lender goes bust, says Martin Sandbu
When European finance ministers meet on Wednesday, they are already in extra time. Last week they could not agree on how EU countries should handle busted lenders to ensure taxpayers never again have to pay for bankers’ failed bets. They have 24 hours to come to an agreement on “bail-ins” – imposing losses on creditors of banks that run out of money – before their bosses meet for the EU summit meant to take the formal decision on Thursday and Friday.
The main stumbling block is some nations’ demand for greater “flexibility” in the bail-in rules. That term should set off alarms. Flexibility can mean two things, both bad.
First, it could mean lots of ad-hoc making: leave governments to decide on a case-by-case basis who to save (bail out) and who to let drown (bail in) when a bank is bust. This would guarantee unpredictability when a liquidity or solvency crisis hits.
Part of what made the Cyprus bail-in more damaging than it should have been was the initial uncertainty about whether supposedly guaranteed deposits would be written down. And Cyprus is just the most extreme case. Every banking crisis in the EU has been made worse by uncertainty about who would take losses on their claims against banks.
If ministers are serious about reducing future financial instability, they must commit to explicit predetermined hierarchies of claims on banks. They must make clear who bears losses, and in which order and to what extent, when their bank runs out of money.
Second, flexibility could mean that a hierarchy of loss absorption is clear in advance but differs between countries. This makes no sense in a single financial market. If rules are different, each type of bank funding will flow to the states that are the most willing to bail them out. Anyone who does not see why this is harmful should remember Dublin’s blanket guarantee of bank liabilities in 2008, thrown back into the spotlight by the release of taped conversations between shameless Irish bankers in those hectic days.
If the Ecofin meeting chooses the public good and not special interests, it will agree explicit common bail-in rules for all. What should these be?
Everyone now surely agrees that guaranteed depositors should be so in reality and not in name only. They should always be the first to get their money back, and states must top up to compensate if any bank fails too dismally even to honour small deposits.
What about the rest of banks’ liabilities? Before now, unsecured creditors above the deposit guarantee – holders of larger deposits and unsecured bonds – have been treated equally unless explicitly subordinated. Some states now want to be allowed to bail out specific larger deposits. If we give them the benefit of doubt, they presumably have in mind widows living off bank savings, families preparing a deposit for a house or small organisations needing access to their working capital.
There is clearly a legitimate need for safe places to put away more than €100,000. But this does not justify picking holes in the bail-in framework the EU badly needs.
Better to follow the US practice of depositor preferences – in which deposits (above the guarantee, which should be ironclad) rank before other senior unsecured creditors. That should meet most of the demand for safety.
For those who want more, banks themselves can offer externally purchased insurance as part of a savings product – mini-credit default swaps, as it were. They could even be required by regulators for client accounts used in housebuying, for example. The market should be used to provide – and price – solutions beyond the minimum protection no one should be permitted to go without.
A safe banking system requires people to understand that higher rewards come with higher risks. That means they must be told clearly and uniformly what risks they take by entrusting their money to banks in various ways. This is what the ministers profess to want and yet seem to find it so agonisingly difficult to do.
The main stumbling block is some nations’ demand for greater “flexibility” in the bail-in rules. That term should set off alarms. Flexibility can mean two things, both bad.
First, it could mean lots of ad-hoc making: leave governments to decide on a case-by-case basis who to save (bail out) and who to let drown (bail in) when a bank is bust. This would guarantee unpredictability when a liquidity or solvency crisis hits.
Part of what made the Cyprus bail-in more damaging than it should have been was the initial uncertainty about whether supposedly guaranteed deposits would be written down. And Cyprus is just the most extreme case. Every banking crisis in the EU has been made worse by uncertainty about who would take losses on their claims against banks.
If ministers are serious about reducing future financial instability, they must commit to explicit predetermined hierarchies of claims on banks. They must make clear who bears losses, and in which order and to what extent, when their bank runs out of money.
Second, flexibility could mean that a hierarchy of loss absorption is clear in advance but differs between countries. This makes no sense in a single financial market. If rules are different, each type of bank funding will flow to the states that are the most willing to bail them out. Anyone who does not see why this is harmful should remember Dublin’s blanket guarantee of bank liabilities in 2008, thrown back into the spotlight by the release of taped conversations between shameless Irish bankers in those hectic days.
If the Ecofin meeting chooses the public good and not special interests, it will agree explicit common bail-in rules for all. What should these be?
Everyone now surely agrees that guaranteed depositors should be so in reality and not in name only. They should always be the first to get their money back, and states must top up to compensate if any bank fails too dismally even to honour small deposits.
What about the rest of banks’ liabilities? Before now, unsecured creditors above the deposit guarantee – holders of larger deposits and unsecured bonds – have been treated equally unless explicitly subordinated. Some states now want to be allowed to bail out specific larger deposits. If we give them the benefit of doubt, they presumably have in mind widows living off bank savings, families preparing a deposit for a house or small organisations needing access to their working capital.
There is clearly a legitimate need for safe places to put away more than €100,000. But this does not justify picking holes in the bail-in framework the EU badly needs.
Better to follow the US practice of depositor preferences – in which deposits (above the guarantee, which should be ironclad) rank before other senior unsecured creditors. That should meet most of the demand for safety.
For those who want more, banks themselves can offer externally purchased insurance as part of a savings product – mini-credit default swaps, as it were. They could even be required by regulators for client accounts used in housebuying, for example. The market should be used to provide – and price – solutions beyond the minimum protection no one should be permitted to go without.
A safe banking system requires people to understand that higher rewards come with higher risks. That means they must be told clearly and uniformly what risks they take by entrusting their money to banks in various ways. This is what the ministers profess to want and yet seem to find it so agonisingly difficult to do.
Copyright The Financial Times Limited 2013.
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