By Stelios Orphanides
The risk of a bank run in Italy as the capital situation of its lenders deteriorates by the day following the British referendum, making losses for depositors more likely, coupled with concerns about the capital adequacy of Deutsche Bank, has prompted the bank’s chief economist to propose a re-writing of Europe’s rules: let’s bail out banks instead of resorting to bail-in.
David Folkerts-Landau, the chief economist of Germany’s largest bank, proposed in an interview with Welt am Sonntag, that European banks should receive a capital injection worth €150bn in taxpayer’s money. His comments came days after Italian prime minister Matteo Renzi played down the problems banks in his country were facing – which accumulated a total of €360bn in non-performing loans, one-third of the euro area’s total – indicating that the exposure to derivatives is the main threat to Europe’s banking system.
According to Renzi, this may apply for Folkerts-Landau’s employer, which posted a net loss of €6.8bn net loss last year and has a total exposure in derivatives of €54.7tn, almost 20 times Germany’s gross domestic product as its core equity tier 1 capital ratio stands at 10.7 per cent. “Sticking strictly to the rules could cause bigger damage than suspending them,” Folkerts-Landau was quoted as saying by the German weekly newspaper. A bail-in would be politically difficult to implement and would harm a large number of Italian depositors and trigger a bank run.
Marios Clerides, a Cypriot economist agreed with his German colleague. Changing Europe’s rules would indeed make sense, especially following the experience of Cyprus, the first euro area member which was forced to rescue its banks with depositor’s money.
A bail-in, in any of Europe’s systemic banking system’s, would mean “an earthquake comparable to that of Fukushima and even worse,” former banker Clerides said in a telephone interview on Tuesday. “The effects will be felt worldwide, just look at what happened with the Brexit referendum”.
The March 11, 2011 powerful earthquake off the coast of Japan, triggered an up to 13 metres tsunami which struck the Fukushima Daiichi nuclear power plant causing the largest nuclear disaster since the Chernobyl disaster in 1986. The outcome of the referendum in the UK caused a political earthquake in the country, leading to a 10 per cent devaluation of the country’s currency and a sell-off of shares worldwide.
“What we learnt in Cyprus is that the effects of the bail-in are unpredictable,” Clerides said adding that apart from the loss of wealth which led to less consumption and investment of depositors affected, the bail-in also led to an increase in the non-performing ratio and more strategic defaults.
“Just think of depositors with money deposited at Laiki and loans at Bank of Cyprus,” said Clerides, who chairs the Cyprus Economic Society. “They underwent a haircut in Laiki but their loans at Bank of Cyprus are still there even after the forced merger. Some feel they were treated unfairly and don’t pay their loans”.
As some depositors saw their working capital evaporate overnight, in addition to their ability to pay their loans, that of their suppliers was also affected, Clerides said.
The non-performing loans ratio in the Cypriot banking system stood at 48 per cent of banks’ portfolio in April, according to the Central Bank of Cyprus’s latest data. In December 2010, the share of loans in arrears was 14.2 per cent of total credit facilities, including those fully secured with collateral. The ratio gradually increased to 24.7 per cent in March 2013, when Cyprus agreed to the terms of its adjustment programme.
According to the terms of Cyprus’s bailout, depositors at Bank of Cyprus saw 47.5 per cent of their uninsured deposits turned into equity while those at Laiki, as Cyprus Popular Bank was widely known, lost all their deposits in excess of €100,000. The overall loss in deposits is estimated at almost €8bn.
Clerides said that replacing bail-ins with bailouts requires “very strict banking supervision”.
“Banks should not operate based on the free market rules,” he continued. “Bail-in rules are somewhat unfair in the sense that we decided that the loss of a bank, let’s say Laiki, will be shouldered by the Laiki depositors and not the general public”.
This is discrimination against one portion of the population “not in financial alert” which ultimately gets punished for keeping their funds at a problematic lender, which in turn “creates tremendous economic distortions and injustice,” Clerides added.
“It starts based on the assumption that whoever possesses more than €100,000,” also has an understanding of his actions and knows where to place his money, he said. “Well, not even the banks know where to place their money, that’s how complicated the banking system has become”.
On the other hand, a sophisticated depositor who “picks up a scent” of something going wrong “jumps out quickly” to another bank, something that is not possible for the average depositor, especially given the anti-money laundering rules that are in place, Clerides added.
For the time being, Europe seems to be reluctant to ditch bail-ins in favour of bailouts.
Jeroen DijsselbloemJeroen Dijsselbloem, the Dutch finance minister who chairs the Eurogroup, as the body of the conference of the euro area’s peers is also known, on Monday described the bail-in as a “very sound economic principle” which may reflect the presence of political will to change the rules.
Even if the EU does changes its rules, it will be “difficult” for Cyprus to demand any compensation for the damage caused by being forced to subject its depositors to this type of unfair treatment, Clerides concluded.