Until very recently, depositors in European banks held the following core beliefs:
- The Europe-wide Deposit Guarantee Scheme (DGS) was sacrosanct for amounts below €100,000.
- Depositors above €100,000 would be protected by governments.
- The European Central Bank would support Eurozone governments to protect depositors.
- The European Stability Mechanism (ESM) would provide funding to recapitalise banks.
- Capital could move freely within the Eurozone.
Recent events in and around Cyprus have challenged, if not fundamentally undermined, widely-held beliefs about the security of deposits.
In March, Cyprus requested a bail-out. The initial plan was to levy a tax on all depositors, with a lower level applying to deposits under €100,000. The plan was resoundingly defeated in the Cypriot parliament and following further discussions, a new plan was unveiled which included:
- No levies/taxes/haircuts on deposits under €100,000
- Complex arrangements for amounts above €100,000 which include substantial haircuts and debt/equity swaps
While these discussions were going on, the banks remained shut (for two weeks) and on re-opening a range of capital controls were imposed.
Economic weakness in Europe is exacerbating the strain on weak banks and sovereigns. Creditor countries have hardened their stances in terms of further support. The initiatives required to solidify the Euro and the European banking system are slow to progress. Ireland’s debt sustainability is clearly linked to pledges of support which evidence suggests may not be fulfilled. A further recapitalisation of Irish banks may be required with question marks over Permanent TSB viability.
Until a robust framework is put in place to buttress it, the Europe-wide Deposit Guarantee Scheme should be regarded as sovereign risk.
Depositors should:
- Re-assess their beliefs about deposit security.
- Develop criteria for selecting banks and financial counterparties
- Devise a plan to diversify risk by bank and by sovereign
- Look to be paid a rate of interest which compensates for the risk being taken
The goalposts in relation to resolving banks and the treatment of depositors have changed fundamentally:
- The new orthodoxy is that creditors, including depositors over €100,000, can expect a haircut in a bank failure.
- Depositors should not rely on the DGS in the case of weak sovereigns until such time as a robust framework is put in place to support it.