Deutsche Bank economist proposal to ditch bail-ins not a bad idea, Cypriot economist says

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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.

Deutsche Bank fined 2.5 billion dollars in Libor caseDavid 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.

MARIOS CLERIDESA 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, led 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.

LaikiAccording 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 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 the EU does change 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.

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Stelios Orphanides is a journalist at CyprusBusinessMail.com. To contact Stelios Orphanides: [email protected]

  • Jim Demetrios

    Looks like our overexposure with The UK will hurt us as it did with our overexposure to Greece and Russia. Hopefully we will have learned a lesson or two from before so that we can manage the situation better.

  • Dede

    how smart some people can be…
    “hey guys, I’ve got a new perfect theory: let’s privatize profits, and nationalize debts and losses”
    great, isn’t it? 🙂

    • Pc

      Spot on.

      • Dede

        Well, it’s not new…they’ve tried to get that down taxpayers’ throat for decades…
        It’s a good idea that the taxpayer saves his banks…but once their situation is better banks should paid for their rescuing, the same way the bank clients pays an unexpected overdraft: dearly… This NEVER happens.

    • Jeremy Rigg

      Dede…..loved you comment.

  • Pc

    Ever since 2008 politicians have been trying to eliminate the problem of moral hazzard (the problem that someone does an undesirable thing because the negative consequences will be born by others). They wanted to eliminate “too big to fail” and ensure that the owners of the banks would pay the bill, not the tax payer. And now we have bankers coming back and suggesting to reintroduce it and take the tax payer for a ride.

    Also, the article is not entirely accurate. A bail-in would not harm depositors as the Italian banks are mainly equity and debt financed (as opposed to the Cypriot banks who were/are deposit financed). But many of the bank’s bond holders are private people instead of large institutional investors. So, the effect would be the same as in Cyprus: your average Mario losing the life savings of the family.

  • Tyler D

    Italian banks have been warned to sort out their non-performing loans for years, instead using Brexit as an excuse, they are asking for a bailout. Since the Germans blocked this bailout, the Italian PM pointed out the precarious situation of Deutsche Bank, as a form of blackmail. Deutsche Bank is an enormous systematic risk to the global economy with its derivatives exposure. Beware European tax payers, Bailout Rides Again will be coming to a cinema near you sometime soon.

    • Mist

      “derivatives exposure” is the House of Cards.

    • Jeremy Rigg

      Yes, it will be showing at a lot of cinemas in the very near future mi ‘thinks.

  • It seemed a great idea when German economists used a bail in on Cyprus. Rules are rules just get on with it.

  • Mist

    What is his pension from the co-op? I never worked out why he just suddenly left, I only guess he could see what a pile of poo had been made and he did not want to be a Zoo keeper.

  • konstabo

    what there telling people with the bail-inn is that with the slightest smell of smoke get your money out , unless your in a northern european country which always get a full bail-out from the taxpayer…..its not right that the poor northern europeans and there families should loose there money , its too cold there to be broke and how will they buy food , but in southern europe its a tropical climate and they dont need heat in the winter and they dont need food so its ok to rob there bank account….double standards breeds hatred….you cant fully bail-out some and others loose there savings….

    • Pc

      The northern Europeans simply had their houses in better order so they could help themselves instead of playing beggar with their neighbours and then complain about it.

      • Tyler D

        When they bailed out Greece, something like 95% of the money went back out, mainly to European banks. Weren’t they to some extent bailing out their own banks who had been recklessly lending?
        Anyway the banking crisis, supposedly solved years ago, has now moved from the periphery to the core so their houses were not in much better order.

        • Pc

          First, the Italian problems pre-date the bank crisis that erupted with the bankruptcy of Lehman Brothers in 2008. The Italian crisis is mainly due to the fact that the economy has been at a stand still since around 1999. It is the consequence of years of bad government (bunga bunga parties, new governments every few years, prime ministers who were more interested in stopping prosecution rather than the welfare of the country).

          And that highlights exactly my point: that the northern states run a tighter ship than the south. Countries in the north invested in their economies, while the southern nations mainly consumed the benefits that the Euro brought. Portugal, Spain, Greece, Cyprus and now Italy all failed to adjust their economy for changing circumstances.

          Lastly, let’s tackle the myth of the Greek crisis. No, the bailout money did not find its way back to banks in Germany or France. In fact, a substantial amount was used to plug the enormous gap in the Greek current account (the total sum of money going in to the country vs money going out of the country). It was mainly used to keep the Greek government afloat and to keep endebted household and companies from drowning. Also, many companies in 2011 took a hefty cut on debt through the second Greek bail out.

          • konstabo

            what your saying makes good sense and i agree to a point , but the article states that there asking for an injection of 150 billion to save Deutsche bank , does that sound like there house is in order…..the southern countrys have a different mentality and climate than the cold northeners that depend on the south for food in the winter…..
            as far as greece , have you ever heard of economic warfare , thats when you inslave someone with debt….
            lots of greeks i met were very hard working people , more than me , also in cyprus….

          • Pc

            The 150 billion is not for Deutsche bank but for all banks in the Eurozone. It happens that the economist who proposes it works for Deutsche Bank. Most of that 150 billion would need to go to the Italian banks who are battling NPLs after decades of lackluster economic performance.

            And don’t give me the whole Greek drama again. They were on their way out of their mess, and they put themselves back into the hole again. I think next time, northern Europe should not help them at all. The pain will be much greater for them, but the whinging and shouting will be much less ofr northern Europe. Also note that so far, except for their payments to the IMF, the Greek government has not paid a cent in interest and not paid a cent back.

            And I know Greeks are hardworking people. But that does not mean their government and institutions are not corrupt.

          • Tyler D

            There is plenty of evidence to refute your claim. From Germany’s ESTM “This paper provides a descriptive analysis of where the Greek bailout
            money went since 2010 and finds that, contrary to widely held beliefs,
            less than €10 billion or a fraction of less than 5% of the overall
            programme went to the Greek fiscal budget. In contrast, the vast
            majority of the money went to existing creditors in the form of debt
            repayments and interest payments. The resulting risk transfer from the
            private to the public sector and the subsequent risk transfer within the
            public sector from international organizations such as the ECB and the
            IMF to European rescue mechanisms such as the ESM still constitute the
            most important challenge for the goal to achieve a sustainable fiscal
            situation in Greece.”

          • Pc

            That quote does not constitute evidence but opinion. Also, this article and thread are supposedly not about Greece.

          • Tyler D

            The quote was from a report by a German economics institute, trust those pesky Germans to believe the myth. Anyway, I bow to your greater knowledge and can sleep peacefully knowing northern European institutions are sound; it’s just those dodgy Mediterranean types that I need to worry about.

          • Pc

            I never said they were sound. I simply pointed out that they were less unsound to the point where they did not need to hold up their hand. If you want even less unsound, look at how the Americans and Canadians managed their house.

  • costaskarseras

    HSBC avoided US money laundering charges because of ‘market risk’ fears:
    US officials refused to prosecute HSBC for money laundering in 2012 because of concerns within the Department of Justice that it would cause a “global financial disaster”.

    It would be more useful if these institutions and their ivory towers dotted in places like the City of London were closed down and turned into warm houses for the homeless. There must be another way to plan our economies without these huge cost which feeding these parasites.