Bail-in At Your Local Bank – Part 1: The Stage Is Set

Series: Bail-in At Your Local Bank

With no fanfare and little to no media coverage, your government has just put in place a mechanism to use your deposit money to bail-in a failing bank, like what happened in Cyprus a short time ago.

The derivatives market, the trigger of the 2008 global financial crisis, has since gotten even bigger and more concentrated into fewer hands. A mutually assured destruction awaits the global economy next time it goes off again.

Herded along by the Financial Stability Board, governments of leading economies endorsed a framework during the past G20 Summit whereby depositors’ money will be used to rescue a failing bank when the global derivatives casino blows up again next time.

G20 governments are quietly slipping bail-in provisions into law to make sure that next time a too big to fail bank blows up again by derivatives it will be rescued using depositors’ money, in the name of protecting the taxpayers.

Financial derivatives are financial contracts in which the promised payoffs are derived from the performance of another underlying entity. The underlying entity can be an equity (such as an individual stock or a stock index), interest rate, credit or c …

bail-inThe recent G20 submit in Brisbane, Australia, would have gone into the history books as one of those typical content free political episodes staged by the global leaders with a dose of Putin bashing during the intermissions. That is, if it wasn’t for the endorsement of an agreement which would impact just about anyone and everyone all over the G20 world who has money or assets in a bank account.

As usual, this monumentally significant event was largely ignored by the mainstream media. And even for those that did cover it, the message was way different from the true one which would justifiably cause a big outcry from the public the world over.

In case you missed it (which is probably the case judging from the fact that you are still reading this), it was an agreement signed by the leader of your country to institutionalize the concept of bail-ins in the likely event of the next banking crisis.

In other words, the legal framework has been put in place so that depositors’ money in the bank will be used to bail out a failing bank. The following two key provisions of the framework, as obscure and obfuscated as they look to a casual observer (hint: they are probably designed that way), would virtually seal the fate of any savers who happen to have their money in the wrong bank at the wrong time.

  • Deposits, i.e. your money, become ‘unsecured debt’ of the failing bank. As an unsecured creditor, you are practically at the very bottom of the totem pole when it comes to the line of creditors struggling to salvage whatever they can from the wreckage.
  • Derivative obligations by banks to each other are placed at the top of the heap and ahead of any other creditors.

The remaining of this series of articles will try to explain in laymen terms what the above provisions mean in case you are still unsure, and why you should be outraged.

Field Tested Model of Bank Bail-Ins

What happened in Cyprus in 2013 should provide a glimpse of what a future bail-in will look like if it happens to a bank near you. For those who need a refresher, here’s a quick rundown of the first bail-in episode (see wiki: 2012–13 Cypriot financial crisis).

The small island economy of Cyprus had a nominal GDP of $24 billion prior to the crisis. Despite its small size, the banks managed to amass €22 billion of Greek (yes, that Greek) private sector debt and had a huge offshore banking industry to the tune of $120 billion, $60 billion of which from Russian businesses.

In the wake of the 2008 subprime mortgage crisis, Cyprus’ economy went into recession. With commercial real estate and non-performing loans imploding, Laiki Bank, Cyprus’ second largest, became insolvent and in need of a bail-out to the tune of €6 billion.

Suffering from bail-out fatigue during the Greek crisis not so long ago, the European Central Bank (ECB) refused to bail-out the country without Cyprus’s own people absorbing at least some of the loss first.

At the end, a deal was struck whereby a one-time 9.9% levy was applied against all deposits over €100,000 and an additional 6.75% levy hitting deposits under €100,000. A daily limit on the amount of cash one can withdraw from the bank was put into effect with no end date.

So who got bailed out and who got bailed in at the end?

In short, the cronies (banks and other governments) escaped whole while the commons like depositors got the shaft.

In principle, the idea of a bail-in is the right thing to do in a fully functioning and truly fair capitalistic economy. When a bank fails, the liabilities of the no-longer ongoing concern get purged by simultaneous writing-down/off the ‘assets’ of the creditors of said bank, starting with the most junior and working up the ladder to the most senior of creditors. Equity investors lose everything,  junior creditors get a major amputation, and senior creditors hopefully walk away losing just a toe or two. No public money was involved in this unfortunate scenario, which is the idea.

The primary problem with the Cyprus incident, then, was the order in which seniority is arranged.

One would have thought depositors were, and should be, the most senior creditors, while those responsible for the poor loan decisions should take a good part of the blame.  Instead, as this tragic episode showed, the logic was completely turned upside down.

The bail-in of Cyprus depositors should have tripped a lot of alarm bells, especially over Europe. It did not. Beside the public being told that a lot of the money involved was ‘shady Russian money anyway’, the European populace were understandably conflicted – nobody wanted to use their own money to bail out someone else’s bank in another country.

The field trial of the bail-in mechanism was so successful that the president of the euro zone finance ministers Jeroen Dijsselbloem hailed it as a template for future bank restructurings in the euro zone, as Reuters reported.

What happened in Cyprus is a taste of what’s to come when, not if, the next financial crisis emerges again. In the overall scheme of things, the measly $10 billion, give or take, Cypriot bail-in is just a puppy. When the next banking crisis erupts, the thermal nuclear scale toxic mix of derivatives will ensure that no depositors large or small will be spared. Your government will ensure that is so.

In Part 2 and beyond, we will delve into the nature of the derivative beast, the likely mechanism through which depositors like you and me will be bailed in when it happens, how governments around the world are quietly laying out the groundwork and turning the provisions into law, and what you should do about it.


Bail-in At Your Local Bank series guide



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