Why?

Most bank account holders in the EU think that their deposits are safe. They think European banks are solid. And in case something happens with the banks the government guarantees their deposits. A guarantee that in most European nations is set at 100.000 Euro.

But this dream has already been shattered by one of the “solid” EU economies: Austria.
 
Because the Austrian government has simply decided to stop guaranteeing bank deposits [1] in the aftermath of  the failing of ‘bad bank’ Hypo Alpe. To compensate, they want to create a fund paid for by the banks. The fund will be filled for the coming 10 years to am amount of 1.4 Billion Euro.
And yes, this looks a bit small in today’s leveraged world.
 

The Legal Framework? Bail-in Legislation.

After the financial crisis the leaders of the world have been debating. A major objective has been to find alternatives to bailing out banks with taxpayer money. A solution has been found. During the next banking crisis shareholders and creditors will have to pay the bill.
After this has been decided during G20 meetings EU has implemented the Bank Recovery and Resolution Directive (BRRD) [2].
 
On the official website “europa.eu” we can read the following:
“Welcoming the deal, Gunnar Hokmark (EPP, SE), the MEP who steered the legislation through Parliament, said “We now have a strong bail-in system which sends a clear message that bank shareholders and creditors will be the ones to bear the losses on rainy days, not taxpayers. At the same time we also established clear rules to deal with the most exceptional cases, in which overall financial stability is in danger.
The bail-in tool set out in the directive would require shareholders and bond holders to take the first big hits. Unsecured depositors (over €100,000) would be affected last, in many cases even after the bank-financed resolution fund and the national deposit guarantee fund in the country where it is located have stepped in to help stabilise the bank. Smaller depositors would in any case be explicitly excluded from any bail-in.””
This seems like a fair solution. After all, the average taxpayer does not have any responsibility towards an individual bank.
 

Bank Recovery And Resolution Directive

But as always, there are some interesting details in the actual directive “2014/59/EU” [2].
The first point of interest concerns the bank deposits (of individuals and businesses):
“In order to protect holders of covered deposits, the bail-in tool should not apply to those deposits that are protected under Directive 2014/49/EU of the European Parliament and of the Council.”
So covered deposits (covered by a so called Deposit Guarantee Scheme, or DGS) are excluded in case of a bail in. This means that uncovered deposits ARE included.
So just for anyone to be clear, any deposits larger then 100.000 Euro should not be stored in a single bank account in Europe.
Anything above that threshold will be used for a bail-in. This is what happened in Cyprus. That is why the president of the Eurogroup Mr. Dijsselbloem called Cyprus a “blue-print”.
 
The second remark is what will happen when there will be an actual bail-in. First of all, the authorities will gain full power over a financial institution:
“Resolution authorities should have all the necessary legal powers that, in different combinations, may be exercised when applying the resolution tools. They should include the power to transfer shares in, or assets, rights or liabilities of, a failing institution to another entity such as another institution or a bridge institution, the power to write down or cancel shares, or write down or convert liabilities of a failing institution, the power to replace the management and the power to impose a temporary moratorium on the payment of claims.”
And they will have the ability to split up the financial institution in to a ‘good bank’ (bridge institution) and a ‘bad bank’:
“The resolution tools should include the sale of the business or shares of the institution under resolution, the setting up of a bridge institution, the separation of the performing assets from the impaired or under-performing assets of the failing institution, and the bail-in of the shareholders and creditors of the failing institution.”
Moreover, the Deposit Guarantee Scheme can be used in multiple ways:
“The resolution tools should be applied before any public sector injection of capital or equivalent extraordinary public financial support to an institution. This, however, should not impede the use of funds from the deposit guarantee schemes or resolution funds in order to absorb losses that would have otherwise been suffered by covered depositors or discretionarily excluded creditors.”
So the bank deposit guarantees can be used to recapitalise a failed bank. This is of course assuming that the bridge institution will remain solvent itself.
 
Ok, so at first it does not sound that bad. Bank depositors are at risk as are the shareholders. This is how it should be in a free market. At the same time the government still backs small depositors through the DGS’s.
 
But the news from Austria does reveal a weakness in the system to those that think they are covered by a DGS. We would like to summarize some points that depositors should be aware of.

1. In some cases like in Greece the state might may be to insolvent to actually guarantee bank accounts.
2. Even when your deposits are covered by a DGS, a bankruptcy might be very bad news. It may take months or even years before your funds are returned to you. If you run a business, this is deadly.
3. The Austrian case shows that governments can revoke (or perhaps lower) the DGS at will.

Suddenly those ‘guaranteed’ deposits look a lot less secure…
 

What Else?

We advise you to study these directives (although they are very boring). There is a lot of other interesting open-ended legislation to be found.
It is nice to see that governments have at least some sort of idea to bringing free market accountability back to the financial world. And at least trying to force shareholders and depositors to keep an eye on the management of their assets. At the same time the governments are more and more discouraging the use of cash and use the electronic system they acknowledge is risky. And they also force financial institutions to invest in risky government bonds.
All this looks nice on paper. But the idea that the EU or a national government could coordinate the effective and fair management of even a small number of different banks with all different international and intertwined exposure during an extreme financial crisis is of course debatable.
And the real problem still exists.
Financial institutions take on to much risk with depositors money. They know that they are rescued when things go bad. This legislation also leaves room for that.
In 2008 the taxpayers were the victims in the bail-out schemes. During a potential next crisis depositors will be the victims in the new bail-in schemes.
All to keep the banks alive and the financial system from collapsing.
 

European Bank Deposits At Risk – Conclusion

New EU legislation establishes that depositors, creditors and shareholders will pay the bill when a next banking crisis will emerge.
This seems fairer than having the tax payer pay for it. But the legislation also leaves questions unanswered.
The bottom line is that bank deposits in Europe (especially above 100k Euro) are at risk. In addition might governments lower the DGS’s, cancel them all together like in Austria or use them in the bail-in process of a failed financial institution.
Surprisingly, most depositors in Europe are completely unaware of what is going on.
What can you do to limit the risk to you capital? You could look for a bank outside the Eurozone in a jurisdiction that has a solid reputation.
Panama, Singapore, Hong Kong and the UAE come to mind.
Banks in those jurisdictions are often much better capitalized then banks in Europe. But do also check how they are capitalized. We once checked the balance sheet of a highly capitalized bank and saw that a lot of their deposits were held by the big European and American banks.
An exception to this rule is the UAE, where because of sharia compliant banking the banks are restricted in their actions. They are simply not allowed to leverage your money like is happening in Europe so they just collect a fee for keeping it safe.
 
But we are happy that we are not investment advisers.
With the instability of the banking system added to the equation the world in its current state is not an easy place to be conservative and preserve your wealth.
Tread carefully…
 
[1] Es wird ernst oesterreich garantiert die sparguthaben nicht mehr, published on 30 March 2015, Deutsche Wirtschafts Nachrichten
[2] DIRECTIVE 2014/59/EU OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL, published on 15 May 2014
 
 
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