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Fear of EU bank runs increases [ClearOnMoney]
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Fear of EU bank runs increases

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Commentary

Fear of EU bank runs increases

21 May 2012 by Jim Fickett.

Depositors in the banks of peripheral countries have good reason to move their money elsewhere. It is difficult to see what the authorities can constructively do.

Current talk of bank runs in Europe, in the context of weak banks, some deposit outflow, and a high risk of Greek exit from the euro zone, is particularly dangerous because, as many are currently observing, although it is irrational to start a bank run, it is entirely rational to participate in one once it gets started.

Part of the public's problem is the obvious one – confidence in individual banks. Ragarding Bankia, the Spanish bank recently rescued by partial nationalization, Walter Muenchau at the Financial Times writes:

A Spanish saver in Bankia is confronted with the following questions: Does the balance sheet give a true and fair depiction of the risks? Is the Spanish government’s deposit insurance credible? Is Bankia safe now that it is partly nationalised?

My answers to these questions would be “no”, “no” and “no”. In the absence of a European backstop, Spain has a similar problem to that of Ireland. The Spanish state is too weak to provide sufficient guarantees to the banking system. The refusal by Bankia’s auditors to sign off on the accounts has raised suspicions about accounting practices, which are probably not confined to Bankia.

Individual banks could probably be rescued. It is harder to address the fear of euro exit and subsequent devaluation. Gavyn Davies writes,

the underlying fear of depositors in the periphery is not simply, or even mainly, one of bank failure. Instead, they probably fear the devaluation of their deposits relative to those in core economies if the euro should break up.

Therefore, the run is being caused by concerns about exchange rate risk, not necessarily by the fear of bank failure as such. This makes it much more complicated to deal with, since it is very difficult to offer guarantees against future exchange rate losses to today’s depositors. Germany would not want to stand behind such guarantees to Greek and Spanish citizens in the event of a euro break-up.

And Muenchau again,

Should Greece leave the eurozone, it will almost certainly have to impose capital controls and deposit freezes. Since the cost of transferring a savings account from Athens to Frankfurt is negligible, such action constitutes cheap insurance against a potentially catastrophic event.

I would go as far as to say that it would be economically irrational for savers to keep their money in Greece under the present circumstances.

The flight of capital is already well underway. Davies again:

deposits in Greek banks have fallen by about a third since the beginning of 2010. Deposits in Irish and more recently Spanish banks have also been falling. Depositors have been shifting their money to “safer” banking systems, notably those in Germany. The extent of these declines and other financing difficulties for the banks is illustrated by the rise of Target 2 imbalances contained within the ECB’s balance sheet, which reflect the mechanism through which these cross-border flows have been financed [see his graph, which shows an impressive acceleration in recent imbalances]

So far the authorities have not addressed the issue. The mechanics of short-term liquidity needs may soon be a problem. Many banks are seeing credit rating downgrades. This makes short term funding more expensive, and reduces the amount of available collateral for ECB loans:

Allegra Berman, co-head of European debt capital markets at UBS, says that while many people had forecast that banks would follow their sovereigns in being downgraded, few have properly anticipated the severity of the consequences of these ratings actions.

A few banks and groups such as BlackRock have warned that there could be an immediate impact on the ability of money market funds to provide short-term financing to banks, because some clients stipulate that counterparties must have a minimum credit rating. …

“All banks have thousands of collateral agreements with clients. They are all slightly different and most have some sort of ratings trigger. A downgrade would mean a vast majority of banks would potentially have to post additional collateral,” says Ms Berman.

Since such contracts are legally binding, technically this would mean banks having days or possibly weeks to post more collateral at a time when banks are already using an increasing amount of their collateral to tap European Central Bank funding or for other forms of secured funding, she says.

“Major banks shouldn’t have a problem with posting collateral,” says Alexander Batchvarov, international structured finance strategist at Bank of America Merrill Lynch. “But second tier banks might.”

Going beyond short-term liquidity needs to a real underwriting of the risk would be very expensive. Davies again:

As deposits are withdrawn from Greek banks, the ECB replaces these deposits with liquidity operations. If these are standard repo operations, such as those undertaken in the LTROs in December and February, then the ECB is directly assuming risks which the Greek private deposit holder is no longer willing to hold. …

The problem is that this potentially exposes the ECB to much bigger losses than anything which has been contemplated so far by the core economies.

And Muenchau:

The only policy that can credibly counter the threat of a self-reinforcing bank run in the eurozone would be a eurozone-wide deposit insurance and bank resolution regime – at eurozone level. In other words, you have to take the banks – all the banks – out of the control of their home country.

The euro zone crisis has been with us so long it is hard to imagine things actually coming to a head. But so far I do not see anyone proposing a realistic solution for the bank run threat.