Bank Bail-Ins: The New Normal
It appears that bank bail-ins, similar to what occurred in Cyprus in 2013, are becoming a widespread practice across the globe.
Megabanks Empowered to Gamble with Deposits: In November 2014, the leaders of the G20 (the world’s 20 largest economies) made an important decision. They have now officially granted permission to the world’s largest banks to use depositor accounts as collateral to make high-risk, leveraged derivative bets. If these bets go wrong, the counterparty to the contract will have the first claim on the depositors’ money.
Governments Implementing the G20 Decision: The governments of the G20 countries are now expected to put these arrangements into law. Most of them, including the United States, have already done so.
Ongoing Central Bank Interventions: The G20 meeting was largely focused on the latest plan to have central banks inject trillions of dollars more into the global economy. This appears to be a continuation of the same approach that has been used in the past. However, the G20 also endorsed a proposal called “Adequacy of Loss-Absorbing Capacity of Global Systemically Important Banks in Resolution.”
Understanding Bank Bail-Ins
What is a bank bail-in? A bank bail-in is a way for a failing bank to get financial relief by reducing the value of the bank’s shares, bonds, and uninsured deposits. This is different from a bailout, where the government uses outside money to rescue the bank. Instead, a bail-in puts the burden on the bank’s shareholders and depositors, rather than taxpayers.
How does a bank bail-in work? If a bank is on the verge of collapse, the government may decide not to provide a bailout. Instead, the bank’s depositors and bondholders can be forced to have their deposits or investments converted into worthless bank stock. This is done as a last-ditch effort to keep the bank afloat and avoid a complete collapse.
The unfairness of bank bail-ins: Bank bail-ins are widely considered to be very unfair to depositors. Depositors did not sign up to become investors in the bank. Yet they are forced to bear the losses and essentially have their money converted into essentially worthless bank shares. This is seen as a “legal” form of theft, as depositors lose access to their funds.
The Cyprus Example: The case of the Cyprus banks in 2013 is a prime example of a bank bail-in. When the Cypriot banks faced collapse, the government decided not to provide a bailout. Instead, depositors with balances over a certain threshold were forced to have their deposits converted into bank stock, effectively wiping out a significant portion of their savings.
In summary, bank bail-ins represent a shift in the burden of bank failures from governments and taxpayers to the banks’ own depositors and bondholders.
The Shift Towards Global Bank Bail-Ins
The G20’s proposal profoundly changes the rules for banking globally, but with controversial implications.
Instead of relying on taxpayer-funded bailouts, insolvent banks deemed “too big to fail” will be quickly recapitalized using their unsecured debt, primarily targeting bank deposits – including checking accounts, money market accounts, and CDs – which will be converted into stock.
This restructuring means depositors now encounter a risk level comparable to that of stock investors when depositing funds in a bank.
In addition, the G20’s classification of derivatives as secured debts further complicates the scenario, as depositors’ funds are now considered unsecured debt, leaving them vulnerable in case of bank losses. Ultimately, this shift underscores a fundamental change in the banking landscape, potentially impacting depositors’ financial security and risk exposure.
What About “Insured Deposits”
Fortunately, “insured deposits” won’t be subject to this treatment.
In the US, 100% of deposits in insured banks are protected up to $250,000 per depositor by federal deposit insurance. But the reserve ratio of this fund is less than 1%. This means that for every $100 deposited, the FDIC has less than one dollar in reserve.
The FDIC holds around $54 billion as of September 2014. But this amount pales in comparison to the $6 trillion in insured deposits and the vast $300 trillion value of derivatives contracts.
Indeed, the failure of just a single major Wall Street bank could exhaust the fund.
Federal law authorizes borrowing from the US Treasury to make up the shortfall. But when a banking crisis hits, it’s not likely to occur in a vacuum. Lots of other people will be demanding a handout. Many of them with stronger political connections.
How Bad Could It Get?
In the scenario endorsed by the G20, uninsured bank depositors could face a more severe outcome than those in Cyprus’s government-owned banks during the 2013 insolvency. Back then, some uninsured depositors received only a fraction of their funds back, with others losing everything.
A comparable situation occurred during Lehman Brothers’ bankruptcy in 2008, where unsecured creditors recovered approximately 21 cents on the dollar.
The G20’s decision aims to prevent unpopular bailouts of “too big to fail” megabanks, offering a clear incentive for this restructuring.
Additionally, the G20 seeks to encourage investment in government bonds supported by member governments’ full faith and credit.
The Illusion of Ownership
By depositing your funds, you are effectively transferring your property to the bank in exchange for a debt claim. This means you have become an unsecured creditor, holding an IOU from the bank rather than maintaining direct ownership of the deposited funds.
This shift in the nature of your relationship with the bank is an important consideration. It means your deposited funds are no longer entirely under your control. The bank now has the ability to use those funds for its own purposes, potentially exposing you to greater risk than if you had maintained direct ownership.
You can find more information on this topic and the potential risks of keeping cash in the bank here: Don’t keep cash in the bank.
How You Can Protect Yourself
Protecting yourself in light of potential bank bail-ins involves several key strategies:
- Limit Bank Deposits. Keep your bank deposits well below the maximums covered by deposit insurance to reduce exposure.
- Diversify Assets. Accumulate physical currency, gold, other precious metals, and tangible assets to diversify your holdings beyond the banking system.
- International Diversification. Consider diversifying investments internationally to mitigate risks associated with bank bail-ins.
- Choose Strong Banks. Opt for well-capitalized banks with high levels of “Tier 1” liquidity, ideally at least 25% to enhance financial stability.
- Offshore Private Banking. If you have at least $500,000 or so to spare, consider opening an account with an offshore private bank. Make sure it has minimal exposure to commercial lending and derivatives.
- Avoid “Too Big to Fail” Banks. Move your assets away from institutions deemed “too big to fail” to reduce vulnerability in case of financial crises.
By implementing these measures, you can enhance the security of your financial assets. As well as reduce the potential impact of bank bail-ins on your wealth.
7 Ways to Avoid a Bank Bail-In
You can find more information here: How do you protect against bank bail-ins?
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