A Better Way To Do The Cyprus Bank Bail-in

Inspired by reading this article that hints at Sarris's and the Cyprus's government's initial approach on how to bail-in depositors, I am going to run some rough numbers to see if it could work. Short Answer:  Yes, but it needs to be much more aggressive than the numbers shown in the article.  It looks like they were aiming for 3B, I ran the numbers on the 10.6B figure.

Let's say I accept all the conditions of the Troika as a starting point of the analysis:

1. The amount to be taken from bank creditors is 10.6B

2. It is proper to use creditors of other banks to protect the ECB / CBC from itself in its extension of ELA to Laiki

Let's give it a shot at how we find 10.6B in a much less destructive manner:

1. Wipe out bond holders and stockholders of BoC and Laiki.   That is probably good for about 1.5B of the 10.6B, leaving 9B.

2. Cyprus has 70B of deposits at the time of capital controls, so we need to somehow confiscate 12.8% of them (9B/70B)

3. This is a total guess, but let's assume 75% were in interest-bearing accounts (averaging 3.5%) and 25% were in non-interest bearing accounts.   I know for sure that as late as last year the competitive rates for time deposits were in the 3% to 4% range depending on amount and time of lockup

That would imply an average cost of deposit financing / interest earned of 2.625% or 1.8B euros per year.

In 4.8 years x 2.625% = 12.85% that you need.   Let's round it to 5 years

4. So, the tax comes in as follows:   100% of interest income for the next five years.    To prevent withdrawals, you also have an withdrawal / exit tax as follows:

Subtract March 1, 2013 balance from end of year of balance and multiply any reduction by the Exit Tax below so that the bank recap is revenue neutral on withdrawals.   You apply a 12.85% escrow on the initial balance of everyone's account to make sure the money is there if you need to tax it and you reduce the escrow by 2.625% every year.

Exit Tax 2013: 12.85% 2014: 10.23% 2015: 7.61% 2016: 4.98% 2017: 2.35%

By then you hope that there is a rational common banking union in place and the banks emerge into normalcy under that union.

5. You still resolve Laiki (as it is insolvent, not illiquid), rationalize bank staffing, branch networks and so on.   If there are bank assets like branch networks overseas that should be sold, that can be done in a logical commercial way trying to maximize the value to the bank selling them (and reduce the bail-in needs).

It seems to me that this satisfies all the Troika demands

1. Bank creditors pay for losses:  Check!

2. Resolve Laiki / Restructure Bank of Cyprus: Check!

3. ELA fully protected: Check!

4. Reduce Cyprus's attractiveness for foreign deposits:  Check! (I am not saying this is a VALID or LEGAL troika demand but it appears to be a troika demand)

But while having many more advantages relative to the current plan

1. To the average depositor this does not feel like 'theft' in the same way that haircut does.   I understand that in real terms it is the same thing, but no real person lives their financial life in real terms, they live their lives in nominal terms and their mortgages, car payments and so on are in nominal terms.   So, this does not feel like their current money is stolen, it just a high tax rate on future INCOME.

This is exactly what countries with real central banks have been doing since 2008 (US and UK).   They have suppressed interest rates and have been stealthily recapitalizing the banks that way which, relative to other solutions, is a very good idea.   Basically, nobody has complained or even really noticed a thing.   People just accept that right now, in the US or the UK, a bank is only useful for storing your money, not as a way to earn income.

This might be fair or unfair in some platonic sense, but it is certainly better than the 1930s-style Banking 'Supervision' that is currently happening in Cyprus.

2. For the same reason as number 2, I don't think it violates the deposit insurance guarantee.  Nobody is losing their principal balance.

3. It does not cause wildly unfair outcomes based on basically random factors such as 'which of the main banks in Cyprus you used' and 'how much cash on hand you had on day X'.   So the number of tragic sob stories will go from 'a lot' to 'zero'.

4. It does not crush business liquidity (which is the main catastrophe of the current plan) -- At worst, if a company needs ALL its liquidity in 1 year, it is a somewhat manageable 12.6% haircut.   But it is rarely the case that cash on hand will go up or down 100% so in practice most businesses will suffer very manageable or no haircuts

In the current model, business liquidity is going to be hit close to 100% for most businesses in Cyprus.   I cannot even imagine the drop in GDP / bankruptcies / increased unemployment / reduced tax revenue / reduced debt sustainability this is going to cause.   It is the most utterly moronic part of the current model and is what makes even the revised DSA an exercise in fantasy.    It is also so completely an own-goal for everyone involved, including Cyprus and its creditors (who will suffer bigger losses when the Cyprus economy collapses).

5. For the savers/pensioners/etc, you are telling them: 'hey, I am sorry, you won't have interest income for five years but sit tight and you won't lose a single euro of *your money*'.    It is a winning proposition under the circumstances.   It is also a perfectly good message to the Cypriots: "hey, we need you to keep the money in our banks for five years to support the country" which will play OK.

6. For the foreign depositors who are going to bolt at the first loosening of capital controls in the current plan, you provide a hard monetary incentive to sit tight.    It might not be enough, but it is certainly better than today's model where they have no incentive to stay.   And, OK, if they leave, great, we get revenues for the bank recap.     You could even make the haircut higher on them *if they leave* - it would not be the first time there has been hot money capital restriction imposed by a sovereign.

What are possible disadvantages?

1. Theoretically it spreads the moral hazard across all the banks instead of concentrating it where it belongs (Laiki and Bank of Cyprus).    In practice, I am not sure it is much different:

(a) The Troika already proposed a plan (the first one) that spread the pain across all banks so it can't be that much of a concern for them

(b) The current plan pushes losses from Laiki to Bank of Cyprus which makes no sense under any moral hazard reason

(c) The current plan is going to put the viability of other Cypriot banks in question anyway given the damage it is going to cause to the economy

(d) In any case, we are only talking about the moral hazard for depositors.  Laiki and Bank of Cyprus shareholders and bond holders should be wiped out in any plan.

I am utterly unconvinced by the theory being promoted by many parties, particularly the Germans, that anyone with >100K in a bank account earning 3% was 'gambling' and should be punished.

It is absolutely not the retail depositor's responsibility to be monitoring the balance sheets of banks and figuring out if they are illiquid or not.   That is why we pay our taxes to hire bank regulators and Central Bankers who are financial specialists whose main responsibility in life is ensuring that banks under their watch *don't* burn retail depositors.

If it gets to the point that it might be obvious to a retail depositor that a bank is in trouble, the regulators should have already stepped in to take corrective action.

I am not sure how anyone can say with a straight face that ECB is not at fault for giving these banks green lights as late as mid-2011 (EU Stress Tests) but retail depositors were supposed to figure out what the ECB did not figure out.  And all the losses that the banks have faced were already on the asset side of the balance sheet by mid-2011.

2. The other downside of this plan is that it does not absolutely decimate the Cypriot economy.   Possibly that is a flaw to some...


Posted on April 13, 2013 and filed under Cyprus.