The idea of a bail-in of bank depositors, instead of using EU taxpayers’ money, was originally put forward as a one-off by the IMF and endorsed by the German government. However, Cyprus has established a precedent which would be too dangerous to ignore.
The European Commission’s proposed plan to make the bail-in official from 2018 – and possibly 2015, if Draghi’s calls are heeded – means the likelihood of failing banks being initially recapitalized from the euro area’s rescue fund is becoming more and more remote.
This development, in theory, has worrying implications for depositors of stressed banks in Spain, Italy and other EU states.
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| John Grout, policy and technical director at the ACT |
Wholesale bank deposits, which are not covered by the EU’s €100,000 deposit guarantee scheme, have arguably been subordinated to secured and preferred creditors, says John Grout, policy and technical director at the Association of Corporate Treasurers (ACT). “Cyprus makes all the more poignant the risks of bank deposits, something corporations have been becoming increasingly worried about.
“It’s a very significant development for corporations because it means we have to add bail-ins to the list of hazards facing wholesale bank deposits.
“We know that when we place cash into a money fund that we have an investment. Generally, we don’t tend to think of cash deposits in the same way, but this is a stark reminder that deposits transferred to a bank also entail risk.”
Grout warns that corporations will be looking at their banks and the banking systems of countries in which they operate, and where they have concerns are likely to respond as hot money.
Hot money is money that shifts suddenly and frequently in search of the highest short-term returns which can cause problems for banks operating with few liquid assets.
“It’s a sad state of affairs where many banks have lower credit ratings than their customers,’’ says Grout.
The ACT has issued contingency planning guidance to its members on how to protect overseas operations from potential losses from crises in the eurozone, including potential exits from the currency union.
Recommendations include repatriating surplus funds, extracting surplus capital by repaying inter-company loans and establishing bank accounts outside the eurozone for subsidiaries in countries most at risk of exiting.
Companies are also advised to prepare to receive euro customer proceeds to their eurozone units in euro accounts, or other group units, outside the country concerned.
Post financial-crisis regulation and banks’ consequent focus on reducing risk has placed wholesale deposits at even greater risk because banks are accessing short-term funding through repos – secured borrowing.
That leaves the deposits of large companies in a vulnerable position, and the companies potentially the last unsecured creditors. Basel III, due to be phased in from 2015, should improve the situation by requiring banks to hold a 40% liquidity buffer against short term non-operational balances.
Large corporations need to hold substantial amounts of liquid funds for general purposes, to repay funding from the group or lend to the rest of the group, and use various cash-pooling or sweeping systems that operate daily for this purpose.
A range of strategies are used to invest these funds based on the principles of security, liquidity and yield, in that order. In practice, this means banks get the largest share followed by money market funds, with treasury bills coming in a distant third.
Sweeping systems, which move cash from all the accounts of the company’s different operations and subsidiaries into a central account, from where it can be more easily invested, are the first line of defence against credit risk and are also cheaper than using borrowing.
Central accounts are usually held in a financial capital such as New York, London or Frankfurt. Companies might facilitate sweeping through the use of zero balance accounts which are automatically funded from a central account. Similarly, deposits made into the zero account are automatically shifted to the central account.
Diversification is most widely employed – splitting investments between a number of banks or institutions and investment types – to achieve liquidity while spreading counterparty risk.
Investments span a range of liquidities, maturities and credit risk levels from daily – liquid money market accounts – and segregated funds, to weekly, 30-day and three-month time deposits.
Nevertheless, while the theoretical implications of the Cyprus bailout on the sanctity of deposits are huge, there has been no systemic impact on eurozone inter-bank liquidity conditions, suggesting the market consensus on cash management post-Cyprus is relatively sanguine.
However, only time will tell.