CYPRUS: MONETARY SCUTTLING OR BANK RESCUE?
We believed that the Eurozone was safe from sovereign bankruptcies and state confiscations of deposits. Nevertheless, we have felt the full force of another reality. The examples of Greece and Cyprus have reminded us that in the economic sphere, within which the expression of values is merely relative, one has to imagine the unthinkable.
Of course, Belgium or Belgian bank are not affected at all by these events. Our country and its financial institutions are very robust and very highly controlled. For certain countries in southern Europe, however, the monetary scuttling of Cyprus is perhaps a microscopic vision of the end of a particular monetary world.
Who would have thought a Eurozone country would suffer from the control of capital, the confiscation of deposits and other restrictions that go against the freedom of circulation of currency in just a few days? Over there, and whatever the reasons are, the notion of private property has been changed. The currency itself, which symbolises value, has been seen to be precarious, despite the fact that Cyprus should never have joined the Eurozone. Cyprus has taught us that the currency symbol is relative and subject to the sovereign right to issue – or erase – a currency.
Since the decision to make large depositors of Cypriot banks pay, the world of banking has undergone a major mutation. Previously, it was implicitly agreed that if a bank lost its equity (i.e. the money put in by shareholders), the State, acting as a shock absorber aimed at protecting depositors, would intervene to inject capital and effectively act as a shareholder. Nationalisation, either partial or total, was the final stage in the failure of a bank.
The shareholders effectively contribute equity. They are the co-owners of the enterprise, and they expect to receive dividends and capital gains if they re-sell their shares. In exchange for this expected yield, however, they become the first to absorb any losses.
Only when shareholders lose all their wealth do depositors start to be negatively impacted, i.e. they only recover part of their saved assets.
Technically, the shareholders bear the risk of losses when things start to go badly and they protect the depositors, who are only next in the chain, after a bank’s capital has been eroded. It is also to protect savers that States replace bank shareholders in the event of loss of solvency, with the corollary that some of them have taken excessive risks in the knowledge that the State would intervene in the event of a problem.
A bank should therefore possess sufficient equity capital. Its level is determined by a series of strict regulations (Basle Agreement III, etc.) as it represents a ‘cushion’ at the disposal of banks.
This cushion is all the more important because the defaults of certain big banks can lead to systemic risks, i.e. a domino effect. Banks are not just ordinary companies because they contribute to the creation of money by converting deposits into credits, which become deposits in turn, etc.
Following the Cyprus affair, this reality has been modified: depositors have received a warning that the State may not replace a defaulting shareholder.
A depositor runs the risk of seeing his/her savings converted, in an authoritarian manner, into shares of a defaulting bank. Incidentally, this has recently been confirmed by Olli Rehn, the European Commissioner for Economic and Monetary Affairs. The grab of Cypriot deposits, associated with their conversion into shares of defunct banks, does not seem to be a collective error but a deliberate choice.
In other terms, the value of bank deposits depends on the robustness of the banks in which these deposits are invested. This should encourage bank depositors to diversify their assets and ensure that the interest rate they receive is in line with the intrinsic risk of their bank.
Finally, Europe has adopted the same principles as those that have always prevailed in the USA, the ones that correspond to the rules of limited liability of shareholders. This should discipline the banks within a logic of survival of the fittest. Indeed, the more a bank is capable of attracting deposits and guaranteeing its solvency and liquidity, the less its chances of suffering a deposit grab and the conversion of deposits into shares.
Furthermore, the European approach will lead banks to finance States that are their own supervisory authorities, in the knowledge that these banks should not hold reserves of equity capital when they invest in government bonds.
There are risks, however: the loss of confidence by depositors and the fact that a euro, depending on the bank it is deposited, no longer has exactly the same value. Moreover, we should ask ourselves if it is a good idea to create concerns among bank depositors, knowing that their savings will be indirectly used to finance the debt of the very States that are charged with protecting them.
As I see it, the consequences of the decision on Cyprus have not been felt yet because a State-led conversion of deposits confirms that crazy situation of the lack of intrinsic value of the currency; it will no longer be guaranteed by itself (because the currency symbolises rather than specifies value) and will undergo a process of dematerialisation.
Furthermore, since the announcement of the implosion of the Cypriot euro (which is no longer equivalent to a continental euro) a chill of concern has been felt in Europe. What asset remains a frame of reference when the currency loses its status? Maybe none, because the currency is a “general equivalent” in which any asset should be converted one day, unless we are contemplating a barter economy. In the weakened countries of southern Europe the equation of banking risk has been changed. The depositor needs to know that he/she is no longer completely protected by shareholders and States. Belgium is not threatened by these realities that are applicable to countries that should never have joined the Eurozone. In southern Europe, however, they will go from one surprise to another.
