How Bank Depositors Have Become Unsecured Creditors

The news item tripping everyone up was that a Portuguese bank announced it was delaying coupon payments on short-term debt securities. This revived, for a brief moment, fears of wider European banking problems. It also may have reminded people that most of the world’s debt problems have merely been re-financed to mature at a later date.

In Europe, Portugal’s Banco Espirito Sante cited ‘ongoing material difficulties’. It’s a subsidiary of Portugal’s second-largest lender, Espirito Santo Financila Group. The markets reacted negatively because this is how systemic problems have started in the past. A single firm gets in trouble. Then it spreads.

After opening down, US stocks quickly shrugged off worries of the dreaded ‘C’ word (contagion). We’ll see how it goes. But two quick points on the bank issue. Pay attention if you value your savings.

First, most holders of bank debt have a claim on the liquidated assets of a bank in a wind up. The fact that the bank missed a coupon payment on some of its debt securities should be a reminder to shareholders that equity is last in line in a wind up. Your equity entitles you to a piece of the firm’s earnings. But past that, good luck. It’s all risk and no security.

The other banking note is ominous. Not two days ago, Germany’s federal cabinet adopted a plan that forces owners and creditors to prop up troubled banks ahead of taxpayers. It’s adopted the new rules a year ahead of schedule. The stated goals are to prevent one failed bank from causing ‘systemic’ risk and to save taxpayers the cost of bailing out or recapitalising systemically important banks.

A ‘bail in’ by any other name would smell as much like rotting barramundi in your bedroom on a hot summer’s day. I have no problem with bank creditors being forced to pay for the recapitalising of a firm. That’s the risk you take as a creditor. Equity holders would also pay, inasmuch as that they’re in the hierarchy of creditors.

The problem with the way the ‘bail in’ is being unleashed on the public is that most depositors in major banks don’t see themselves as unsecured creditors to the bank. That’s exactly what they are, though. Thus, it may not be clear to ordinary bank depositors that when ‘bail in’ legislation is adopted in your country, it means your savings could be confiscated to recapitalise a bank that’s taken big losses on bad loans. See also, Cyprus.

No one has been able to show me that Aussie bank depositors aren’t also considered unsecured creditors to the bank in which their savings are held. Is a ‘bail in’ scenario here, where some percentage of your savings are confiscated, possible?

Well, you’d have to have a major bank take massive losses. And the only way that could happen is if the housing market crashed, or a bank had major exposure to a property crash in, say, New Zealand or the UK. Clearly none of those things is possible (ahem).

And in any case, should an Australian bank ever get into serious trouble, you can imagine the government and the Reserve Bank of Australia would step in to prop it up. They’d be doing it with taxpayer money or newly printed money. You would suffer indirectly through a ‘levy’ or through devaluation of the currency. But they’d do it anyway. Because financial interests drive public policy in the Western world.

Speaking of Germany, though, wasn’t that a strange time to bring-forward bail-in legislation? Why now? Coincidence? Plan? Hmm. You decide.


Dan Denning
for Markets and Money

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Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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