by Piet Coetzer

Cyprus starts new financial phase

Response to crisis moved from a bail-out to a bail-in

Empty ATMs in Cyprus.jpg

Last week, Canada strongly indicated that the confiscation of deposits in Cyprus has already had global ramifications. At the same time, a prestigious organisation of the world’s largest banks warned that the 'Cyprus approach' would, most likely, become a model for dealing with bank collapses elsewhere in Europe and possibly in other countries.

The Canadian federal budget document, sketched out Ottawa’s plan to establish a roadmap for what happens when a bank gets into trouble, proposing a 'bail-in' approach similar to what other major economies, such as the United States and Europe, either have in place or are looking to implement.

In the wake of what happened in Cyprus earlier in March, the term 'bail-in' so badly spooked investors that within hours the federal government had to clarify the use of the term.

Canadian regulators have used 'bail-in' to describe their proposed plan for stabilising the financial sector the last two years without much reaction. But since the recent debt settlement deal in Cyprus, which included taking a cut off customers' deposits, the term clearly took on a different meaning.

The reaction of Canadian investors seems to have been vindicated by a statement from the International Institute of Finance (IIF), which represents more than 400 leading banks worldwide. On Wednesday last week it warned that "investors would be well advised to see the outcome of Cyprus ... as a reflection of how future stresses will be handled."

It also noted that the Cyprus approach "[was] a very marked shift in strategy from earlier on in the Euro Area crisis."

The previous strategy was to provide blanket guarantees of protection to senior creditors and all depositors, who are now also treated as creditors. The result was that in the end the rescue costs were essentially shouldered by governments.

In the case of Cyprus however, the EU/IMF bail-out loan of €10-billion was linked to an arrangement that would ensure that  the Cyprian government did not shoulder the brunt of the bank failures, which would have elevated the risk to one of a sovereign default.

"It remains to be seen whether this desire to pass the burden for financial support of the banking sector on to bank creditors is a new approach to be applied generally across the Euro Area, or a one-off solution to be applied just in the very special case of Cyprus," the IIF said.

It also noted that previous rescues of banks in countries like Ireland and Spain are still hampering those governments in rebuilding their own finances.

The IIF also concluded that the examples of Spain and Ireland made clear that the efforts to shift the burden of bad bank assets to the EU bail-out fund are "unlikely to be successful".

In the end the 'Cyprus approach' will still badly damage the country’s overall economy with a forecasted contraction of up to 20% through 2015, which will leave the Cypriot government's ability to service its debt at risk, the IIF said.

What further scares many commentators, is that although it is the first time that a 'bail-in' for creditors, including deposit holders, has became practically implemented, it has been around for some time. And legal frameworks exist for it in a number of developed countries.

In New Zealand a 'haircut plan' was envisaged as far back as 1997, during the time of the then Asian financial crisis.

There are also provisions in place in both the United Kingdom and the United States to facilitate the confiscation of bank deposits.

In a joint document of the US Federal Deposit Insurance Corporation and the Bank of England, under the title Resolving Globally Active, Systemically Important, Financial Institutions, specific procedures are put forth whereby “the original creditors of the failed company“, including the depositors of a failed bank, would be converted into equity.

In an article on the subject, Professor Michel Chossudovsky of Global Research, concludes that “[w]hat is occurring is that the bank bail-outs are no longer functional. At the outset of Obama’s second term, the coffers of the state are empty. The austerity measures have reached a deadlock.”

Bank bail-ins are now being contemplated instead of bank bail-outs.

“The lower and middle income groups, which are invariably indebted, will not be the main target. The appropriation of bank deposits would essentially target the upper middle and upper income groups which have significant bank deposits. The second target will be the bank accounts of small and medium sized firms.

“This transition is part of the evolution of the global economic crisis and the impasse underlying the application of the austerity measures.”

Chossudovsky is known for his belief that there is an ongoing conspiracy between big corporate entities and government but he does seem to echo the sentiments expressed by the IIF when he remarks that “[t]he application of a bail-in in the EU or North America would initiate a new phase of the global financial crisis, a deepening of the economic depression ...” and that “an entire global banking network characterised by electronic transactions (which govern deposits, withdrawals, etc), – not to mention money transactions on the stock and commodity markets – could potentially be the object of significant disruptions of a systemic nature.”

 

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