Blog Post

To bail-in, or not to bail-in: that is the question (now for Cyprus)

There is an intense debate on the possibility of bailing-in bank shareholders and lenders of troubled financial institutions (ie forcing investors to take losses), or relying on taxpayers to take the hit.

By: Date: July 23, 2013 Topic: European Macroeconomics & Governance

There is an intense debate on the possibility of bailing-in bank shareholders and lenders of troubled financial institutions (ie forcing investors to take losses), or relying on taxpayers to take the hit. For example, in a recent debate Charles Goodhart from LSE argued against, while Matt King from Citi in favour of bailing-in. The main arguments against bailing-in, and therefore in favour of bailing-out from taxpayers’ money, are that otherwise investors would demand a higher return when investing in a bank, and lenders would flee at the first sign of trouble. The main arguments in favour of bailing-in are:

·         private sector losses should be absorbed by those who took the risk;

·         it is unfair to burden all taxpayers for the result of risky banking businesses;

·         an eventual public bail-out even increases banks’ inclination for running risky businesses;

·         and bank rescues can endanger fiscal sustainability.

The current Cypriot banking mess is a prime case for at least the last point. According to news reports, for a full publicly financed bank rescue, the official lending programme to Cyprus should be €17bn (which is almost equal the €17.5bn GDP forecast for 2013), of which €10 billion would be used for banks. News reports suggest a public debt to GDP ratio peaking at about 150% of GDP. Clearly, such a high public debt ratio may prove to be unsustainable, especially if growth forecast will disappoint again. Moody’s concluded yesterday that there is a high probability of Cyprus defaulting.

What are the options? Reportedly, bailing-in in Cyprus cannot be sufficient without bailing-in depositors with deposits over the guaranteed €100 thousands and some euro-area members and the IMF are pushing for such a bail-in. But in that case, there is a fear from a deposit run in Cyprus and other countries with fragile banking system. Imposing a one-time wealth tax on deposits, like Italy in the late 1990ties, is a mild form of bailing-in depositors. All alternatives would burden the Cypriot taxpayers (or other euro-area taxpayers if Cyprus defaults sometime after the bail-out). For example, increasing various taxes, using privatisation revenues or revenues from the recently discovered natural gas fields, would use taxing or the national wealth to bail-out banks.

But is bailing-in really so disastrous? Let us draw some lessons from Denmark. It is less known that in 2011, in two middle-sized Danish banks, Amagerbanken and Fjordbank Mors, depositors with net deposits over the guaranteed €100 thousands also faced a haircut.* Even senior creditors had to face a haircut. Certainly, this had an impact on other banks in Denmark: Moody’s lowered the ratings of Danish banks due to less implicit state support and spreads and which these banks can borrow went up. Yet the resolution “shocks” were absorbed and there was no contagion for deposits in other countries.

How could Denmark do this? Since October 2010, Denmark has an effective resolution regime. Failed banks are resolved over the weekend: the bank closes on a Friday afternoon and a new bank is opened at 10am on the next Monday at the distressed bank’s premises, carrying the “healthy” part of the failed bank and continuing to service credit cards, loans, deposits, etc, which were transferred from the failed bank. Shareholders and unsecured lenders are bailed-in in the first place and a special company called Financial Stability Company manages the mess of the distressed assets and the corresponding liabilities of the failed bank. See a nice description of the resolution regime in the 2011Q3 Monetary Review of Danmarks Nationalbank , pages 81-96.

The comparison with Denmark is limited, I know. Cyprus does not have in place such a powerful resolution framework for bailing-in private lenders. Enacting an ad hoc legislation to this end, as well as its execution over a weekend, could be difficult. In Denmark the issue in 2011 was two middle-sized banks, while in Cyprus most of the banking system is in trouble, including the two biggest banks. And Denmark has a larger and presumably more resilient economy than Cyprus. But there is a similarity as well: the bank assets/GDP ratio is rather high in both countries: about 4 in Denmark and about 8 in Cyprus; even the Danish figure is well above the euro-area average.

The question for Cyprus: should Cypriot (and probably other euro-area) taxpayers bear the brunt of bank rescues or unguaranteed depositors should take a hit as well? In my view, there is a clear case for bailing-in unguaranteed depositors as well, because of the four bullet-pointed principles listed above and at the same measures should be taken to limit the potential adverse effects on Cyprus and elsewhere. When the bank capital shortfall is about 50% of GDP, as in Cyprus, one cannot talk about financial stability anymore and urgent action is needed.

Concerns about money laundering delayed the negotiations for the financial assistance of the country, which in turn delayed the resolution of the Cypriot banks. But since there are talks about a possible bail-in of unguaranteed deposits, in January 2013 deposits in Cypriot banks declined by about €2bn and I expect that even more have left during the past few weeks. This means that the pool for bailing-in is drying-up quickly and hence urgent action is needed.

The Cypriot government forcefully rejects any calls for bailing-in depositors. Certainly, they cannot do else; otherwise the bank run would accelerate immediately. The Greek government, along with the troika of the European Commission, European Central Bank and the IMF, have also long denied the need for restructuring Greek public debt in 2010-11, which has just exaggerated the problems.

For Cyprus, the government has to decide now whether to bail-in unguaranteed depositors or charging taxpayers and risking sovereign default. The IMF made its choice by demanding bailing-in, according to news reports, but since European partners may not favour such an action, they may provide financial assistance to Cyprus without the IMF. Instead, Russia, which has strong interests in Cyprus, may contribute to the bail-out financially either by extending the current €2.6bn loan that would otherwise expire in 2016 (and possibly lower its interest rate from the current 4.5% per year), and/or with a new loan. In my view, defying first principles, charging taxpayers and risking a sovereign default would fight back. I a quick action is needed for bailing-in private creditors, including unguaranteed depositors, supported by an ad hoc legal solution.

What about the impact on other countries? True, depositors in unsafe banks may consider their unguaranteed deposits unsafe. But the proper response is not charging the Cypriot (and possibly other euro-area) taxpayers with the Cypriot bank losses due to bank fragility in other countries, but to strengthen banks in other countries immediately. And let’s not forget that Denmark has already bailed-in depositors and senior creditors and the EU has not collapsed afterwards.

* Except for certain special deposits, which are fully covered by the Danish deposit guarantee fund, such as certain pension-savings accounts, children’s savings accounts, lawyers’ client accounts and certain accounts stemming from property transactions and mortgaging. See the Danish central bank document cited above.

Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article More by this author

Blog Post

The impact of Brexit on the Irish energy system – pragmatism vs. principles

Brexit promises pain for Ireland that could be cut off from the EU internal market and be left exposed to market instability in the UK. Georg Zachmann assesses the scale of the possible damage for Ireland, and how the UK and EU might use the special energy relations on the Irish island to commit to a pragmatic solution.

By: Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance Date: November 21, 2017
Read article Download PDF More by this author

Parliamentary Testimony

Croatian Parliament

After the crisis: what new lessons for euro adoption?

Key learning for euro adoption lies within the experience of southern euro member states and the macroeconomic performance of euro ‘ins’ and ‘outs’ among newer member states. Zsolt Darvas discusses promising signs for eventual euro adoption in Croatia and the unsuitability of the Maastricht fiscal criteria for joining the euro, in his speech delivered at an event organised in the Croatian Parliament on 15 November 2017

By: Zsolt Darvas Topic: Croatian Parliament, European Macroeconomics & Governance, Testimonies Date: November 20, 2017
Read about event

Upcoming Event


Sustainable growth in transition countries

This event will feature a presentation of the EBRD Transition Report 2017-18.

Speakers: Jonathan Charles, Zsolt Darvas, Sergei Guriev, Debora Revoltella and Lucio Vinhas de Souza Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event


Responsibility to reform Europe

At this event, we will host Vice President of the European Commission Jyrki Katainen and the President of Nea Demokratia and Opposition Leader in Greece, Kyriakos Mitsotakis who will have an interactive discussion on how to reinvent the EU and the eurozone.

Speakers: Maria Demertzis, Jyrki Katainen and Kyriakos Mitsotakis Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event


Flexicurity and labour market reforms in Europe

This event will discuss the potential of the flexicurity model as employment strategy and the way it could be implemented in European countries to be successful.

Speakers: Grégory Claeys, Philip Collins, Werner Eichhorst, Antoine Foucher, Maria Jepsen and Marco Leonardi Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More by this author

External Publication

European Parliament

Sovereign Concentration Charges: A New Regime for Banks’ Sovereign Exposures

Europe’s banking union has been central to the resolution of the euro-area crisis. It has had an encouraging start but remains unfinished business. If it remains in its current halfway-house condition, it may eventually move backwards and fail. EU leaders should seize these opportunities

By: Nicolas Véron Topic: European Macroeconomics & Governance, European Parliament Date: November 17, 2017
Read about event More on this topic

Upcoming Event


Health care and macro-economics in Europe

What are the strengths and challenges of health care systems in each EU country? What are the common policy priorities and opportunities for EU value added?What role do healthcare systems play in public finances and macroeconomic developments? What are the economic values of investing in healthcare?

Speakers: Zsolt Darvas, Petra Laux, Xavier Prats Monné and Further speakers to be confirmed Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

A slightly tighter ECB

The ECB’s recent decision on QE was somewhat on the dovish side. Francesco Papadia gives his view on why it is time to start a discussion about reducing the degree of ease of monetary policy.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: November 15, 2017
Read about event More on this topic

Past Event

Past Event

Vision Europe Summit 2017

The 2017 Vision Summit is titled "The Winners and Losers of Globalisation"

Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 14, 2017
Read article Download PDF More by this author

External Publication

The economic effects of refugee return and policy implications

This paper looks at the question of returning asylum seekers and refugees from the economic perspective in the advanced countries that receive refugees: is return in their economic interest?

By: Uri Dadush Topic: European Macroeconomics & Governance, Global Economics & Governance Date: November 14, 2017
Read article Download PDF

Policy Contribution

A ‘twin peaks’ vision for Europe

The organisation of the European Supervisory Authorities (ESAs) is based on a sectoral approach with one ESA for each sector, with separate authorities for banking, insurance and securities and markets. But is this sectoral approach still valid? This Policy Contribution outlines a long-term vision for the supervisory architecture in the European Union.

By: Dirk Schoenmaker and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: November 13, 2017
Read article More by this author

Blog Post

European worries about isolationist trends

Populist shocks in the UK and US threaten the multilateral order on which the EU depends. What lies behind these earthquakes, and what does it mean for Europe? Withdrawing from the world is no solution to geo-political upheavals, but Europe needs to reassess the future of globalisation.

By: Maria Demertzis Topic: European Macroeconomics & Governance, Global Economics & Governance Date: November 7, 2017
Load more posts