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 about event More on this topic

Past Event

Past Event

Perspectives on Universal Basic Income

At this event, we discussed the possible benefits but also the possible disadvantages of Universal Basic Income.

Speakers: Grégory Claeys, Olli Kangas, Professor Philippe Van Parijs and Prof. Dr. Hilmar Schneider Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 12, 2017
Read article More on this topic More by this author

Blog Post

The forward guidance paradox

What’s at stake: the term “forward guidance” is used in economic jargon to describe central bank communications about the likely future path of policy rates. Standard monetary models imply that far future forward guidance has huge effects on current outcomes, and recent literature has been trying to reconcile this with reality.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: July 10, 2017
Read about event

Past Event

Past Event

Is there a way out of non-performing loans in Europe?

At this event we looked at the issue of non-performing loans in Europe. The event also saw the launch of the latest issue of "European Economy – Banks, Regulation and the Real Sector."

Speakers: Emilios Avgouleas, Giorgio Barba Navaretti, Giacomo Calzolari, Maria Demertzis, Martin Hellwig, Helen Louri and Laura von Daniels Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 6, 2017
Read article Download PDF More on this topic

External Publication

Review of EU-third country cooperation on policies falling within the ITRE domain in relation to Brexit

What is the possible future relationship between the EU and the UK in light of Brexit? The report provides a critical assessment of the implications of existing models of cooperation between third countries and the European Union on energy, electronic communications, research policy and small business policy.

By: J. Scott Marcus, Georgios Petropoulos, André Sapir, Simone Tagliapietra, Alessio Terzi, Reinhilde Veugelers and Georg Zachmann Topic: European Macroeconomics & Governance Date: July 5, 2017
Read about event

Upcoming Event


Bruegel Annual Meetings 2017

The Annual Meetings are Bruegel’s flagship event. They offer a mixture of large public debates and small private sessions about key issues in European and global economics. In a series of high-level discussions, Bruegel’s scholars, members and stakeholders will address the economic policy challenges facing Europe.

Speakers: José Antonio Álvarez Álvarez, Agnès Bénassy-Quéré, Pervenche Béres, Jean Luc Demarty, Anna Ekström, Lowri Evans, Sandro Gozi, Peter Grünenfelder, Patrick Graichen, Reiner Hoffman, Levin Holle, Steffen Kampeter, Peter Kažimír, Emmanuel Lagarrigue, Steven Maijoor, Nathalie Moll, James Murray, Carlos Sallé Alonso, André Sapir, Dirk Schoenmaker, Mateusz Szczurek, Marianne Thyssen, Liviu Voinea, Johan Van Overtveldt, James Waterworth, Ida Wolden Bache and Guntram B. Wolff Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Square - Brussels Meeting Centre
Read article More on this topic More by this author

Blog Post

Eurozone or EU budget? Confronting a complex political question

This week’s European Commission reflection paper is the latest document to ponder a distinction between EU and euro-area budgets. But do we need to split the two, and what would each budget be used for? In this post, I present an analytical framework for assessing this ultimately political question

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 29, 2017
Read about event

Upcoming Event


Unfinished business: The unexplored causes of the financial crisis and the lessons yet to be learned

At this event Tamim Bayoumi will present his upcoming book on the financial crisis, showing how how the Euro crisis and U.S. housing crash were, in fact, parasitically intertwined.

Speakers: Tamim Bayoumi, Maria Demertzis and Aerdt Houben Topic: European Macroeconomics & Governance, Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

Raising the inflation target: a question of robustness

In an unexpected move, the Federal Reserve Chair Janet Yellen has recently brought up the issue of raising the inflation target. This blog argues that an increase in inflation targets may prove to be beneficial in achieving price stability in the long run. This would increase the credibility of central banks in achieving inflation goals and stave off the distortionary effects of deflation.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article More on this topic

Blog Post

Can EU actors keep using common law after Brexit?

English common law is the choice of law for financial contracts, even for parties in EU members with civil law systems. This creates a lucrative legal sector in the UK, but Brexit could make UK court decisions difficult to enforce in the EU. Parties will be able to continue using English common law after Brexit, but how will these contracts be enforced? Some continental courts are preparing to make judicial decisions on common law cases in the English language.

By: Uuriintuya Batsaikhan and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article More on this topic More by this author

Blog Post

The size and location of Europe’s defence industry

There is growing debate about a common European military policy and defence spending. Such moves would have major economic implications. We look at the supply side and summarise some key facts about the European defence sector: its size, structure, and ability to meet a possibly increased demand from EU member states.

By: Alexander Roth Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article More by this author

Parliamentary Testimony

House of Commons

Exiting the European Union Committee

On 19 April 2017 Zsolt Darvas appeared as a witness at the Exiting the European Union Committee, the House of Commons, United Kingdom.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, House of Commons, Testimonies Date: June 20, 2017
Read article More on this topic More by this author

Blog Post

Brexit and the future of the Irish border

The future of the Irish land border has been thrown into uncertainty by Brexit. The UK's confirmation that it will leave the EU's single market and customs union implies that customs checks will be needed. However, there is little desire for hard controls from any of the parties involved. This is especially true for Theresa May's potential partner, the DUP. Creative solutions are needed to reach a solution.

By: Filippo Biondi Topic: European Macroeconomics & Governance Date: June 19, 2017
Load more posts