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How safe are deposits?

20 December 2017
Richard Kemmish

The future of the European deposit guarantee fund is a topic of vital importance to the long term prospects for the covered bond market. And it’s time I vented my spleen.


Call me a curmudgeon if you must – one of the benefits of getting older is that this becomes more socially acceptable – but there was so much in the proposals for the European deposit guarantee fund that annoyed me that I feel an urge to vent. Yes, this blog is supposed to be about covered bonds but one of the main variables in the use of covered bonds in any given country is the level of retail deposits. After Northern Rock – and others – the main determinant of the reliability (if not the absolute level) of retail deposits is confidence in the deposit guarantee fund. So it is a topic of vital importance to the long-term prospects for the covered bond market.

With the growing nexus between bank and sovereign credit and the greater homogeneity in national banking systems, the next bank failure is far more likely to be part of a wider systemic failure than the sort of idiosyncratic bank failure that national deposit guarantee funds were designed and sized for. Commission gets this, hence the drive towards pan-European deposit guarantee funds. No matter that banks in different member states also have correlated risks, as long as that correlation is less than

1, a pan-European deposit guarantee scheme will always be more robust than a national one (and the consequence of its failure more catastrophic. Let’s ignore that for now).

A no from the Germans

A pan-European deposit guarantee fund is politically difficult. It raises obvious concerns about the mutualisation of debt cross-border in much the same way that proposals for European as opposed to national government bond issues do. Basically, the Germans (Finns, Dutch) don’t want to guarantee the debts of the Greeks (Spanish, Italians).

So, political compromise is necessary. The current proposal is a phased in approach. Phase one involves each national deposit guarantee fund agreeing to provide liquidity for their peers if they run out of money. The national fund must then pay that back. Sensible enough. My concern though is that this is described as a ‘reinsurance phase’. It isn’t. Reinsurance is the transfer of the risk of excess loss to a third party. What is proposed is a liquidity facility. Either the person who came up with that title doesn’t understand what reinsurance is or, worse, they are trying to imply that there is a level of risk transfer when there is not. Neither possibility is acceptable.

Sharing the risk

The second phase proposed is the contentious one: genuine sharing of risks across borders. To ameliorate the concerns of the stronger credit countries this will only happen after a thorough asset quality review has been passed – a clean bill of health for the Greek, Spanish and Italian banks. My concern here is that the transition to the second phase seems irreversible – once deposits are mutually guaranteed across the Union they are mutually guaranteed forever. The same cannot be said about the conditions for this to happen – a bank might pass its stress test today but fail it tomorrow (let alone that stress tests are an imperfect predictor of future failure – as was demonstrated so well by Banco Popular).

Political objections to mutual guarantees will not overlook these points. As long as they are outstanding, alternative crisis resistant ways of replacing retail deposits must be in place.

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