On Sunday, Europe introduced the “Cyprus Doctrine”, which says that uninsured deposits are risk assets and that uninsured depositors are “investors”. The deposit claim has been transformed into a capital instrument. Henceforth, holders of uninsured deposits in European banks are supposed to do their homework, and make sure that they are not investing in uncreditworthy banks.
Connoisseurs of European bank regulation may recall that market discipline was one of the original “Basel Pillars” along with prudential supervision and capital adequacy. And now its exists as a real pillar. Advocates of free markets and financial deregulation should applaud the introduction of the Cyprus Doctrine. (I would call it the “Dijsselbloem Doctrine” if I could spell or pronounce it. The Dutch need SpellCheck.) Indeed, the anti-regulation WSJ is just thrilled with the Cyprus Doctrine: “This is a useful lesson in the limits of government guarantees and a welcome blow against moral hazard”.
Banks won’t need to be regulated anymore because they are outside the safety net. Instead, depositors will police the banking system, rewarding the strong and punishing the weak. Bad banks will be weeded out; we will have fewer but better banks. Taxpayers and legislators will no longer need to pay attention to the industry. Banks can be set free.
There is only one problem with European “depositor discipline”: European bank accounting and disclosure is a joke. There is little relationship between a European bank’s creditworthiness and its financial reporting. Both dead Cyprus banks were solvent according to their latest financials, and both passed the European Banking Authority’s 2011 stress test. I think that both Bankia and Banca MPS passed as well: I think everyone passed. The stress test was a joke. It was calibrated to pass everyone. All European banks are created equal--until they fail.
How are depositors supposed to be able to know where to put their money? You might think they could use bank ratings, but most European banks aren’t rated by Moody’s or anyone else. And Moody’s is not clairvoyant; it has to use the same bogus financial disclosure as everyone else. Bank executives seldom blurt out the fact that they are insolvent. Insolvent banks lie about their asset quality to anyone who will listen. They certainly lied to me when I was in the business. I found that one of the best sources of information about insolvent banks was market rumor and anecdote. Not actionable information, but more useful than the lies the banks told.
If you don’t believe that insolvent banks lie about their condition, read the annual report for any one of the banks which have had to be bailed out in the past few years. Not one of them said that they were insolvent, or that their loan portfolio was full of holes, or that their CDOs were mismarked, or that they were becoming illiquid. And I would add that European bank regulators act as advocates for their banks. They take criticism of their banks personally. Are these regulators now supposed to issue press releases pointing out which of their banks are no good and should be avoided at all costs?
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I can’t help making one other observation that will make me sound arrogant. I have been a bank analyst since 1978. I have been following bank regulation for 35 years. Although I may be demented, I remember the lessons of those 35 years, the most important of which is that bank deposits make up most of the money supply and, as such, are contingent liabilities of the central bank. If you screw around with bank deposits, you are screwing around with the money supply which drives nominal growth. You can’t introduce depositor discipline while expecting economic growth. It’s one or the other.
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On Sunday, Europe introduced the “Cyprus Doctrine”, which says that uninsured deposits are risk assets and that uninsured depositors are “investors”. The deposit claim has been transformed into a capital instrument. Henceforth, holders of uninsured deposits in European banks are supposed to do their homework, and make sure that they are not investing in uncreditworthy banks.
Connoisseurs of European bank regulation may recall that market discipline was one of the original “Basel Pillars” along with prudential supervision and capital adequacy. And now its exists as a real pillar. Advocates of free markets and financial deregulation should applaud the introduction of the Cyprus Doctrine. (I would call it the “Dijsselbloem Doctrine” if I could spell or pronounce it. The Dutch need SpellCheck.) Indeed, the anti-regulation WSJ is just thrilled with the Cyprus Doctrine: “This is a useful lesson in the limits of government guarantees and a welcome blow against moral hazard”.
Banks won’t need to be regulated anymore because they are outside the safety net. Instead, depositors will police the banking system, rewarding the strong and punishing the weak. Bad banks will be weeded out; we will have fewer but better banks. Taxpayers and legislators will no longer need to pay attention to the industry. Banks can be set free.
There is only one problem with European “depositor discipline”: European bank accounting and disclosure is a joke. There is little relationship between a European bank’s creditworthiness and its financial reporting. Both dead Cyprus banks were solvent according to their latest financials, and both passed the European Banking Authority’s 2011 stress test. I think that both Bankia and Banca MPS passed as well: I think everyone passed. The stress test was a joke. It was calibrated to pass everyone. All European banks are created equal--until they fail.
How are depositors supposed to be able to know where to put their money? You might think they could use bank ratings, but most European banks aren’t rated by Moody’s or anyone else. And Moody’s is not clairvoyant; it has to use the same bogus financial disclosure as everyone else. Bank executives seldom blurt out the fact that they are insolvent. Insolvent banks lie about their asset quality to anyone who will listen. They certainly lied to me when I was in the business. I found that one of the best sources of information about insolvent banks was market rumor and anecdote. Not actionable information, but more useful than the lies the banks told.
If you don’t believe that insolvent banks lie about their condition, read the annual report for any one of the banks which have had to be bailed out in the past few years. Not one of them said that they were insolvent, or that their loan portfolio was full of holes, or that their CDOs were mismarked, or that they were becoming illiquid. And I would add that European bank regulators act as advocates for their banks. They take criticism of their banks personally. Are these regulators now supposed to issue press releases pointing out which of their banks are no good and should be avoided at all costs?
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Access every new PS commentary, our entire On Point suite of subscriber-exclusive content – including Longer Reads, Insider Interviews, Big Picture/Big Question, and Say More – and the full PS archive.
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I can’t help making one other observation that will make me sound arrogant. I have been a bank analyst since 1978. I have been following bank regulation for 35 years. Although I may be demented, I remember the lessons of those 35 years, the most important of which is that bank deposits make up most of the money supply and, as such, are contingent liabilities of the central bank. If you screw around with bank deposits, you are screwing around with the money supply which drives nominal growth. You can’t introduce depositor discipline while expecting economic growth. It’s one or the other.