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European Bank Accounting Is A Joke

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.