Depositors are not investors
Even if Jeroen Dijsselbloem wants to pretend otherwise. One might have expected better from a distinguished journalist who has read my recent blog, Is your money safer under the mattress?, but, in a piece in today’s Times, “No more shambolic bailouts, please”, David Wighton argues that “it is right to reinstate the discipline of uninsured deposits, which studies suggest make the financial system more stable. And we seemed to get by before. Until 1979, bank deposits were not insured at all.” So forgive me for rehearsing the reasons why that is wrong.
Quite a lot has changed since 1979, making it in effect impossible for depositors to influence the behaviour of the banks where they place deposits. Unlike shareholders, depositors have no votes, and cannot influence behaviour by changing management. Nor is the threat of moving their deposit realistic in an industry that offers inadequate competition (the FSA’s website lists ten big banks with separate banking licences, which in fact are held by just seven independent groups; they represent some 39 formerly independent licences which have since merged). Regulators, who have full access to financial information, have proved utterly ineffective at preventing catastrophe arising from even simple exposures to risky activities, let alone the myriad complex instruments that conceal dangers – and that’s before you get to dishonest, fraudulent and criminal activity. These are not matters that I can control by threatening Lloyds that I will shift my current account to Barclays. Even the banks are unable to manage these threats, which is why they now insulate themselves from imponderable credit exposure in interbank lending by taking security over the borrowing bank’s assets. This is not available to corporate or retail depositors, and was virtually unheard of in 1979.
As I mentioned before, the Government now proposes to weaken the position of depositors still further with clause 9 of the Financial Services (Banking Reform) Bill, the effect of which is not merely to bail in larger uninsured depositors (as Mr Dijsselbloem wants), but to subordinate them to other banks’ subrogated claims for their FSCS contributions. In a simple example I gave before I showed how, if a bank’s assets shrink putting it into liquidation, there is a huge difference between the depositor’s recovery rate – in my example under current rules an uninsured depositor would get back 93p in the £; under the new law, he would receive nothing. The arithmetic is a little more complicated when secured interbank funding is involved, but the same principle applies – the recovery rate for uninsured deposits will be significantly adversely affected, the beneficiaries of this being other banks.
So far from helping stability, this change will only increase panic during the next bank run.
As drafted, the law would apply retrospectively to existing fixed term deposits, turning them into junk bonds without compensation or a right of withdrawal before the rules takes effect. Normally banks have to pay 7–8% to raise subordinated capital: with this law the Government is promoting the next mis-selling scandal.
Corporate depositors will also be affected, and while there may be little awareness at present, once on the statute book large companies will sooner or later realise that their short term surplus funds cannot be safely managed in London. Driving such deposits to Frankfurt or New York would have grave implications for the banking industry.
But fundamentally if this Government can’t figure out what such a step will do for economic recovery, what chance have we got to secure sustainable growth?