Are large bank deposits safe?

From Russell Napier of ERIC

"It is with regret and sadness we announce the death of money on November 16th 2014 in Brisbane, Australia

On Sunday in Brisbane the G20 will announce that bank deposits are just part of commercial banks’ capital structure, and also that they are far from the most senior portion of that structure. With deposits then subjected to a decline in nominal value following a bank failure, it is self-evident that a bank deposit is no longer money in the way a banknote is. If a banknote cannot be subjected to a decline in nominal value, we need to ask whether banknotes can act as a superior store of value than bank deposits? If that is the case, will some investors prefer banknotes to bank deposits as a form of savings? Such a change in preference is known as a "bank run."

Each country will introduce its own legislation to effect the ‘ bail-in’ agreed by the G20 this coming weekend. The consultation document from the UK’s Treasury lists the following bank creditors who will rank ABOVE depositors in a ‘failing’ financial institution:

  • Liabilities representing protected deposits (in the UK the government guarantee protects 100% of deposits up to the value of GBP85,000)
  • any liability, so far as it is secured
  • Liabilities that the bank has by virtue of holding client assets
  • Liabilities arising with an original maturity of less than 7 days owed by the banks to a credit institution or investment firm
  • Liabilities arising from participation in designated settlement systems
  • Liabilities owed to central counterparties recognized by the European Securities and Markets Authorities… on OTC derivatives, central counterparties and trade depositaries
  • Liabilities owed to an employee or former employee in relation to salary or other remuneration, except variable remuneration
  • Liabilities owed to an employee or former employee in relation to rights under a pension scheme, except rights to discretionary benefits
  • Liabilities owed to creditors arising from the provision to the bank of goods or service (other than financial services) that are critical to the daily functioning of its operations

The above list makes it clear that deposits larger than GBP85,000 will rank ahead of the bond holders of banks, but they will rank above little else. Importantly, both borrowings of the banks of less than 7 days maturity from other financial institutions and sums owed by banks in their role as counterparties to OTC derivatives will rank above large deposits.

Large deposits at banks are no longer money, as this legislation will formally push them down through the capital structure to a position of material capital risk in any "failing" institution. In our last financial crisis, deposits were de facto guaranteed by the state, but from November 16th holders of large-scale deposits will be, both de facto and de jure, just another creditor squabbling over their share of the assets of a failed bank.

Interestingly, HM Treasury uses the word ‘failing’ rather than "failed" in its consultation document and investors could find their large deposits frozen for a prolonged period in any "failing" institution while the courts unpick the capital structure and decide exactly where any losses should fall.

If we have another Lehman Brothers collapse, large-scale depositors could find themselves in the courts for years before final adjudication on the scale of their losses could be established. During this period would this illiquid asset, formerly called a deposit and now subject to an unknown capital loss, be considered money? Clearly it would not, as its illiquidity and likely decline in nominal value would make it unacceptable as a medium of exchange.

From November 16th 2014 the large-scale deposit at a commercial bank is, at best, a lesser form of money, and to many it will cease to be money at all as its nominal value can fall and it could cease to be accepted as a medium of exchange."

In short; as we all looked on in amazement when the banks of Cyprus confiscated depositors money above 100,000 Euros thinking that could never happen here, we were wrong. If you have more than £85,000 on deposit in your bank account and your bank is "failing" not failed, you could very shortly be waiving goodbye to your money. Ask yourself, how do you know if your bank is failing? Will we be last to know when a bank is failing?

Posted on February 25, 2015 .