On the one hand, given that the Eurozone remains a major economic and financial flashpoint, it is good to see a major news service like Bloomberg provide a lengthy report on a continuing existential threat, that of deposit flight, or as we have described it, a slow motion bank run. But it’s a bit surprising it has taken them this long to take notice.
If you are a cross border investor or a wealthy national, consider what the exit from the Eurozone of, say, Greece, would mean to you. Deposits will be redenominated in the national currency and will fall in value. Now if you live in Greece, you’ll see costs of imported goods rise. And if you either liked to or had reason to spend money outside Greece, you have a lot less spending power. So as periphery countries have been looking wobbly, deposits have been exiting the periphery countries and going to the core, particularly Germany. And that means the mechanism for recycling savings within the Eurozone had broken down, forcing the ECB to step in.
This problem has been visible for some time. For instance, Marshall Auerback has been telling your humble blogger and others about it since early in the spring. As we have discussed, this remains a point of failure for the Eurozone, and in the last few weeks, German leadership appears to have gotten religion. Followers of the Euro-related press may recall that German leaders in July and August were telling Greece it had to adhere to the widely-recognized-as-impossible bailout requirements, and that they were indifferent to a Greek departure from the Eurozone. The big concern was not of a Greek exit per se, but that if Greece were to leave, it would demonstrate that a periphery country departure could be one part of the endgame, and that means it would be possible for other countries to leave as well. Spanish deposits have been leaving the country at an accelerating rate over the summer. And someone apparently knocked heads in Germany. In early September, the party line became “No, we’d really like Greece to stay” and the IMF has signaled that is preparing to fudge Greece’s performance versus its targets (a necessary condition for the next release of funds, which isn’t going to Greece anyhow but its creditors, natch).
What most investors, experts, and policy makers fail to realize is that this bank run is not simply a Greek problem, which will cease if and when Greece is thrown out of the euro zone. If one looks at the Target 2 balances, the ELA, and the ECB’s lender of last resort facilities, it’s clear that this has extended into all of the periphery countries, including Spain and Italy. It may well end with Germany’s banks effectively serving as the deposit base for all of Europe. See this chart, courtesy of Gavyn Davies
Perversely, the ECB and the European authorities acknowledge none of this and seem to be doing nothing about it…
All of the recent talk about euro bonds, fiscal union and higher capital adequacy buffers for the banks are fine in their own right. But they do not deal with the immediate problem of deposit flight…
It is not necessary to restore the solvency of an institution when a bank run develops and incur all the trouble and expense that this entails. Arguably, on any honest accounting of America’s own Systemically Dangerous Institutions, they could well be insolvent, but there are no runs here because the system is backed by a robust system of deposit insurance via the FDIC. All one need do is reassure depositors that they can get their money out of the bank whenever they like…
It is important to recall that central banks were not created to control inflation. They were created to prevent the bank runs that were so catastrophic for capitalist economies in the past. For all of its protestations to the contrary, the ECB has provided this backstop when catastrophe has loomed in the eurozone, but they have done so in a very reticent manner, undermining the effects of their action by publicly proclaiming each program to be absolute the last…
But so long as there exists a healthy market skepticism that a strong supranational central bank will provide unlimited lender of last resort facilities to its weaker constituent parts, and so long as the ECB, and certain national central banks, continue to act clandestinely with a lot of threatening hard-line public talk, the runs will continue and the crisis will intensify.
Contrary to what the Germans are now indicating, a eurozone wide system of deposit insurance does NOT require the Germans guaranteeing the obligations of the Greek, Spanish, Portuguese, and Italian governments. This can and should be done by the ECB, as it is the issuer of the euro. It’s also in Germany’s massive interests to have these costs born by the central bank, rather than tainting its own credit rating via persistent bailouts of the eurozone’s weaker constituent parts. Because at the end of the day, Germany is a user of the currency as well and is trapped in the same roach motel as the Italians and the Spanish, even if it occupies the penthouse suite.
Marshall provided more details on how the various recycling mechanisms (such as Target2 and the ELA) worked in this June post.
The Bloomberg story tonight (hat tip George P) serves to highlight the issue, but does it give an update as to whether anything has changed in the wake of Draghi’s announcement of OMT. Key excerpts:
An accelerating flight of deposits from banks in four European countries is jeopardizing the renewal of economic growth and undermining a main tenet of the common currency: an integrated financial system.
A total of 326 billion euros ($425 billion) was pulled from banks in Spain, Portugal, Ireland and Greece in the 12 months ended July 31, according to data compiled by Bloomberg. The plight of Irish and Greek lenders, which were bleeding cash in 2010, spread to Spain and Portugal last year.
The flight of deposits from the four countries coincides with an increase of about 300 billion euros at lenders in seven nations considered the core of the euro zone, including Germany and France, almost matching the outflow. That’s leading to a fragmentation of credit and a two-tiered banking system blocking economic recovery and blunting European Central Bank policy in the third year of a sovereign-debt crisis…
The ECB has taken the place of depositors and other creditors who have pulled money out over the past two years, largely through its longer-term refinancing operation, known as LTRO. The Frankfurt-based central bank was providing 820 billion euros to lenders in the five countries at the end of July, data compiled by Bloomberg show. Irish and Greek central banks loaned an additional 148 billion euros to firms that couldn’t come up with enough collateral to meet ECB requirements.
Because central-bank financing is counted as a deposit from another financial institution, the official data mask some of the deterioration. Subtracting those amounts reveals a bigger flight from Spain, Ireland, Portugal and Greece. For Italian banks, what appears as a 10 percent increase is actually a decrease of less than 1 percent.
When financing by central banks isn’t counted, the data show that Greek deposits declined by 42 billion euros, or 19 percent, in the 12 months through July. Spanish savings dropped 224 billion euros, or 10 percent; Ireland’s 37 billion, or 9 percent; Portugal’s 22 billion, or 8 percent.
The pace of withdrawals has increased this year….The difference in funding costs is reflected in loan pricing. Italian rates on consumer loans of less than one year, at 8.2 percent on average, exceeded even those in Greece and Portugal, ECB data show. Spanish consumers had to pay 7.3 percent to borrow from their banks, compared with 4.5 percent for German borrowers.
Ed Harrison also points out in the article that the latest ECB bond buying program is yet another back door bailout of French and German banks.
In the meantime, in terms of reporting actual news (as opposed to discovering old news), Delusional Economics notes that, as anticipated, plans to create a banking union by January 2013 are encountering political roadblocks which means the deadline will not be met. Like Auerback, he believe that achieving a full banking union isn’t pressing, but getting a deposit guarantee is. But he describes the impediments:
The whole point of having a supra-Eurozone backed insurer is that deposit holders in any participating country know that their savings are backed not just by their own national government, which may be struggling, but by all participating governments. In practice this should significantly reduce the outflow of deposits because, although probably not perfect, periphery banks will be seen as being considerably safer than they do today. Of course, as the article above says, deposits have been flowing towards the EZ’s stronger countries shoring up their banks so there is little incentive for France and German, especially, to support such a program.
But to be fair, German lawmakers aren’t the only ones with concerns about the new program. The head of the European Banking Authority thinks the proposal will create a two-tier banking system in Europe with rules applied differently in euro and non-euro countries:
Speaking to lawmakers in the European Parliament, Andrea Enria, the chairman of the European Banking Authority, warned that the union, forming a united front among euro zone countries to protect their lenders, risked seeing one set of rules applied to banks under the ECB’s watch and another to those outside.
“We risk a polarisation … between the euro area, with single rules and supervisory practices, and the rest of the (European) Union, which would operate with a still wide degree of national discretion in … applying the single rulebook.”
In his first public remarks since the announcement of the proposal, the Italian economist said that although banking union was something that “needs to be done now”, the challenge would be “finding the right glue to keep the single market together”.
His remarks reflect a concern shared by many countries that rules such as those on capital, that dictate how much banks must hold in reserve for losses, could be applied differently.
Yves here. So as much as the deposit flight problem needs to be solved sooner rather than later, it looks like it will require time or a crisis to achieve resolution. I don’t think it’s hard to guess which one I’d bet on.