Sir Mervyn King once said it was not rational to start a bank run but rational to participate in one once it has started. The governor of the Bank of England was right, of course. On Saturday morning, the finance ministers of the eurozone may well have started a bank run.
With the agreement on a depositor haircut for Cyprus – in all but name – the eurozone has effectively defaulted on a deposit insurance guarantee for bank deposits. That guarantee was given in 2008 after the collapse of Lehman Brothers. It consisted of a series of nationally co-ordinated guarantees. They wanted to make the political point that all savings are safe.
I am using the expressions "in all but name” and “effectively” because legally, Cyprus is not defaulting or imposing losses on depositors. The country is levying a tax of 6.75 per cent on deposits of up to €100,000, and a tax of 9.9 per cent above that threshold. Legally, this is a wealth tax. Economically, it is a haircut.
I myself had favoured a haircut, or tax, on deposits of more than €100,000 – the portion not covered by the deposit insurance guarantee. There is no moral or economic reason to protect foreigners who have decided to park large sums in a Cypriot bank account for whatever reason. Such a haircut would also have been in line with the philosophy of deposit insurance. Its purpose is not to provide absolute certainty, but to prevent bank runs, which is what happens when you go after small depositors. Well-designed deposit insurance schemes thus impose ceilings.
I just could not believe it when I heard that eurozone finance ministers went after the small depositors in Cyprus. I understand the purely technical reason why they did it. The eurozone could not agree a full bailout, which would have cost €17 billion.
The Germans rejected a loan which they were certain Cyprus would invariably default on. So the sum was cut to €10 billion. A depositor haircut was the only way to co-finance this. When they did the maths, they found the big deposits would not have sufficed.
So they opted for a wealth tax with hardly any progression. There is not even an exemption for people with only very small savings.
If one wanted to feed the political mood of insurrection in southern Europe, this was the way to do it. The long-term political damage of this agreement is going to be huge. In the short term, the danger consists of a generalised bank run, not just in Cyprus.
As in the case of Greece, the finance ministers said: “Don’t worry, this is a unique situation”. This is true only in a very narrow legal sense. The bond haircut in Greece is indeed different to the depositor haircut in Cyprus. And when they repeat this elsewhere, it will be unique once more.
Unless there is a last-minute reprieve for small savers, most Cypriot savers would act rationally if they withdrew the rest of their money simply to protect them from further haircuts or taxes. It would be equally rational for savers elsewhere in southern Europe to join them. The experience of Cyprus tells them that the solvency of a deposit insurance scheme is only as good as that of the state. In view of Italy’s public sector debt ratio, or the combined public and private sector indebtedness of Spain and Portugal, there is no way that these governments can insure all banks deposits on their own.
The Cyprus rescue has shown that the creditor nations will insist from now that any bank rescue must be co-funded by depositors.
The really puzzling thing is why did people not withdraw their money before? Did they not read the newspapers? Maybe they trusted the new president of Cyprus, who had promised them that he would never accept this? And why has there been so little deposit flight elsewhere in southern Europe? Did they, too, trust their governments? More importantly, will they continue to do so now?
There are some institutional impediments against bank runs within the eurozone. Some countries impose daily withdrawal limits, ostensibly as a measure against money laundering. Nor is it easy to open a bank account in a foreign country. In many cases, you need to have residency. You may need to travel there in person, and you need to speak the local language – or at least English.
But I would not take too much comfort from those impediments. Once fear reaches a critical mass, people will act, and then a bank run becomes a self-perpetuating process. There has been a lot complacency about the eurozone crisis in the past eight months.
Many people even thought the crisis was over because Mario Draghi, president of the European Central Bank, gave a lender-of-last-resort guarantee. Bank depositors now understand that if the crisis was over, then that was only because the eurozone had found a new source of funding: their savings.
I have no idea whether or not there will be a bank run in the next few weeks. But surely it would be rational.
Copyright The Financial Times Limited 2013.