Europe Is Warming to Depositor Bail-In

From: WSJ

With little fanfare, Europe’s banking union took an important step forward this week. The European Parliament is coalescing around making uninsured depositors explicitly senior to other bank creditors in the EU’s new bank-resolution rules. The “bail-in” proposal has been on the table since last June, but last month’s Cyprus debacle has concentrated policy makers’ minds.

The statements Tuesday by Gunnar Hökmark, the member of the Parliament’s Economic and Monetary Affairs Committee who is leading negotiations on the new measures, reflect a shifting consensus on the issue. Late last month, when Mr. Hökmark first suggested writing depositors into the bail-in rules at all, the euro tanked against the dollar. Since then, however, Mario Draghi has come out in favor of depositor preference, and bail-in generally has become less of the unnameable menace that it seemed just a few weeks ago.

Depositor-preference rules exist in various forms in some EU states. The principle has also been enshrined in the U.S. Federal Deposit Insurance Corporation’s rules since 1993.

The value of EU-level depositor preference would partly be political. One lesson of the Cyprus affair was that policy makers and the public view depositors as a protected class of creditors, even if deposits are in fact risk-taking investments just like bonds and shares.

Arguably, the current regime, which treats depositors as pari passu with senior bank bondholders, better reflects this economic reality. But as we’ve seen in Cyprus, depositors enjoy implicit seniority: The final bailout deal saw the uninsured depositors of the liquidated Laiki Bank transferred to the restructured Bank of Cyprus. Laiki’s senior bondholders, however, were wiped out.

Rules that make this differential treatment explicit will allow banks and their creditors to price risk more accurately. They will also reduce the likelihood of a chaotic bank rescue in the future. European politicians haven’t exactly distinguished themselves for making the right calls at late-night summits.

The same benefits can’t be ascribed to another hotly debated component of the banking union. Bundesbank chief Jens Weidmann and German Chancellor Angela Merkel both spoke this week at a conference of German savings banks in Dresden, and both took the opportunity to reiterate their opposition to a pan-EU deposit insurance fund.

Since last year, the Chancellor has spoken of joint deposit insurance as akin to jointly issued euro-zone debt. She’s right: Requiring national deposit-guarantee funds to lend to each other in times of need is a thinly veiled version of requiring that euro-zone governments do the same.

But more importantly, common deposit insurance wouldn’t have prevented the present crisis or made it any easier to manage. At the crisis’s peak, depositors pulled out of troubled countries’ banks not chiefly because they doubted governments’ ability to make good on their deposit guarantees. The bigger fear was that their deposits would suddenly and forcibly be denominated in a new, devalued currency.

The currency risk seems to have subsided for now, but asking German taxpayers to guarantee other countries’ banks won’t stop it from arising again. Rejecting joint deposit insurance and formalizing depositor preference will help ensure that Europe’s nascent banking union doesn’t turn into a bailout union.