Back on June 27th, Minister for Finance Michael Noonan pronounced: "Bail-in is now the rule". After a year of argument and all night negotiating sessions among EU finance ministers, they had finally agreed a set of rules that could be used to wind up insolvent banks. In future, banks creditors – including potentially savers – would suffer losses should European financial institutions collapse.
Bank “bail-ins” first entered public consciousness during the Cypriot financial crisis last March, when the EU and IMF forced creditors and some depositors to forfeit part of their investments and savings to keep the banks alive. At the time, there were strong denials that bail- ins were now part of the template for future bank crises. With their accord, EU finance ministers confirmed that they are.
This was a "rubicon". Bank deposits are no longer sacrosanct. This made market participants as well as retail and corporate depositors nervous, especially in vulnerable EU countries.
Restructuring
Bail-in generally refers to restructuring where shareholders and various unsecured creditors, such as bondholders, share the rescue costs: after Cyprus, the term became synonymous with possible deposit confiscation. Depositors were now seen as unsecured creditors and liable to share bank restructuring costs.
The concept of bail-ins as a central bank mechanism to rescue insolvent banks has been discussed openly for some time among central bankers and multilateral institutions. The majority of G20 nations now have or are adopting legislation that will allow for bail-ins in the event of banks getting into difficulty.
So how likely is it that bail-ins will be seen in Ireland?
Most analysts believe there is little chance in the short term. Irish banks are well provisioned and capitalised. The medium-term outlook is less certain, however. Much will depend on how the residential property market and SME business loans perform. Should the fragile recent recovery in the domestic economy falter, both sectors will come under pressure again, impairing the financial positions of some banks.
As a small island nation, Ireland is very dependent on how our large EU, British and US trading partners do. Should those economies stumble, the knock-on effects will be seen in Ireland, including in the banks.
There is also the not immaterial risk of another Lehman Brothers type crash and a new global financial crisis. Five years after Lehman, the world's biggest banks are even bigger and the $60 trillion shadow banking system, with some $700 trillion worth of over-the-counter derivatives, is also bigger. The system depends more than ever on investor faith in central banks.
Reconsider
In Ireland, with interest rates at post-second World War lows and unlikely to go lower, 18 per cent of mortgage accounts are now in arrears – amounting to €25 billion of debt. Should interest rates begin to rise, even more mortgages could slip into arrears. The so-called pillar banks may well be forced to reconsider bad debt provisions in that case, putting them in need of further capital investment.
The consequences of bail-ins are more negative than many realise. Some commentators argue they are good as the wealthy are penalised rather than hard- pressed taxpayers as under bailouts. However, the wealthy already have much of that wealth in non-cash assets and in deposits and assets offshore.
Many other depositors have large cash deposits offsetting debts elsewhere. Were bail-ins to occur, they would badly affect the remaining wealth of the already hard- pressed middle classes, of entrepreneurs and the SME sector – the backbone of the Irish economy. Consumer and business confidence would likely suffer, bringing attendant consequences in the economy.
A policy of bail-ins in one European economy could lead to a series of mini- runs on financial systems all over Europe, especially should a pillar bank report poor earnings or a government miss a fiscal target. Rather than calm nerves, a policy of bail-in may well be a Pandora’s box of unexpected economic risk.
In Cyprus, it drained trust in the banks. Capital controls were required to prevent a flight of capital out of the country. As one of the most globalised economies, capital controls in Ireland would severely damage the economy.
After the period of austerity following our own bailout, the risk is that wealth confiscation by bail-in is a radical step too far for an already very fragile economy.
Stephen Flood is director and head of bullion services at GoldCore Ltd
