Cyprus was right to hit big deposits – but Europe must still end too big to fail

Anthony Browne
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CYPRUS is still a going concern, or at least it was at the time of writing this yesterday tea time. But the difficulties the EU has had in stabilising one of its tiniest members offers many lessons. European politicians are wondering how they can improve their co-ordination in future, but there are also implications for banking sector policy and regulation.

The first is the importance of preserving the €100,000 deposit guarantee, both in spirit and in law. The initially-proposed tax on deposits under €100,000 was in technical compliance with the EU-wide deposit guarantee scheme, but a clear breach of its spirit. Savers were going to lose money unless they took it out of the bank, which would have caused a bank run (had the banks been open). But it was so politically unacceptable that not a single Cypriot MP voted for it. This has thrown down the gauntlet to anyone tempted in the future to take money from ordinary savers to rescue the financial system.

The other major lesson is the importance of banks having proper recovery and resolution plans, or living wills. In a European context, that means stopping the prevarication and adopting the Recovery and Resolution Directive as quickly as possible. It must be the top priority for the Irish European presidency. It is essential for ending the problem of “too big to fail”, and averting future Cyprus-style crises.

Five years after the financial crisis, the EU still doesn’t have a proper legal framework for the orderly recovery of banks, or for resolving them in an orderly fashion if they do collapse. And a statutory bail-in power is a critical part of the internationally-agreed package to protect taxpayers against the consequences of a bank failure. Under bail-in, certain creditors of banks (like bondholders) would take a loss on their investment (by turning it into shares) to provide the bank with capital to stave off collapse. But to be fully effective, the bail-in regime must apply to as broad a scope of liabilities as possible, to maximise the chances of the bail-in being successful and to minimise the size of the haircut shared by creditors. Uninsured depositors – those with over €100,000 in the bank – are effectively senior creditors, bearing some of the credit risk of failure.

European leaders have observed that the Cyprus saga meant they had transferred the risk of failing banks from taxpayers to creditors. In the first rescue proposal, taxpayers were taking the burden, albeit via a novel route; in the second one it was creditors. That is exactly as it should be.

We have long been agitating for a full legal framework to ensure that taxpayers will never again have to bail out failing banks. That means having better-capitalised banks to ensure they are safer in the first place; it means banks having legally-enforceable living wills; and it means putting firewalls around banks to ensure no systemic contagion in the event of failure. There has been more progress in some areas than others – the banks, for example, have more than tripled their core capital levels since 2007. Other pieces – such as living wills and firewalls – are coming, but are not yet in place. Cyprus shows what the consequences of that can be.

Anthony Browne is chief executive of the British Bankers’ Association.