EU Banks Remain Massive Problem

While the US and the UK were mired in political chaos during 2017 the EU claimed it was experiencing improved economic conditions. It appears this did little to move Europe in the direction of implementing long-needed EU and eurozone reforms, instead it merely fueled the complacency that has haunted the region for so long and has set the stage for another crisis down the road. How can anyone claim the situation is under control when a story in Reuters in the middle of last year claimed officials in Europe actually think that telling the public that they will not have access to their funds, even funds covered by official deposit insurance was somehow helpful to addressing Europe’s troubled banking system.  

This is a reminder to anyone thinking that Europe is anywhere close to adopting an effective approach to dealing with failing banks that they may want to think again. The policy that has been in the works for some time was floated out for a reaction less than two months after a run on deposits at Banco Popular contributed to the collapse of the Spanish lender. Judging by the continued reaction by investors and on social media, it appears that the EU has learned nothing about managing public confidence when it comes to the banking sector. That could be why even today the European Central Bank is having difficulty raising rates and has been unable to discontinue its program of asset purchases.

EU Will Not Address "Bank Failures"

All this makes a strong argument that nothing is really better or has been fixed in the Euro-zone and that the area continues on life-support. Why would the ECB leave its refinancing rate at 0%, and the rate paid on deposits parked overnight at the bank at negative 0.4% and the rate on the deposit facility at 0.25% if indeed the economy was on sound footing? The ECB even repeated that it expects rates to remain at present levels "for an extended period of time, and well past the horizon of the net asset purchases." While some Wall Street analysts started encouraging investors to jump into EU bank stocks last year, the fact is that there remains nearly €1 trillion in bad loans within the European banking system.  

This represents around 6.5%  of the EU economy.  That compares with non-performing loans (NPL) ratios in the US of 1.7% and 1.6% of gross domestic product in Japan. Circling back to the issue of the banking sector and public faith in these institutions, the idea that the banking public would ever be denied access to cash virtually ensures that deposit runs and wider contagion will occur in Europe next time a depository institution gets into trouble. The US learned the hard way in the 1930s and again with the S&L crisis in the 1980s, the lack of a robust national deposit insurance function to protect retail depositors leaves an entire society vulnerable to banks runs and debt deflation.

Until the EU is prepared to do “whatever is necessary,” to paraphrase ECB chief Mario Draghi, in order to protect retail bank depositors, the EU will remain far from being a united political economy. The truth is the Europeans appear to be playing a very dangerous game. On the one hand, EU officials talk publicly about getting tough on insolvent banks and even suspending access to funds for retail depositors.  On the other hand, EU governments are continuing to bail out banks and large creditors in a display of cronyism and business as usual. Making matters worse is that there appears to be a significant number of officials in Europe who seriously believe that denying retail bank customers access to funds covered by deposit insurance does not result in financial contagion.

In the US, the Federal Deposit Insurance Corporation (“FDIC”) begins to market troubled banks before they fail and makes an effort to execute bank closures and sales on a Friday to avoid frightening the public.  The branches of the failed bank are then open on the following business day as part of a solvent institution without any interruption in customer access to funds. The important thing is that all insured depositors are always paid out by the FDIC when the failed bank is closed in order to avoid precipitating runs on other institutions.   

In the same way, Eurozone politicians still refuse to deal with Greece’s mounting debt they cannot seem to accept the fact that protecting the small depositors of European banks is necessary to prevent the same sort of bank runs they saw in Cyprus and Greece. If this is not done runs on banks could intensify and spread to other countries in Europe.  Imagine that a large bank failure occurs in Italy and Italian officials would tell retail customers that they will not have access to any funds for several weeks. It is not difficult to see how this would expand concern about banks in other countries. It seems that regardless of the cost guaranteeing the banks are sound and depositors money is safe is the price that must be paid for preserving social order and the EU itself.