Sunday, March 17, 2013

How to Create Runs on Banks

Saturday morning, the EU finance ministers decided that the island country of Cyprus would have to appropriate a significant portion of savers' deposits in return for 10 billion euro of bailout money.  The appropriation will occur via a 9.9% tax on deposits in excess of 100,000 euro and 6.7% on smaller accounts.  The levy will have to be affirmed by Cyprus' parliament, which will begin debate Monday.  This has all happened over the weekend; see here for more.

Naturally ATM machines were hit hard over the weekend, although it seems that this behavior is too late -- the tax will already be withheld from withdrawals.  Many people of course ran to the banks a bit earlier and got all their funds out.  It will be interesting to see how far back the government will reach -- will there be a deadline of, say, March 1 so that anyone who took funds out before then is left whole?

You can see how arbitrary this is going to become.  That is the nature of a bank run -- those who get their money out first stay whole; those who delay lose.

The incentives will be clear, no matter how much the EU says this will not create a precedent.  The sanctity of bank deposits will clearly be in question if this policy is ratified.

I wonder what the capital structure of Cyprus banks looks like?  There must be public debt and there certainly is (or was) equity.  As a matter of good principle, I would want to wipe out equity and public bondholders before I touch deposits.  The whole idea of deposits is that they are among the least risky financial assets (and usually pay rates of interest in accordance with their low risk!).

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