EU-Wide Bank Deposit Scheme: Neither Politically Feasible nor Credible

With the risk of a bank run in the EZ rising, there has been talk amongst EU policymakers of creating a European-wide bank deposit guarantee scheme. Over the past week, members of the European Commission and ECB president Mario Draghi have all spoken out in favour of such a scheme. This would be a form of fiscal union through the back door and therefore a step in the right direction for the EZ, but it is very unlikely to be politically feasible or credible.

Though European policymakers are in favour of a European-wide deposit guarantee scheme, Germany most certainly is not. Even if the German government were willing to sign Germany up to backstopping bank deposits in the southern European countries, the German Constitutional Court would find it illegal on the basis that Germany’s financial exposure would be unlimited in nature.

To get around this problem, a cap could be placed on the European-wide bank deposit guarantee scheme, with only deposits up to a certain level guaranteed. If the cap is not high enough—and history has shown that in the EZ crisis response, the figures are never high enough—then it would most likely exacerbate a bank run as depositors rushed to withdraw their cash above the established threshold.

Even if an unlimited European-wide bank guarantee deposit scheme were politically feasible, it would probably lack credibility. Total EZ deposits amount to roughly €15 trillion. The European bailout funds—the EFSF and the ESM—together total €0.5 trillion. Granted, not all deposits will need to be guaranteed as we are very unlikely to see a bank run in the likes of Germany and Finland. But still, the gap is sufficiently large to make anyone skeptical that an unlimited deposit guarantee scheme really could backstop all EZ deposits. The only way this gap could be filled is if the ECB  were willing to print a wall of money to plug the hole. As I have argued several times already, it is extremely unlikely the ECB will fire up the printing presses in an unlimited fashion.

More importantly, depositors are withdrawing their money from peripheral EZ banks because they are concerned about their savings being redenominated and devalued away should their country exit the EZ. A European-wide deposit guarantee scheme cannot guarantee against a redenomination.

We have seen that national bank deposit guarantee schemes have failed to stem the “bank jog” currently occurring in the weaker EZ countries. A European-wide bank deposit guarantee would be an improvement, but even if it could be agreed by European leaders, it may on its own still fail to stop a bank run.

Click here for Roubini Global Economics’ assessment of what policy measures will be taken in the event of a bank run in the EZ.

This post originally appeared at Economist Meg and is posted with permission.

2 Responses to "EU-Wide Bank Deposit Scheme: Neither Politically Feasible nor Credible"

  1. bstout   June 4, 2012 at 4:58 pm

    Much obliged for a wonderfully clear, insightful, and educational post.

    I'm a experimental homebuilt flyer in the northern Sierra Nevada on the Californian side. At the airfield we have a saying about first flight of an aircraft, "someone's gotta bite off the first chew."

    I reckon those "EU policymakers" are still drawing straws who'll be in that bird for first flight or leaving the ship in the hangar to gather dust and deteriorate.

    "Simplicate, and add more lightness" – Bill Stout

  2. tom   June 5, 2012 at 6:02 pm

    Thanks for all your great posts on the euro crisis. I agree that a euro wide deposit guarantee scheme isn't feasible, but for different reasons.

    As I see it, the EZ already has an established response to bank runs: to provide banks with practically unlimited central bank refinancing, and where glaringly necessary, publicly re-capitalize banks. This has so far kept its banking system working without any major panics. If Europe suddenly tried to develop an EZ-wide deposit-guarantee system in the middle of this crisis, it would signal that authorities are preparing to let banks fail, and that could lead to all kinds of uncertainty and havoc.

    Remember that in the United States, with its well established resolution and deposit guarantee system, authorities chose instead to publicly recapitalize larger banks while providing them with practically unlimited central bank refinancing.

    Europe is very different though and has a key stress point in coming up with the recap funding. It has now hit a point where a big country (Spain) glaringly needs a big chunk of recap funds, and everyone seems unsure what to do.

    Personally I expect to eventually see some manner of ECB funding of national governments, on a scale much bigger than SMP. Perhaps an ESM with a banking license? Or whatever else they can slip past the German judges. We'll see.