{"id":37290,"date":"2013-04-03T22:52:28","date_gmt":"2013-04-04T02:52:28","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=37290"},"modified":"2013-04-03T22:52:28","modified_gmt":"2013-04-04T02:52:28","slug":"deposit-insurance-good-riddance-to-this-bogus-scheme","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/04\/03\/deposit-insurance-good-riddance-to-this-bogus-scheme\/","title":{"rendered":"Deposit Insurance: Good Riddance to This Bogus Scheme"},"content":{"rendered":"

By MoneyMorning.com.au<\/u><\/a> <\/p>\n

Once the public furore and shrill media coverage have died down, it will become clear that events in Cyprus<\/a> did not mark the death of democracy or the end of the euro, but potentially the beginning of the end of deposit \u2018insurance\u2019<\/strong>.<\/p>\n

If so, then three cheers to that. It may herald a return to honesty, transparency, and responsibility in banking.<\/p>\n

Let us start by looking at some of the facts of deposit banking<\/strong>: When you deposit money in a bank, you forfeit ownership of money and gain ownership of a claim against the bank \u2014 a claim for instant repayment of money, but a claim nonetheless. In 1848, the House of Lords stated it thusly:<\/p>\n

\u2018Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him, when he is asked for it…<\/i><\/p>\n

\u2018The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in hazardous speculation; he is not bound to keep it or deal with it as the property of his principal, but he is, of course, answerable for the amount, because he has contracted.\u2019<\/i><\/p>\n

This is not legal pedantry or just a matter of opinion, but logical necessity. It follows inescapably from how deposit banking has developed, how it was practiced in 1848, and how it is still practiced today.<\/p>\n

Deposit Banking Has Been the Same for 300 Years<\/h2>\n<\/p>\n

If ownership of the money had not passed from depositor to banker, then the banker could not lend the money to a third party against interest. He could not then pay interest to the depositor. If the depositor had retained full ownership of the deposited money, the banker would only be allowed to store it safely and to probably charge the depositor for the safekeeping of his property.<\/p>\n

Money stored in a bank\u2019s vault earns as little interest as money kept under a mattress. It is evidently not what bank depositors <\/strong>contract for. If interest<\/a> is being paid or \u2018free\u2019 banking services are being provided, then the depositor must have at least implicitly agreed that the banker can \u2018invest\u2019 the money, i.e., put it at risk.<\/p>\n

For more than 300 years, banks have been in the business of funding loans that are risky and illiquid with deposits that are supposed to be safe and instantly redeemable.<\/p>\n

When banks fail, depositors lose money, although in former times, no rational person claimed that the depositors were unfairly \u2018bailed in\u2019 (a bail-in is an agreement by creditors to roll over their short-term claims or to engage in a formal debt restructuring with a troubled country) or were the victims of \u2018theft\u2019.<\/p>\n

Although the mechanics of fractional-reserve banking have not changed in 300 years, the public\u2019s expectations have greatly changed. Today, banks are expected to lend more generously than ever while depositors are supposed to not incur any risk of loss at all. This means squaring the circle, but it has not stopped politicians from promising such a feat.<\/p>\n

Enter deposit insurance.<\/p>\n

The Bogus \u2018Insurance\u2019<\/h2>\n

\nState deposit \u2018insurance\u2019 is not insurance at all<\/strong>. Insurance companies calculate and calibrate risks, charge the insured party, and set aside capital for when the insured event occurs. A state deposit \u2018guarantee\u2019, by contrast, is simply another unfunded government promise extended in the hope that things won\u2019t get that bad.<\/p>\n

Eventually, the state does what it always does, i.e., take from Peter to pay Paul. Cyprus is a case in point. Private insurance companies would have pulled the plug on a ballooning banking sector long ago. The Cypriot state, still the local monopolist of bank licensing and bank regulation, simply looked on as the banks amassed deposits of four times GDP.<\/p>\n

In the end, Cyprus\u2019 government<\/a> ran out of \u2018Peters\u2019 to stick the bill to \u2014 and \u2018Hans\u2019 in Germany refused to get \u2018bailed in\u2019 completely (although he is still providing the lion\u2019s share of the bailout).<\/p>\n

Cyprus is just an extreme example of what the institutionalised obfuscation of risk and accountability that comes with state-protected banking can lead to. Deposit \u2018insurance\u2019 masks the risks and socialises the costs of fractional-reserve banking. Unlimited state paper money and central banks<\/strong> that assume the role of \u2018lenders of last resort\u2019 have the same effect.<\/p>\n

If the original idea behind these innovations was to make banking safer, it has not worked, as banks have become bigger and riskier than ever before, although I suspect that the real purpose of these \u2018safety nets\u2019 has always been to provide cover for more generous bank credit expansion.<\/p>\n

Under present arrangements, there is little incentive for banks to position themselves in the marketplace as particularly conservative. Depositors have been largely desensitized to the risks inherent in banking.<\/p>\n

They no longer reward prudent banks with inflows, nor do they punish overtly risky banks with the withdrawal of funds. And even if they do, the banks can now obtain almost unlimited funds from the central bank<\/a>, at least as long as they have any asset that the central bank is willing to \u2018monetise\u2019.<\/p>\n

This is a low hurdle, indeed, as banks have become conduits for the never-ending policy of \u2018stimulus\u2019 and are thus being fattened further for the sake of more growth. Once a bank has \u2018ticked the boxes\u2019 and meets the minimum criteria of regulatory supervision, any additional probity would only subtract from potential shareholder returns.<\/p>\n

Our modern financial infrastructure has created an illusion of safety <\/strong>coupled with an illusion of prosperity, thanks to artificially cheapened credit<\/strong>. The risk of the occasional run on an individual bank has now been replaced with the acute and rising risk of a run on the entire system.<\/p>\n

This would change radically if we reintroduced free market<\/a> principles into banking. Bankers would again be answerable to all their lenders, including small depositors, who would no longer be lulled into a false sense of security. Rather, in their proper role as creditors to the banks, they would become \u2018deposit vigilantes\u2019 and would help keep the banks in check.<\/p>\n

In order to gain and maintain the public\u2019s trust, the banks would again have to communicate balance sheet strategy and risk management to the wider public, not just to a handful of highly specialized bureaucrats at the central bank or the state\u2019s bank regulator. Banking would become less complex, more transparent, and less leveraged<\/strong>. Conservative banking would again be a viable business model.<\/p>\n

The wider public would begin to appreciate how dangerous the populist policies of cheap credit and naive demands for \u2018getting banks lending again\u2019 ultimately are. The depositors would finally realize that they\u2019re underwriting these policies and that they carry the lion\u2019s share of the risks.<\/p>\n

Detlev Schlichter<\/b><\/p>\n

Contributing Writer, Money Morning<\/i>\u00a0<\/b><\/p>\n

Join Money Morning on Google+<\/u><\/a><\/strong>\n<\/p>\n

Publisher\u2019s Note<\/i>: This article first appeared here<\/a>.<\/p>\n

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<\/p>\n","protected":false},"excerpt":{"rendered":"

By MoneyMorning.com.au Once the public furore and shrill media coverage have died down, it will become clear that events in Cyprus did not mark the death of democracy or the end of the euro, but potentially the beginning of the end of deposit \u2018insurance\u2019. If so, then three cheers to that. It may herald a … <\/p>\n

Continue reading “Deposit Insurance: Good Riddance to This Bogus Scheme”<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-37290","post","type-post","status-publish","format-standard","hentry"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/posts\/37290","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/comments?post=37290"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/posts\/37290\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/media?parent=37290"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/categories?post=37290"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/tags?post=37290"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}