David Green: Deposit guarantees, European style
So even if Apple Corporation's entire $160 billion cash pile was deposited at a single EU bank, none of that could be touched in a bail-in until all local authority deposits have been wiped out completely.
The latest EU law to impact on local authority treasury management is the recast Deposit Guarantee Schemes Directive which affects the operation of the Financial Services Compensation Scheme (FSCS) and similar deposit protection schemes across Europe. The Bank of England is currently consulting on how to transpose this directive into UK law, ready for the 3rd July 2015 deadline.
Among its many arcane rulings, the directive extends FSCS protection to all bank deposits except those made by public bodies or other financial firms, such as banks, pension funds and money market funds. The preamble to the directive is clear why public authorities have been singled out for exclusion: “Their limited number compared to all other depositors minimises the impact on financial stability in the case of a failure of a credit institution. Authorities also have much easier access to credit than citizens.” That is to say, the EU believes that passing the costs of bank failure onto companies would impact upon the real economy, but public sector bodies don’t impact on the economy in the same way. And you can always borrow the money that you’ve lost – don’t forget that in the crazy world of central government cash accounting, loans can count as income.
Now, you might think that having £85,000 of deposit insurance makes little difference to a multi-million pound investor like a large company or local authority. But you’d be forgetting the impact of that other new piece of EU law, the Bank Recovery and Resolution Directive. This ensures that insured deposits, even those above the £85,000 coverage limit, rank above uninsured ones in the creditor hierarchy. So even if Apple Corporation’s entire $160 billion cash pile was deposited at a single EU bank, none of that could be touched in a bail-in until all local authority deposits have been wiped out completely.
Now, I don’t know about you, but that doesn’t exactly sound fair to me. Earlier discussions on ending taxpayer funded bank bailouts revolved around the losses being borne by large investors, i.e. those with the broadest shoulders. This seems to have been replaced by those with the smallest voices.
Actually, the small print of the directive does make an exception for some local authorities. Member states can opt to extend insurance schemes to authorities with a budget of less then – wait for it – €500,000. Not much use to most readers of this blog, but that would cover most UK parish and community councils. Unfortunately, the Bank of England consultation doesn’t even mention this option. While it looks like the game is up for principal local authorities, maybe we could do our parishes a favour and respond to the consultation before the 7th January closing date asking the Bank to incorporate this exception.
The changing face of bank regulation isn’t all bad news for local authorities. International and European rules will force banks to hold more equity capital that can absorb losses while a bank remains a going concern, and more bonds that can be bailed in without touching deposits.
But with much of this good news deferred until 2019, while the bad news hits in the middle of next year, there are three and a half years where local authority deposits will be the loss-absorbing buffer for failing banks. With the BBB credit ratings we could see early next year indicating a higher chance of default, and the EU directives increasing the loss given default, surely it’s time to start questioning whether any bank deposits are suitable for local authority investments.
David Green is Client Director at Arlingclose Limited. This is the writer’s personal opinion and does not constitute investment advice.
Bailing in Locals is just a taxpayer funded Bail Out by another name.