bank run as defined by Barron’s dictionary of banking terminology as follows: ‘A series of unexpected cash withdrawals caused by a sudden decline of depositor confidence or the fear that a bank will be closed by the chartering agency. Today the ‘silent run’ is much more prevalent than bank runs in the past where customers lined up in front of the tellers window and demanded their cash. Today depositors simply transfer interest rate sensitive funds – called ‘hot money’ to other institutions, also called ‘a run on the bank’.
Several things have been happening in Ireland that feed into this, firstly is that some banks are leaving the country, that partly helps to make the €40bn that left in December make sense (the figure for all of 2010 is about €110bn). Then there are confidence issues with downgrades and the like.
One of the most common personal finance questions I get is about deposits being safe in the bank here, and on sums below €100,000 I hand on heart believe that to be the case.
Efforts to save banks don’t always work, but they are often more successful than efforts to save yourself -if you look at Argentina in the start of the last decade the system was falling apart, Argentinians, desperate to put their cash somewhere safe moved all of their money into Uruguay the so called ‘Switzerland of South America’.
The Uruguayans fearing contagion equally took out all of their money and again, ATM’s stopped working, everybody lost money, Argentinians looking for a safe haven having taken the majority of the damage, a friend in PWC there told me that in effect, Argentinians ensured that fewer Uruguayans took ‘the hit’. Even today, nearly a decade later there is a fundamental mistrust of banks in both of those countries.
In fact, Banc do Brasil in the heart of Montevideo still lies empty as testament to this period. When GMAC fell apart in the US people with more than $100,000 were left wondering for months whether they would get any of the balance over that amount back, and I trust the FDIC far more than the ECB!
I don’t think we will see that in Ireland, a blog post by Lorcan Roche Kelly adequately sums this up. The thing that isn’t being mentioned though is the role of corporate and banking treasury departments in the way that they manage their money and how it is causing the flight of deposits.
Take a pension fund in Arizona, they wanted Euro deposit exposure and they are happy with leaving it in Ireland, but part of their policy is that they can’t keep money on deposit with any institution that is less than A3 or A- (quoting Moody’s & S&P respectively), an upper medium grade rating.
We have passed from upper medium grade last year to lower medium grade, but in 2011 we crossed the Rubicon into the Ba1/BB+ territory which is non-investment grade speculative.
Commonly referred to as ‘junk’, Irish banks earned this esteemed rating on the 11th of February.
What I can say is that any depositors who were holding out before on the corporate deposit side will now be giving up the ghost. The big damage wasn’t done in Q3 or Q4 of last year, it is happening right now. As you read this there is quietly money flowing out of our banks into other banks.
The fact is that even people on the street are afraid, fear doesn’t mean that banks go under, it just exacerbates an existing problem. Banks are a confidence game, I mean that in strict adherence to the nature of the word ‘confidence’ as opposed to implying a ‘con’.
Fractional reserve banking means that they never have the actual cash to hand that is necessary if all liabilities are called in at once; while deposits are ‘capital’ on the balance sheet they constitute a liability to the bank.
To get over this loss of depositor cash banks are increasingly using repurchase markets, often called ‘repos’, currently the main market maker is Goldman Sachs in London and haircuts are in the region of 30% on high quality assets. To address liquidity the banks are leasing out their remaining good assets, but that is different than the issue that is occurring with solvency. The repurchases that could be placed with the ECB or Irish Central Bank are already being done, as was a further €17bn of ‘self sold’ or ‘own bond’ issuances under the ELG, effectively any usable asset is on lease.
The tricky situation is that while deposits fly away that banks in fact have fewer liabilities, but at the same time it affects their capital position. That is what the updated PCAR and PLAR reviews are for.
Suffice to say, that somebody somewhere just clocked into work and sat down to their treasury workstation, and the alert came up with an allocation order for part of their assets under management. That alert is saying to move x amount of money away from an Irish bank to another place.
It is mechanical in nature, yes, confidence and news about Ireland plays a part, but with many other funds it is just a domino effect of ratings versus allocation. That is part of the role that treasury managers work with, Irish banks are doing the exact same thing with other banks in other jurisdictions that get similar downgrades.
So the next time you hear that we are downgraded and people say ‘ah sure it doesn’t matter, sure we aren’t out in the market looking for money so it doesn’t affect bond pricing’, be sure to remind them that a corporate can’t list above the credit rating of the sovereign and that mechanical trades will be occurring that make our banks weaker as a result of it. We might not be ‘looking to the markets’ for money, but it doesn’t mean we won’t be looking anywhere for money fairly soon, the biggest damage to deposits to date is likely being done as we speak.