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Let Savers Take The Hit If Banks Fail, Urges Policy Exchange

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http://www.telegraph.co.uk/finance/economics/8212889/Let-savers-take-the-hit-if-banks-fail-urges-Policy-Exchange.html

By restructuring savings accounts, regulators would be free to let bondholders bear a share of losses in any future banking failure – removing the obstacles that "threaten the ethical foundations of capitalism", said Andrew Lilico, Policy Exchange's chief economist.

The biggest mistake of bank rescues across the world in the latest crisis was that bondholders were largely unaffected, he said.

"State guarantees of bank creditors threaten the ethical foundations of capitalism, making it a system in which the poor pay taxes so that the system can keep the rich rich, regardless of how foolish, lazy, or unlucky the loans they have made might be."

He added "such guarantees mean that remuneration schemes will involve more risk-taking" as bankers target larger bonuses. The Bank of England has revealed that the guarantees were worth £100bn to the big UK banks in 2009.

Regulators are devising new resolution regimes that would see bondholders take losses to strengthen a struggling bank.

However, Mr Lilico said: "Bondholders are too entangled with depositors for losses to be imposed upon bondholders without also imposing losses on depositors."

By disentangling depositors and bondholders, regulators would be able to trigger a resolution regime if a bank was at "risk of becoming insolvent".

So does this mean depositors will be offered equal footing with bondholders with interest earned?

Also if the bank gets to take huge risks with your money then you should also be entitled to similar rewards to the guy taking all the risk with your money. Bonuses all round.

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It seems like a question about seniority to me. Who takes the losses first and now much. A bank is not a storage warehouse for money. When you deposit your money with a bank you lose all rights to it. You have exchanged your money for bank credit and no longer have any money. The bank credit only has value so long as someone will accept it in return for money. Thus the depositor is in the same position as the bondholder. If the bank goes under, everyone takes a haircut depending on how much the remaining assets are worth. However most savers are covered by the government guarantee.

The problem is that this is not the kind of scheme that many savers want. They will put cash under the mattress rather than analyse banks risk profiles. So a new breed of bank will be born, charging fees, to offer this service. There is much to be said for the old division between retail and investment banking. If the punters want to risk their capital with investment banks, so be it. But they must learn to eat their losses if their bets go wrong.

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BTW, I feel this thread has the wrong subheading. The important bit is:

"Banks should offer customers two types of deposit account, one with a blanket guarantee that pays little interest and one that leaves savers exposed to losses"

This is the narrow banking concept and one which I and others have been pushing for on this forum. It is also what Carswell and Baker are trying to get voted through parliament.

If you have two types of account:

- one with counter party risk + a return (investment)

- one with no counter party risk + no return (storage)

Then people can chose their risk exposure. If you end up with money in an 'investment' account when a bank fails, then you would likely take a loss. If you had your money in a 'storage' account, then you would not.

Pretending that all accounts are risk free, when peoples' money is being used to speculate with by the investment bankers, is 'alchemy' (in the words of Mervyn King). I very much agree that this needs to change.

Edited by Traktion

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However, Mr Lilico said: "Bondholders are too entangled with depositors for losses to be imposed upon bondholders without also imposing losses on depositors."

But depositors only get 85K protection, so, can't the bondholders be given just 85K protection as well?

Peter.

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Of course, he's right.

But then if we did this we'd have no banks, as no one would deposit any money in them.

Which the PTB dont want.

People would certainly deposit less in risk bearing accounts, but this is entirely as it should be. The assumption that all accounts are 'risk free', is clearly a nonsense (unless you can borrow from the next generation and/or print money).

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But depositors only get 85K protection, so, can't the bondholders be given just 85K protection as well?

Peter.

Who is paying for this protection? It would just create an even bigger potential taxpayer liability.

Maybe they are 'bond holders are too entangled with savers' because many are bond holders are those with pensions (being saved). If you mainly hurt those saving for pensions instead, would you feel that is just?

It's all a bit of a mess and I don't think you can just target bondholders (although they need to take a hit too). You can target the shareholders (who clearly risked their money), but beyond that, it's a bit grey over who else should take haircuts first, IMO.

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Of course, he's right.

But then if we did this we'd have no banks, as no one would deposit any money in them.

Which the PTB dont want.

On the contrary, people would deposit money with them. The difference is though, that the rates of interest the people would demand would be a lot higher.

And if you wanted a mortgage, the banks would charge you a correspondingly higher rate.

That isnt such a bad thing. If there was more fear in the system, then things are less likely to go wrong.

So lets do it, have two types of bank account. One that charges you for using it, a transactional monetary system, but where the money is not lent out to anyone. This is paid for by charges to the customer. And next to that a deposit type account, that pays you interest, but is not protected in the case of bank failure. Make it a legal requirement for banks to offer depositors the same rate of interest as they offer to bondholders, taking into account the amounts deposited (better rates for bigger deposits), and the length of time the money is tied up for.

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People would certainly deposit less in risk bearing accounts, but this is entirely as it should be. The assumption that all accounts are 'risk free', is clearly a nonsense (unless you can borrow from the next generation and/or print money).

Why would anyone deposit anything if you were'nt ahead of bondholders in event of default/liquidation in the line of creditors though?

I cant see why both bondholders and depositors would exist were it not for the risk and return differential in either.

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On the contrary, people would deposit money with them. The difference is though, that the rates of interest the people would demand would be a lot higher.

And if you wanted a mortgage, the banks would charge you a correspondingly higher rate.

That isnt such a bad thing. If there was more fear in the system, then things are less likely to go wrong.

So lets do it, have two types of bank account. One that charges you for using it, a transactional monetary system, but where the money is not lent out to anyone. This is paid for by charges to the customer. And next to that a deposit type account, that pays you interest, but is not protected in the case of bank failure. Make it a legal requirement for banks to offer depositors the same rate of interest as they offer to bondholders, taking into account the amounts deposited (better rates for bigger deposits), and the length of time the money is tied up for.

PTB wouldnt let it happen.

Zopa have a lower default rate than the banks, and, as you say, often a higher interest rate. But they dont offer MPs non-exec positions, so dont get the FSCS bailout, so remain a *very* niche operation.

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On the contrary, people would deposit money with them. The difference is though, that the rates of interest the people would demand would be a lot higher.

And if you wanted a mortgage, the banks would charge you a correspondingly higher rate.

That isnt such a bad thing. If there was more fear in the system, then things are less likely to go wrong.

Why?

The people taking these risks still have the same one way bet as before, i.e. if the risk pays off they take the bulk of the profit and if it goes bad someone else takes the loss.

The only difference is we will have changed the "someone else" taking the loss, at the expense of having to share a very misiscule part of the profit.

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People would certainly deposit less in risk bearing accounts, but this is entirely as it should be. The assumption that all accounts are 'risk free', is clearly a nonsense (unless you can borrow from the next generation and/or print money).

which leaves less money to speculate, which leads to reduced bonus.

ergo, it won't happen.

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Why?

The people taking these risks still have the same one way bet as before, i.e. if the risk pays off they take the bulk of the profit and if it goes bad someone else takes the loss.

The only difference is we will have changed the "someone else" taking the loss, at the expense of having to share a very misiscule part of the profit.

People would still put their money in the bank, only which bank?

Those banks that pay high bonuses and take huge risks, wont be getting my money. They will either have to lend like legends, or more likely go bust.

If the taxpayer isnt on the hook for the losses, you will find that in short order there is a return to sensible lending. Only those banks that are sensible with lending, and transparent, will be able to attract enough deposits to fund their operations.

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People would still put their money in the bank, only which bank?

Those banks that pay high bonuses and take huge risks, wont be getting my money. They will either have to lend like legends, or more likely go bust.

If the taxpayer isnt on the hook for the losses, you will find that in short order there is a return to sensible lending. Only those banks that are sensible with lending, and transparent, will be able to attract enough deposits to fund their operations.

Leave it to the market!

As it stands, the guarantee applies equally to all banks, regardless of their recklessness or prudence. And the industry-funded scheme is doubly-perverse, as it charges more if you raise more money via safer deposits than if you raise it Northern Rock style in speculative money-market instruments that have to be renewed daily.

Instead of taxpayer guarantees, let deposits be covered by insurance. That is to say, insurance from the highly-regulated insurers, not free-for-all derivative instruments like credit default deals. That way insurers are looking over the shoulders of the banksters, and charge a premium that reflects the level of risk, 'cos it's their own money on the line!

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Why would anyone deposit anything if you were'nt ahead of bondholders in event of default/liquidation in the line of creditors though?

I cant see why both bondholders and depositors would exist were it not for the risk and return differential in either.

Regarding who should lose out, I'm just outlining that bondholders are people all around us. By targeting 'them', many of 'us' will take a hit on 'our' pensions. One way or another, losses will be born if there is insufficient capital reserves and assets, to cover all liabilities of bondholders and depositors in full.

As to whether people would risk their money, if they thought they weren't in the appropriate place in the queue, that sounds like the market pricing risk more appropriately, to me. The banks should be competing for your money, based on said risk/return profiles. Instead, we are lead to believe that all banks are equally safe, which encourages the banks to maximise risk, in search of profit.

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I've mentioned this before - but it is exactly this sort of arrangement that building societies have - and they used to have the vast bulk of the nation's savings.

You can either opt for a lower paying deposit account or a higher paying 'share account'. The deposit accounts do not bear any membership rights whilst share accounts do. Deposit accounts sit above share accounts when bankruptcy occurs and would have a very good likelihood of 100% payout.

Trouble is how many people are aware of the niceties? How many people working for them these days are aware of these niceties? It used to be an important distinction but it is one of these things that if bankruptcy doesn't happen for a generation or so, the collective memory gets wiped out and the thought of a bank going bust becomes impossible to conceive of - hence the death of the distinction and people just opt for the higher paying of the accounts. Especially when everyone is bailed anyway.

Of course when rates are so low, there is no incentive for your money to be risked at all which could lead to its own set of problems.

If you are worried about your savings - just go into a branch tell them of your concerns and tell them that's why you've opted to open a deposit account with them - (they won't know what you're going on about).

It's not just the people who have forgotten about the risks, but also the government and policy makers too. The former have been sucked into trusting the banks, because the latter have made little attempt to make the risks obvious; in fact they have hidden the risk through huge deposit guarantees and bailouts.

While I can sympathise with emergency action (to a degree) to stop the banking system completely exploding, we surely can't tolerate this situation indefinitely. Risk needs to be correctly appropriated, not papered/borrowed over by the government, while the banks play fast and loose.

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On the contrary, people would deposit money with them. The difference is though, that the rates of interest the people would demand would be a lot higher.

And if you wanted a mortgage, the banks would charge you a correspondingly higher rate.

That isnt such a bad thing. If there was more fear in the system, then things are less likely to go wrong.

So lets do it, have two types of bank account. One that charges you for using it, a transactional monetary system, but where the money is not lent out to anyone. This is paid for by charges to the customer. And next to that a deposit type account, that pays you interest, but is not protected in the case of bank failure. Make it a legal requirement for banks to offer depositors the same rate of interest as they offer to bondholders, taking into account the amounts deposited (better rates for bigger deposits), and the length of time the money is tied up for.

Exactly - let the market decide what risk/return it wants.

IMO, the actions of the government are preventing the market from adjusting and providing alternatives. When savers all think their cash is safe, what encouragement is there for the savers or the bankers to change their ways?

If some of the more extreme support is removed and the banks are allowed to be wound up, then alternatives will spring up. I would expect narrow banks and limited purpose banks (LPB) could well offer better risk/return profiles, giving more choice to savers. LPBs could certainly bridge the gap between safe (narrow) and risky (fractional reserve) banks, by offering many variations of liquid assets to invest in (from safe to risky).

I think the world has moved on from the current banking system and it is time that the government, the banks and the savers realised this. The current system doesn't seem fit to provide for the modern economy.

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which leaves less money to speculate, which leads to reduced bonus.

ergo, it won't happen.

If it doesn't, then there will be more money printing and losses will be felt via this soft default. Additionally, the system won't have been fixed and the bankers will still have perverse incentives. It will lay the foundations for another crisis in the future. Risk has to be present and well appropriated for capitalism to function properly - risk/return needs to be dictated by the market.

Ofc, what you are saying is that the banks are too powerful and therefore they will do as they please. That may be the case, but to just give up, hands them this status. I'm always optimistic that change will occur, though.

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The banks should be competing for your money, based on said risk/return profiles.

Excuse me but this is free-marketist nonsense, same sort as "spherical horse in vacuum" (physicist's favourite)

First of all, you don't start with situation where all money is in people's hands, banks are all depositless and thus are forced to compete.

If deposit protection is repealed/changed tomorrow, there will be widespread bank runs, see Northern Rock 2008.

And there is not enough cash in this country to satisfy withdrawals on all on-demand deposits let alone term deposits.

Payments between economic entities will also stop because no one will be sure if money goes thru.

On one line - all-out panic and state of emergency as a result. That's why repealing deposit protection does not make sense but it does not mean it won't be tried :P

See Russia's experience in 1990s where there was no deposit insurance at all and people held their savings in 100 US dollar bills/cash under mattresses. At some point Russia populace held majority of 100 USD bills issuance.

Edited by matroskin

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Isn't it well passed time that the old style mutual building societies made a comeback.

You know, not lending to ridiculous people, and paying a commensurate interest. With little or no extraneous liability.

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Instead of taxpayer guarantees, let deposits be covered by insurance. That is to say, insurance from the highly-regulated insurers, not free-for-all derivative instruments like credit default deals.

Oh do behave!

What if the regulator fails to spotthe problem? Who stands behind the regulator? That sounds like a government arm to me. That sounds like tax-payer funds.

Risk is risk is risk. You can't insure it away. Surely, if we learnt anything we learnt that!

Returning to the main point, as has been discussed above, by all means bring about these "no risk, no interest accounts". Just be prepared for bank credit to COLLAPSE whilst money FLOODS into:

- UK full reserve accounts;

- gilts;

- allocated gold accounts;

- physical gold;

- foreign banks who can afford to offer stae guarantees .

See, bankers aren't the only things that will leave if the financial climate does not suit them.

Of course, we could try to bring about a worldwide change of banking (much as we have with bankers bonuses - :lol: ). Thing is, even if we did, would we suffer from net capital flight or inflow?

I'll let you draw your own conclusions : External Debt by Country

Edited by Sledgehead

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"State guarantees of bank creditors threaten the ethical foundations of capitalism, making it a system in which the poor pay taxes so that the system can keep the rich rich, regardless of how foolish, lazy, or unlucky the loans they have made might be."

Since the politicians work for the 'rich' this ain't going to fly.

Dave and Osborne's handlers wouldn't permit it.

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  • 276 Brexit, House prices and Summer 2020

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      • down 5% +
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