To Bank or not to Bank

2 December 2011 | Philip Ammerman

One of the inevitable consequences of the Greek and European debt crisis is the question of whether bank account deposits are safe. This question has been asked a number of times recently, but no clear answer is possible given the rapid changes in the financial sector. Another frequent question concerns the consequences of a Greek Eurozone exit: what practical effects would this have on banking, loans and deposits?

Some thoughts on the subject follow. These should not be construed as financial recommendations, and the author disclaims any and all liability for actions taken by readers as a result of this post.

Banking Safety

The Greek banking system is only functioning due to the extension of approximately EUR 150 billion in sovereign guarantees and emergency liquidity assistance issued by or through the Greek government. Moody’s estimates that non-performing loans in Greece will reach 20% over the next 18 months. A number of Greek and Cypriot banks have faced important write-downs in the past two quarters. On the wider European field, Standard & Poor’s recently downgraded 30 international banks, including major players such as Citibank, Bank of America, Merrill Lynch, Goldman Sachs and others. The recent collapse of Dexia, together with the massive share price falls of BNP, Societe Generals and others, compound the doubts most people have as to the security of their deposit accounts.

In most countries, holders of individual accounts are insured up to a specific level. However, the assumptions behind this insurance have never been tested in a system-wide financial panic. Given the dual threat of a large-scale sovereign financial meltdown together with a banking panic, it is impossible to tell what would happen in the worse-case scenario.

In choosing a bank for the purposes of asset safety in a worse-case scenario, I would use the following criteria:

a.     Jurisdiction: The bank should be located in a country with a well-regulated banking sector, where each bank must publish detailed financial accounts and a risk assessment. For obvious reasons, this should be outside the Eurozone, and outside the United States. (And probably not in Japan).
 

b.    Retail: The bank should be a retail bank as far as possible. I would avoid banking with any of the global giants with derivatives and public debt exposure. In other words, I would avoid keeping a deposit with a large investment bank which happens to have retail banking operations, unless this is in the United States.
 

c.     Currency Sovereignty: I would choose a country which is not in the Eurozone, and which has a positive trade balance, or other unique currency reserves or resources.
 

Drawing up a shortlist of non-Euro currency banks, I would probably choose Canada, Norway and possibly Switzerland as countries in which to choose a bank if the priority is to gain deposit security in an independent currency.

Canada has one of the best-regulated retail banking systems in the world. It has been relatively untouched by toxic retail mortgages and, so far, by exposure to sovereign debt. Its oil shale resources mean that the country has strong economic growth in its future (with some caveats due to its exposure to the United States). The fact that it has its own currency and a well-functioning central banking system means that any damage will hopefully be limited in case of a downturn.

Norway is another solid bet. It is outside the European Union, but in the European Economic Area, and has natural gas and oil resources which feed into a sovereign wealth fund (the Global Pension System, or Oil Fund) considered a model in the industry. Its exposure to dodgy investments is moderated by ethical investment guidelines. In 2010, 38.5% of the Fund was invested in fixed-income securities; this rose to 44% in Q3 2011. The Fund is exposed to US, UK, French and German government bonds, and also to movements in EUR, USD and Yen. Its Central Bank is also well-governed and transparent.

Switzerland is a perennial favourite, but does have some significant systemic risks. UBS and other Swiss banks have accrued large scale exposure to foreign investment banks via loans and derivatives contracts, and also to foreign government bond holdings. The large scale of UBS compared to the Swiss GDP means that any downside movement in USB’s portfolio may have a disproportionate effect on its own capital structure, and on Switzerland’s capacity to recapitalise it. On the plus side, banking accounts for a major share of Switzerland’s economic success, and it is likely that any crisis will be managed adequately.

Looking at banks in the Eurozone, I would focus on retail banks in countries such as The Netherlands or Luxembourg. Luxembourg has a debt:GDP ratio of only 18%, and a fairly strong banking sector. Its small size (0.5 million) also means that its participation to any Eurozone bailouts will be limited. If your income is in Euro, and your expenses are in Euro, it is likely that opening a deposit account in a well-regulated, retail bank in these two countries is a safe bet.

Impact of a Greek Eurozone Exit

I’ve also been receiving lots of questions on what the impact of a Greek eurozone exit would be. I should make it clear in advance that I don’t believe this will happen, although the possibility is becoming increasingly possible given the wider financial crisis.

In the case Greece does exit the Eurozone, we can anticipate the following decisions being made as national policy:

 

  1. All Euro deposits will automatically be converted from Euro to the new currency
     

  2. All loans in Euro will be automatically re-denominated from Euro to the new currency
     

  3. It’s impossible to know what the exchange rate target will be, but the pre-ERM entry rate of 340.75 GRD:EUR is possible. If I were a Central Banker, I would push for a 1:5 or even 1:1 parity to try to lessen the “sticker shock” of such a change.
     

  4. In the run-up to the change-over, and for some time thereafter, it is likely that the government will impose capital controls to prevent capital flight. Thus, I would expect a limit on physical cash withdrawals, to a limit of EUR 500 per week, and a selective ban on international transfers.

We can anticipate that in the case of a Euro exit, the new currency will rapidly devalue against the Euro as Greek households and companies change the new currency for Euro. This is inevitable, given the large current account deficit. (About 50% of Greece’s imports are from the Eurozone; a large share of other imports are from China, Russia and the Gulf and are denominated in USD).

We can also anticipate that Greek inflation will rise in response to the currency devaluation. Inflation rates of 10-20% (CPI) are not impossible to imagine.

It will be impossible to tell what interest rate the banks will set for existing or new loans. This will be a key issue in debt service and wider consumer prosperity.

In any case, my personal opinion is that the Greek banking system is no longer solvent. Its exposure to Greek government bonds and non-performing loans in Greece, as well as its exposure to hard-hit sectors such as real estate and shipping, lead me to the conclusion that holding deposits in a Greek bank is no longer safe. My own strategy since 2010 has been to reduce my exposure and deposits as far as possible.

But I do not believe a Greek Eurozone exit is likely, unless this is driven by external factors, i.e. a break-up of the Eurozone for factors not relating to Greece itself. We should remember that the Euro is a real currency used by 17 countries and over 250 million citizens, and that there have been many cases where a sovereign debt and banking sector crash have occurred while a national currency has remained usable.

We should also remember that the benefits of a Greek eurozone exit are miniscule, given Greece’s small GDP share of the Eurozone, while the contagion and moral hazard risks are disproportionately high. But this is not to say it couldn’t happen.

Philip Ammerman

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