Thursday, 23 October 2014
Banks can be rescued without taxpayers being hit?
The Bank of England seems to claim that is possible. I say it’s a mathematical impossibility under the existing system and given a bad enough bank failure. More details are as follows.
The Bank of England has just published a paper entitled “The Bank of England’s Approach to Resolution” which says in the foreword that “The Bank seeks to ensure that firms — whether large or small — can fail without causing the type of disruption that the United Kingdom experienced in the recent financial crisis, and without exposing taxpayers to loss.”
And on p.8 they say one of their aims is to
“…protect depositors and investors covered by relevant compensation schemes..”
On p.13 they say:
“The bank insolvency procedure involves putting the whole
bank into an insolvency process designed to allow for rapid
payment of deposits protected by the FSCS (up to the limit of
I’ve only skimmed through this BoE paper, so I may be doing them an injustice, but I’m baffled by their claim that no recourse will ever be needed to taxpayer money.
Let’s assume a bank is funded by depositors, bond-holders and shareholders in the ratio D, B, S.
D, B and S sum to 100% of the banks assets / liabilities.
If the bank’s assets fall to D% of book value, then shareholders and bond-holders are wiped out and the bank can be rescued without recourse to taxpayer’s money. But if the assets fall to LESS than D%, and depositors are going to be fully protected, then there is no way depositors can be saved without recourse to taxpayers’ money.
At least that’s the case in the UK where depositor protection is funded by taxpayers (as I understand it). In contrast, in the US, those who deposit at SMALL BANKS are protected by the Federal Deposit Insurance Corporation, with insurance premiums being paid by banks.
As to LARGE BANKS in the US, they are protected by taxpayers. Those large banks like to argue that the recent bail out cost taxpayers nothing because all bail out money has been repaid. However it is questionable whether those banks were charged a realistic rate of interest for bail out money, and whether the collateral they offered in exchange was “first class” (as recommended by Walter Bagehot) or whether it was nearer the “junk” end of the scale.
So how do we prevent all taxpayer support for banks? Well it’s easy: full reserve banking.
Under full reserve, at least as set out by Laurence Kotlikoff, entities that lend, or the subsidiaries of banks that lend as opposed to accepting deposits, are funded just by shareholders, or creditors who are in effect shareholders. So given catastrophic failure (e.g. when bank assets fall to say just 10% of book value) all that happens is that those shares fall to about 10% of book value.
And there’s no need to close down the bank!
What more do you want?