The Bail-In: Or How You Could Lose Your Money in the Bank

Tuesday, May 31, 2016
By Paul Martin

By: David Chapman
GoldSeek.com
Tuesday, 31 May 2016

Buried in the Liberal Federal Budget that was introduced on March 22, 2016, under Chapter 8 – Tax Fairness and a Strong Financial Sector, was a section titled “Introducing a Bank Recapitalization ‘Bail-in’ Regime.” Simply stated, in the unlikely event of a large bank failure, the Government proposed it would reinforce that bank shareholders and creditors are responsible for the bank’s risks – not taxpayers.

What that means is that shareholders, bondholders and depositors, rather than taxpayers, are responsible for the bank’s risks in the event of a failure. During the 2008 global financial crash, banks that were deemed “too-big-to-fail” were bailed out by the government, meaning the taxpayer footed the bill. None of the banks were Canadian banks, but it does need to be noted that Canadian banks received some $114 billion from Canada’s federal government. This was against the background of Canadian banks being declared “the most sound banking system in the world.” At the time, the government denied there was any bailout, preferring to use the term “liquidity support.” To put the amount in perspective, $114 billion is roughly 7% of Canada’s GDP.

The 2016 budget notes that in implementing a “bail-in” regime, it will strengthen the bank resolution toolkit in Canada and ensure Canadian banking practices are consistent with international best practices endorsed by the G20. Bail-in regimes are being instituted in the Western economies especially – in the EU, the USA, Japan, Australia and, of course, Canada. This isn’t the first time that a bail-in has been introduced, as the previous government came forward with one in 2013, and in 2014 presented a consultation paper. Initially it was thought that depositors would be excluded.

Surprisingly, in the budget, depositors are not mentioned specifically. It should be noted, however, that depositors have paid a price in bail-ins that have already occurred in Cyprus and in Italy. So the risk to depositors cannot be ignored.

First of all let’s dispel a myth surrounding bank accounts. Most Canadians hold their funds in chequing and savings accounts. These are known as “demand” deposits. Most people mistakenly believe that their monthly bank statements show them how much they own. Au contraire. They are in fact a statement of what the bank owes its clients.

Under Canada’s fractional reserve system, the banks promise to keep some cash on hand in the event of withdrawals, but the reality is that they lend out the funds or use the funds to purchase assets or incorporate into their global trading operations. The funds on deposit are no longer the property of the depositor. Instead the depositor becomes an unsecured creditor or lender to the bank. Banks pay you interest, but their real purpose is to use your funds to earn a spread. They put your funds at risk in the global markets through lending, syndication and trading.

If things do go wrong, depositors get nervous and run to the bank to withdraw their funds. This is known as a “bank-run.” A “bank holiday” could also be declared in the event of a massive bank-run. What happens, essentially, is that the bank closes its doors and the ATM machines. This happened during the Great Depression, and also happened most recently in Cyprus. Effectively what happens with a bank holiday is that the bank bails itself in. And even that was insufficient to save many banks in the Great Depression and in Cyprus.

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