Academic journal article Nottingham Law Journal

Protecting Bank Depositors after Cyprus

Academic journal article Nottingham Law Journal

Protecting Bank Depositors after Cyprus

Article excerpt

INTRODUCTION

During the recent financial crisis in the Republic of Cyprus, (1) in March 2013, (2) the government proposed taking a percentage of all bank deposits. Despite the fact that the proposal was not pursued, it raised a number of questions about the current nature of depositor protection. The particular question that was asked after the Cypriot proposal was: what is the point of a deposit guarantee system if a government can simply decide to remove funds from guaranteed deposit accounts because the country is in a state of financial crisis? But in the wider context of depositor protection and the movement from "bail-out" to "bail-in" for failing banks, this question should be re-framed to ask whether depositor protection should apply only where an institution is declared to be insolvent and unable to repay its depositors or whether it should apply in a wider set of circumstances.

It has long been an article of faith amongst deposit insurance experts that deposit insurance schemes (3) play a crucial role in ensuring the stability of the financial system and in protecting depositors. (4) The rationale behind deposit insurance schemes is that they work because a limit is set determining the extent to which depositors' funds will be protected and depositors' funds are then protected up to that limit. Depositors then have the certainty that, in times of financial turbulence, their funds are protected against bank failure up to this limit, so giving them confidence in the financial system as a whole. The Cypriot government did not appear to have considered the possibility that their proposal might have implications for the Cypriot depositor protection scheme and so it is unsurprising that questions were immediately asked. Fortunately, the proposal was quickly withdrawn in relation to deposits which came within the level of protection provided in all Member States of the European Union (5) under the EU Deposit Guarantee Schemes Directives. (6)

In the discussion that follows, it is important to be clear that the authors are concerned only with the protection of depositors' funds up to the insured limit. It is accepted that, once the insured limit is reached, any surplus funds held in depositors' accounts will be available to the liquidator, receiver or other manager of an insolvent bank. These surplus funds may then be legitimately applied to meet the bank's debts in the event that other capital adequacy measures, such as bail-ins, provide insufficient funds to do so.

The potential damage which the Cypriot proposal could have caused to financial stability throughout the EU had not been adequately considered before it was made public. The proposal was ill-thought through from the start, since it would have had the effect of imposing a "tax" of 6.75% even on deposits guaranteed under the DGSD. Since the financial crisis began in or around September 2007, its impact on public trust and confidence in banks and bankers has become a matter of real concern. Trust in bankers has been severely eroded and the Cypriot government's proposal is unlikely to have done anything to improve matters. As Ian Henderson remarked "when trust in the banking sector is at an all-time low according to the Edelman Trust Barometer, and people all around the Eurozone periphery are watching nervously to see what happens to Cyprus because it may be their bank going under next, who but the wilfully blind would do the thing guaranteed to collapse any remaining trust in their banks?" (7)

As has been identified at the beginning of this article, it is significant that the levy on deposits was to be charged even though no Cypriot bank had actually failed. This begs the question as to what it is that we are trying to protect through deposit insurance schemes? One of the most important reasons for the introduction of the DGSD was to ensure that all bank depositors, up to a particular limit, would know that their deposits were totally safe. …

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