Notwithstanding last night’s vote in Cyprus, this is the question that inevitably now hangs over all deposit guarantee schemes.
Although the proposal to impose a 6.75% tax on small depositors was rejected by MPs in the Cypriot parliament last night, few Europeans will not have noticed that it was – for several days – a serious proposal.
Given the damage that it has caused (even in defeat) it is nothing short of remarkable that it ever made it to the light of day. It is hardly surprising that it is increasingly hard to find anyone who will admit to supporting the idea.
Breach of trust
The EUs directive on deposit guarantee scheme is supposed to protect all deposits up to 100,000EUR.
Just for clarity, this is the definition of a guarantee from the Oxford English dictionary:
• a formal assurance (typically in writing) that certain conditions will be fulfilled, especially that a product will be repaired or replaced if not of a specified quality
The simple fact is that if depositors with less than 100,000EUR in Cypriot banks had lost 6.75% of their savings, then based on most people’s understanding of the word, the guarantee would have been broken.
It is no surprise that people were talking about legal challenges if the deal had gone through.
Bad for consumers
Deposit guarantee schemes have two effects. At the most basic level they simply protect the savings of small depositors.
Along with depositor preference, whereby investors and share holders are first in line to take responsibility for bad decisions taken by banks, this helps to ensure that small depositors who played no part in the decisions taken by their banks (and were probably not even aware of them) do not pay the price for the risks that others took with their money.
Bad for banks
However, deposit guarantee schemes, by protecting individual deposits, are also designed to prevent a run on a bank and thereby offer some security for the banking sector as a whole.
But this aspect of the guarantee relies entirely on trust. And it must now be the case that these schemes have lost some, or all, of that power.
