Written by Eric De Keuleneer
A possible EU or euro-zone banking union would be easier and safer, if the risk on deposits was better defined and monitored. In fact, in many large banks, depositors are becoming quasi subordinated creditors, without even being told. Of course they usually enjoy a state guarantee, usually up to a certain amount (€100,000 in most of the EU), but that merely transfers (most of) the problem from depositors to taxpayers… .
This quasi subordination is due to the combination of collateral consumption by the market activities (derivative transactions, short selling, etc) of these banks, increased use of collateralized funding, like repos and central bank funding, and of course the growth of covered bonds issuance; all of which mostly with over-collateralization. Their best assets being pledged in favor of various creditors, many banks present increased risks for non secured creditors, thus holders of plain deposits, and the guarantors of those deposits. It is thus understandable that some U.S. regulators are trying to limit or even prevent the introduction of covered bonds in the U.S. It is to be hoped that they will succeed.
A limitation of the proportion of covered bonds that a deposit-taking bank can issue, or in general of the assets they can pledge, and of the risks they can take, might be useful to contain the problem, but not enough to solve it, and difficult to implement.
It would be better to implement “covered deposits”, through a progressive ( to give them some time to adapt) collateralization by each bank of their deposits, with diversified loans and other appropriately selected quality assets, up to, say, 75% to 100% of the amount of deposits. The assets given in collateral in favor of depositors should be approved by regulators or a deposit guarantee Institution, along lines very similar to those that would prevail for the ring-fencing of banks as recommended by the Vickers Commission in the UK. Thus loans to investment banking and market activities, or to real estate development (which would be outside the “ringfence”) would not be accepted to “cover” retail deposits.
This would certainly not discourage banks from lending to individuals, to businesses, or for trade finance, even to the contrary. But it might discourage them to engage in some market activities and other unnecessary risk taking. It might also reduce shadow banking, at least the part of shadow banking that is conducted with loans or securities borrowed from retail banks. It would reduce the huge subsidy which the state guarantee on their deposits represents for some banks (the riskier the bank, the bigger the subsidy).
It would also smoothly prepare –in the countries that will implement it- for a separation and ring-fencing of retail banking, and in general make for easier bank resolution cases.
Banks that pledge less than 10% of their assets may get an exemption if it is clear enough that all their creditors are treated equally, and prudently.
Size in Banking: Efficiency of Scale vs. Abuse if Power by Eric De Keuleneer and Nastassia Leszczynska
Eric De Keuleneer received his commercial engineering degree from the Free University of Brussels. He later went on to earn his MBA from Wharton School. Amoung his many achievements, Eric De Keuleneer has worked for several prestigious banks, lectured at Solvay School of Economics and is currently the CEO of the state owned bank, Office Central de Credit Hypothecaire. He has several publications concerning finance, corporate governance and banking and regulation.