Part 7 – New EU Bail-In Agreement Yesterday – What Bail-Ins Would Look Like

Today’s AM fix was USD 1,243.50, EUR 902.79 and GBP 758.51 per ounce.
Yesterday’s AM fix was USD 1,255.25, EUR 912.05 and GBP 765.49 per ounce.

Gold fell $9.60 or 0.76% yesterday, closing at $1,252.90/oz. Silver slipped $0.09 or 0.44% closing at $20.31/oz. Platinum dropped $3, or 0.2%, to $1,381.75/oz and palladium rose $1.05 or 0.1%, to $736.2/oz.

Gold Prices / Fixes / Rates / Volumes – (Bloomberg)

Gold has found strong technical support at the $1,200/oz level, which the yellow metal reached earlier this week on speculators short-covering and physical demand in China. Premiums in China have risen this week as Chinese New Year approaches and gold on the Shanghai Gold Exchange (SGE) closed at $1,285.09 (see table above) which was a $30 premium over spot gold.

Gold was down in London after retreating from a three week high on speculation that the U.S. Fed will ‘taper’ and U.S. lawmakers reached a budget agreement that avoided a government shutdown.  This funding expires on January 15.

The deal is actually bullish for gold as it is extremely modest in size.  Republican and Democratic Congressional leaders unveiled an agreement to reduce the federal deficit by $22.5 billion over 10 years while freeing up $63 billion in government spending over the next two years. 

It is important to remember that the Federal Reserve is printing nearly $20 billion every single week. The U.S. National Debt is now over $17.2 trillion and continuing to rise and the U.S. has unfunded liabilities (Social Security, Medicare and Medicaid) of between $100 trillion and $200 trillion.

U.S. Treasury Amount of Outstanding Debt – Price/Billion – (Bloomberg)

Staggering numbers which suggest alas that the U.S. politicians are rearranging chairs on the titanic.

These numbers alone should make people wary of buying into the notion that gold will fall in 2014 as the dollar strengthens due to the “normalisation of the economy.” The economy is not normalising and the recovery is completely abnormal, hence it will be wise to again ignore the publicised bearish calls of certain banks.

New EU Bail-In Agreement Yesterday
The EU agreed new rules yesterday for bank bailouts or “bail-ins.”

The new system will take effect from 2016 but emergency resolutions can be brought forward in the event of banks failing in the interim period. The “bail-in” will require that shareholders, bondholders and importantly now depositors will all suffer ‘haircuts’ or be burnt if a financial institution is in trouble.

The European parliament confirmed in a statement overnight that depositors with more than 100,000 euros ($137,000) would be bailed in after shareholders and bondholders. It is important to note that the 100,000 figure is an arbitrary figure and there is a possibility that this figure could be reduced by an insolvent government faced with an imploding banking system.


The deal does not exclude the possibility of public money being used “in exceptional circumstances,” the parliamentary statement said.

The agreement was spun as a victory for taxpayers, however the risks and ramifications of bailing in savers including families with their life savings and the deposits of already struggling small and medium size enterprises has yet to be appreciated.

Gunnar Hoekmark, who steered the legislation through the European parliament, said: “We now have a strong bail-in system which sends a clear message that bank shareholders and creditors will be the ones to bear the losses on rainy days, not taxpayers.”

Gunnar forgets that savers are taxpayers too and have paid taxes – on their income, on goods and services, on capital gains etc – on their hard earned savings already. Indeed, many are already paying punitive deposit interest rate taxes also.

There also appears to be a failure to realise that deposits – including family’s life savings, retirees pension incomes and businesses – are a vital part of the economy. You cannot have consumption without saving. You cannot have business growth and expansion and a consequent growth in much needed employment without capital.

Many countries now accept the principle that if banks get into difficulty, then it will not be the taxpayer but investors and creditors including already hard pressed savers that will suffer losses.

However, the situation regarding some countries – notably the BRICs is less clear. The imposition of bail-ins in western countries and not in BRIC and other nations would likely lead to capital flowing to the non bail-in countries.

Therefore, rather than solving the banking and debt crisis, bail-ins could ultimately compound the problem by further undermining the public’s confidence in our banks and the banking system. 

What Bail-Ins Would Look Like
While bank bail-ins have not yet become commonplace, it’s worth examining what a bail-in would look like in practice. Some helpful insight comes from the Bank of England, but more importantly, from the evidence witnessed in Cyprus during its bank bail-ins.

The Bank of England recently extended the Financial Stability Board’s Key Attributes guidelines and added four practical steps to follow when bailing-in a financial firm.

These four steps are Stabilisation, Valuation and Exchange, Relaunch, and Restructuring:

• Step 1 – Stabilisation

Stabilisation is key, in that it reveals that international regulatory authorities are leaning towards the well-used ‘weekend solution’ plan, to which they actually refer as a ‘Resolution Weekend’

However, if the situation requires dramatic intervention, they can even opt for a mid-week bail-in:
“Ideally a firm would enter resolution at close-of-business on a Friday evening, which would provide the authorities approximately 48 hours in which to stabilise the firm outside market hours. But this cannot be guaranteed. If a firm reached the point of non-viability during the middle of the week, it would be necessary to commence resolution proceedings at that point.”

At the time of resolution intervention, the regulatory authorities would suspend stock and bond listing of the bank while making various announcements to the market. These announcements would include details on which securities were being totally wiped out, and which creditors, such as bondholders and depositors, would have their bonds and deposits converted into bank shares. The announcements would also, according to the Bank of England, provide a timeline for the other stages of the bail-in and seek to reassure insured depositors that they were protected while attempting to provide “market counterparties with confidence”.

• Step 2 – Valuation and Exchange
This step would re-value the firm, calculate its losses and capital needs, and then write down creditors (including deposit confiscation where necessary), while converting these creditors to shareholders before embarking on relaunch.

• Step 3 – Relaunch
Relaunch would relist the bank’s shares (and possibly some of the bank’s bonds) and then allow the bank to re-open while implementing restructuring.

• Step 4 – Restructur
Restructuring would aim to force the bank to appoint new management, change its corporate governance procedures, and force it to operate in a way that prevents subsequent financial market instability.

Although the Bank of England’s four step bail-in approach is quite detailed, it does not address the capital controls that would be needed so as to prevent a bank run. This is where the Cyprus example becomes useful.

Capital controls were widely implemented in Cyprus during a theoretical two week long ‘Resolution Weekend’. Authorities knew that depositors would act rationally and attempt to close their accounts or transfer their funds abroad, thereby causing capital flight. To prevent this happening, draconian capital controls were imposed and banks were kept shut for two weeks.

This was the first time that capital controls had ever been imposed within the Eurozone.
Some of the capital controls included the following: Limits were imposed on bank withdrawals, foreign money transfers, and credit card transactions.

Customers could only withdraw a maximum of €300 per day from branches and ATMs, and could only carry a maximum of €3,000 while travelling out of the country.

In addition bank transfers over €5,000 needed Central Bank of Cyprus approval, and foreign credit card transactions were limited to €5,000 per month.

When capital controls are imposed on economies, they usually remain in place for some time, for example, Icelandic capital controls imposed in 2008 are still in place. Not surprisingly, Cypriot capital controls are still in place and will not likely begin to be lifted (in various stages) until early 2014, according to the Cypriot President, or even longer, according to the finance ministry. Controls on international fund transfers are envisaged as being the final piece of the controls to be lifted.

The lessons from the Bank of England plan and from Cyprus are essentially that depositors will not get any notice that their bank is about to be bailed in. The bail-in would probably happen during a weekend. The bank would probably not re-open on the following Monday. There is also a strong likelihood that capital controls would be imposed on the country’s banks during the bail-in and for a lengthy follow-on period.

Given this lack of warning, depositors need to plan in advance for the day when ATMs do not work and they cannot access cash in their bank accounts.

Download our Bail-In Guide: Protecting your Savings In The Coming Bail-In Era(11 pages)

Download our Bail-In Research: From Bail-Outs to Bail-Ins: Risks and Ramifications –
Including 60 Safest Banks In The World List 
 (51 pages) 


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