Wednesday, March 20, 2013

Cyprus, Russia and EMU... Who prints for the bank run?

Earlier today I received a text from a friend of mine reporting that none of the commercial banks in Greece accept cheques issued by Cypriot credit institutions and I got really concerned for "the day after tomorrow"- it is either a signal that they fear the worst or perhaps just the fact they they cannot "liquefy" these cheques at the moment. Although I am really confident that depositors may not inundate the Cypriot banks to withdraw their funds, such a risk is still lurking... While we are focusing on restoring (via government debt and haircuts) the regulatory capitals we seem to ostentatiously exhibit our negligence for the bank-run risk; even of the slightest probability that that scenario might actually occur. 

If someone had € 100,000 of deposits and suddenly the government decided to levy a 10% tax on their value how this depositor would react? First of all, he does not know whether this tax is collected once and for all or not and, even worse, his neighbours (depositors "nearby") cannot be sure whether their own government levies such a tax in the following days. Maybe they all get concerned, maybe some of them and maybe only a few of them. Worst case scenario: needless to say. As I said, most probably it may never come true perhaps because the markets do not seem to expect its realization or because at the end authorities will take actions.

Let us elaborate on the notions of "all", "some of them" and a "few of them", by borrowing certain identities from McCallum (2002, Greek Edition)[1] and applying elementary mathematics. The picture that follows provide a simple mathematical proof that when the bank run is massive enough the system is condemned to collapse, but the most important feature is the definition (condition) of "massive enough". Briefly, the rate of the increase of the banknotes supply by the ECB must be higher that the rate of the propagation of the withdrawal requests.





My poor and inexperienced logic does not permit me to understand why should the governments worry about acquiring funds to restore regulatory capitals, in the first place! My poor and inexperienced logic tells me again that the crisis of the post credit-crunch period propagated mostly by rolling over the default risk of the financial sector to the general government via transforming the notorious "toxic" assets into public debt. And here we are again! I am asking myself what is the role of a central bank (but "maintaining the mid-term inflation below but close to 2%") if not the maintenance of the soundness of the financial and credit entities among other. What will happen to Cypriot banks if the 2nd Greek debt haircut 
takes place and requires the participation of private debt holders once more? Another haircut to cyprus' deposits will take place as well? Hopefully, this relentless-austerity insanity  across Europe will eventually be terminated... Untill then, we offer sacrifices upon the altar of "mid-term inflation below but close to 2%".

Finally, I strongly believe that if the ECB does not wish- or is not allowed- to intervene and cover the regulatory capital needs of Cypriot banks then the second-best solution is their absorption by foreign institutions with the following condition: the absorber will cover the capital needs. In addition, credit expansion following the merger and the subsequent recapitalization might kept restrained (as part of the absorption agreement) to allow for inflation control. I do not see why this option is not admissible at all, especially when non-EMU funding is involved. On the contrary, increasing public debt and imposing a savings haircut are the only options. Without leaving any space for conspiracy theories, there must be a geo-political agenda that I am unaware of. 

[1]McCallum, Bennett T. (2002); "Nomismatiki theoria kai politiki [Monetary theory and policy]". Kritiki, Athens. In Greek. [McCallum, B. T. (1989); "Monetary economics: Theory and policy". Pearson Education.]