The Italian banking crisis has moved to its next inevitable stage. European institutions have started to struggle with the question of whether and how to protect deposits in Italian banks. Italy adopted new EU-mandated policies regarding bail-ins in January. The rules for these bail-ins require a bank’s shareholders and debt holders to absorb losses before taxpayer money can be used to assist a bank. Deposits of more than 100,000 euros ($109,000) could be affected, but those containing less than 100,000 euros are protected by European deposit guarantees and cannot be touched. As a result, individuals who hold what they believe to be relatively low-risk investments, as well as small businesses that keep more than 100,000 euros on hand, could be at risk.
As Italy grapples with the new policies, there is a dispute within the eurozone over who should ultimately be responsible for guaranteeing deposits that, under European laws, are protected even in the case of a bail-in. This is a familiar scenario: the EU once again discovers its original dictum would lead to disaster, so it changes its course to find a solution that is acceptable to all members. In other words, we are now at the point of paralysis. But this time it is paralysis over an issue with catastrophic implications.
We can make a distinction between investments and putting money in the bank. Investments are understood to carry with them both opportunities and risks. Putting your money into the bank is not expected to carry either. The benefit of having an individual bank account is to safeguard money. If banks cannot guarantee this safety, then there is little point in putting money in a bank in the first place. In fact, withdrawing funds from an unsound bank becomes a matter of urgency because if enough depositors become uneasy and withdraw their money, the last man to the door may be wiped out. For the middle class, insecurity in banks is an existential crisis.
Wealthy individuals and corporations have experience in managing risks. They diversify not only among banks, but among countries or among asset classes. They can be hurt, but rarely completely devastated. Although the middle class may have money in more than one bank, most risk-management tools are both out of their reach and outside their experience.
For the middle class in Euro-American culture, banks are where those assets that are accumulated over a lifetime are stored and kept secure. Once they are seen as insecure, various stratagems emerge, from buying homes or gold, to buying foreign currency, to getting the money out of the country. When this occurs on a massive scale, the result is a contraction of lending by banks, bank failure, and depression.
But the most important result is the loss of confidence in social and political institutions by the middle class. We are seeing this happen now in some export-oriented countries and some European states. There is a social contract between the middle class and society as a whole, where the middle class agrees to work hard and save their money. In return public institutions guarantee that the fruits of their labor will be secure. If they were to lose their deposits, it would be a financial catastrophe. But the violation of the implicit social contract would lead to political catastrophe. This is why US President Franklin D. Roosevelt, in his first fireside chat, focused on the need to restore confidence in institutions such as banks. Stripping the middle class of their assets—or making them afraid this might happen—leads to massive political unrest.
The fear of loss of deposits is stalking countries besides Italy. As exporters across the globe experience reduced revenues and as the European Union’s financial troubles continue, governments in East and Central Asia and across Europe are growing worried about the public’s confidence in their banking systems. Reduced confidence would not only have immediate financial consequences, but could also have far-reaching geopolitical implications as the ability of governments to manage growing crises diminishes.
Deposit insurance is at the core of government efforts to maintain confidence in banking systems. What sets deposit guarantees apart from other government tools for stabilizing financial systems is that these schemes are a direct pledge to each deposit holder to safeguard some of their assets.
The massive crisis that the US financial system faced in the early 1930s led to the creation of the Federal Deposit Insurance Corporation (FDIC), which protects deposits if an FDIC-insured bank or savings association fails. The FDIC is backed by the US government and can insure up to $250,000 in deposits for individuals. Deposit insurance schemes around the globe differ in their design and coverage, but fundamentally they are designed to maintain public confidence in the system.
Both the economic crisis facing exporters and the eurozone’s ongoing financial difficulties are increasing the significance of deposit insurance. For example, in Azerbaijan, a major energy exporter, deteriorating economic conditions have already led to protests throughout the country. Azerbaijan’s government announced on Jan. 28 that the country’s central bank may provide financial assistance to the Azerbaijan Deposit Insurance Fund (ADIF) if it is unable to pay compensations to depositors. The statement came after the central bank revoked licenses of six Azerbaijani banks and was likely intended to alleviate fears following their closure. The central bank’s pledge to provide extra funding for the ADIF signals that the regime is worried that public confidence in the banking sector could be undermined. Should confidence erode, the out come could be not only a run on the banks and significant disruptions to the country’s financial system, but also an erosion of the regime’s position.