13 April 2013

Paul N Goldschmidt: Reforming the banking market

In my recent paper concerning the “Compatibility of Ethics and Finance” (April 8^th), I suggested that, as a precondition for implementing the third pillar of the Banking Union, one should limit Government Deposit Guarantee Schemes (“DGS”) to a single account per taxpayer, while considering an increase in the amount covered.

I would like hereunder to develop further this question demonstrating why this proposal should receive support both from public opinions and governments alike (though, undoubtedly encountering the wrath of bankers). It should be particularly welcomed in France, where it addresses several of the President’s campaign promises.

In the first place it is an “equitable” proposal: Why should the State indemnify preferentially – at the expense of the taxpayer - those who are privileged enough to multiply the number of their accounts? The aim of the guarantee is to preserve access to the means necessary to meet without interruption payments covering ordinary day-to-day expenditures. Its amount could be increased to, say, €150.000 for married couples with an additional allowance of €25,000 for dependants. It would protect the vast majority of citizens (including, for example François Fillon who declared €76,000 in a savings account).

The guarantee should be restricted to an account opened in the country where the beneficiary is fiscally resident so as not to burden national taxpayers with a guarantee of non-resident depositors (Cyprus, Iceland).

Such a limitation would considerably reduce the risks covered by the State, thereby facilitating the implementation of a mutualised DGS within EMU which is necessary to finalise the Banking Union. It would also avoid the use of “tax havens” to shelter often dubious transactions by dissuading clients seeking outlandish returns (Iceland, Cyprus, etc.)

Furthermore, better than any law on the “supervision”, the “regulation” or the “moralisation” of the financial sector, this proposal would lead banks to greater prudence in assessing risks as they will be forced to justify to their wealthier (and most profitable) clients of the intrinsic strength of their balance sheets to deserve their trust.

Banks will immediately point out that, being deprived from this source of cheap (unjustified) financing, they will no longer be able to play their part in supporting the economy. However, if this measure led to a limitation of high risk “market” operations, it would achieve, without any need for legislation, the objective of reorientating banking practices more in keeping with traditional commercial banking activities. Thus it would be possible, for soundly managed banks, progressively to regain the trust of their depositors, the loss of which is entirely due to their own excesses. Thus, it would put an end to the privatising of exceptional profits and the “socialisation” of reckless losses.

Depositors would also seek to protect their wealth in the face of the loss of deposit guarantees in excess of the single guaranteed amount. However, one can rely on the proverbial faculties of innovation of the financial sector to create instruments that will fully meet the need for security. For example, banks could suggest that any amount exceeding the guarantee be invested in short term “Treasury Bills” with maturities of three, six, nine and 12 months (rolled over), which would allow the regular provisioning of their ordinary (guaranteed) account when necessary. The depositor would benefit from the same “State guarantee” as the one provided currently to a series of individual accounts. This would simplify account management by concentrating deposits within a single or a limited amount of institution(s) to deal with objective needs: accessibility near a secondary residence or by companies operating in multiple locations.

From the point of view of the State, rather than guaranteeing depositors for free, a transfer of funds into Treasury securities would constitute an appreciable new source of funding. This would contribute to maintain funding costs low. Proceeds could be reinvested, at least in part, in longer-term projects without risk (in government-sponsored financing schemes to compensate for initial reduced bank credit availability) as a significant part could be considered “stable”, at least if overall Government finances are managed with the necessary “rigour”!

Within the eurozone, this system would contribute significantly to reducing market fragmentation, reducing commensurately the risks of implosion of the euro. Modalities of extending the scheme to the EU as a whole and thereafter to the world at large should be pursued as fast as possible.

Limiting State guaranties exclusively to tax residents of a territory would considerably reduce the attraction of tax havens, especially those located within developed economies (UK, France (for Qatari’s), Belgium, Austria, Luxembourg, etc.). If complemented by measures concerning the exchange of information, which at last seem to be gaining greater traction, this simple and easily understood proposal would be particularly effective. By showing the necessary political will to confront the discredited banking sector, the measure would contribute, more than any other, to restore the people’s trust in governments and clean up a system on the brink of failure both in financial and moral terms.

Paul N Goldschmidt, Director, European Commission (ret.); Member of the Advisory Board of the Thomas More Institute

Tel: +32 (02) 6475310 / +33 (04) 94732015 / Mob: +32 (0497) 549259

E-mail: paul.goldschmidt@skynet.be / Web: www.paulngoldschmidt.eu

© Paul Goldschmidt