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On claims of depositors, subordinated and creditors and central banks in bank resolutions

Regarding Cyprus, recently I heard someone claim that depositors are not creditors of a bank despite the fact that deposits are bank liabilities. This is bollocks. Depositors are indeed creditors, particularly in Europe where they are often legally pari passu with other unsecured creditors. Below is an extract from a presentation given by an ECB expert on bank resolution schemes addressing who gets preferential treatment in carving up the losses. The full PDF is linked below.

I think this is highly relevant to what is occurring in Cyprus

Depositor preference rule.

So, the first topic I would like to address is the debate surrounding the introduction of a depositor preference rule in insolvency. As you know, a depositor preference rule requires that in the insolvency of a bank the claims of depositors enjoy a privileged status. This is a powerful form of depositor protection, as it effectively pledges the assets of the bank for the benefit of depositors, so it is to be hoped that the existence of a depositor preference rule reduces the risk of bank runs.

A majority of G-20 countries have some form of depositor preference rule, including Australia, Switzerland and the United States. The depositor preference rule has traditionally been less commonin EU Member States. However, an increasing number of European countries which have undergone, or are undergoing, EU/IMF programmes, including Greece, Portugal, Hungary, Latvia and Romania, have introduced depositor preference regimes. Beyond the EU/IMF programme countries, the Vickers report advocates the introduction of a depositor preference rule in the UK, which would prefer retail depositors up to the limit of the deposit guarantee scheme.

The precise ranking of the deposit claim varies in those countries which have adopted a depositor preference rule. In most jurisdictions, including most relevant EU Member States, the deposit claims rank behind secured claims and other preferred claims, such as tax and employee compensation claims, and ahead of the claims of general unsecured creditors. However, in the U.S., among unsecured creditors, the claims of the insolvency administrator rank first, and the depositors rank ahead of tax and employee compensation claims. Greece has also created a super-priority claim for depositors, which rank ahead of tax and other state claims, and only behind the Bank of Greece or any other financial collateral holder. Bank employees have priority over depositors for part of their claims to be determined ad hoc by a ministerial decision. As I understand it, secured creditors seem to retain their preferential rank on the specific asset charged, limited however to 2/3 of the asset’s net value upon liquidation.

Most countries impose some limitations on their depositor preferences, such as a limit linked to the guarantee limit under the deposit guarantee scheme, as in the case of most European regimes, including the Greek and Portuguese legislation.

The interaction of a depositor preference rule with the deposit guarantee scheme varies from jurisdiction to jurisdiction.

Source: Niall Lenihan, Assistant General Counsel, Legal Services, European Central Bank - EU website

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Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

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