Interview with Yves Mersch – PartTwo
Cyprus Bail-in

The case of Cyprus changed the discussion about who should pay the price for bailouts and who should be bailed in.
There are principles already laid down in the FSB/G20 proposals. In theory, it's very clear that banks that lack capital ought to find it first in the market. If they cannot, they have to examine if their business model is still viable. That is exactly where the link between sovereign and banks comes into place. Banks in some countries were affected not because of their business model, but because of the weakness of the sovereign. In others, it was the other way around. If a bank has not enough capital, but is still a viable institution, you have to see how to step in. Start with the private sector, before you turn to the taxpayer. In theory, the pecking order of liability is according to risk taken: shareholders, junior, then senior bondholders, only then depositors - while distinguishing between insured and uninsured. Likewise, the level of risk should determine the level of remuneration. We have to get the correct framework of incentives to avoid moral hazard. In the case of Cyprus, there was not enough capital or debt on the liability side of the affected banks, but a very high amount of deposits, earning very high interest. All this had to be taken into consideration. The Cypriot solution followed the Cypriot structure of the banking system. It is not the model to be followed in the future. What I take back from this experience is that we might have to accelerate the introduction of bail-inable instruments, which were due to be introduced in 2018, to 2015. This is something that Mario Draghi has already mentioned. Then, afterwards, you still have the ESM, but you would not start with it. Still, Europe needs to have the full toolbox ready, which is not the case right now.

You said Cyprus will not be a model, but the initial proposal about bailing-in insured depositors instilled fear in the minds of investors.
Financial investments are exposed to risk. And there is a link between risk and yield. Therefore, one should be sceptical if depositors receive interest rate payments 5 or 6 times higher than in other country in the same monetary union. If you look at the Irish solution, it was different, but again not a model. Each country, each banking system is different. We have to adjust to national circumstances. The given we have at the European level is that deposits are insured up to 100,000 euros.

The last leg of banking union, deposit insurance, seems to be off the table.
It is quite far in the future. Like for eurobonds, you first have to deliver on the conditions for fiscal union, before you can even discuss eurobonds. Same here: we have to deliver SSM and resolution, before we talk about the next step.

Why did the ECB not stop the proposal for bailing-in insured depositors in Cyprus?
The question is posed with the benefit of hindsight. It was certainly not the ECB proposal. As President Draghi said the outcome was not a very smart decision. Also, at the time, this was not presented as a bail-in, but it was presented as a tax, which is part of national competence and not part of the ECB remit.

Part Three - Tough credit conditions for Euopean Sme's »

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