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Bank run history shows capital limits can feed the fear

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(Globalpost/GlobalPost)

By Steve Slater

LONDON (Reuters) - When Argentina froze access to bank deposits in December 2001, the popular backlash was so severe its president and his successor had resigned within a month.

Cyprus, where banks reopened on Thursday after being closed for nearly two weeks, has imposed restrictions on capital flows -- the first euro zone country to do so since the introduction of the single currency -- to limit panic withdrawals.

The Argentine and other examples meant some in financial markets had anticipated a rush to withdraw money -- a sight that risked spooking depositors in other euro zone countries like Spain and Italy.

On the first day the banks reopened, there was no sign of that, with orderly queues made up of dozens, rather than hundreds of people.

Bank "runs" not only have the potential to topple presidents, they can cripple banks and financial systems and, once started, are notoriously difficult to stop.

Television images of queues or rumours banks have shut or are in trouble can provide the trigger for people or companies withdrawing their deposits. And while it may start irrationally, once one takes hold it is a natural reaction to join in.

Given the capital controls, the reopening of Cyprus's banks was far from business as usual. Officials have said the controls will be temporary, but past experience in Argentina, Iceland and elsewhere shows that is unrealistic.

"It is a major mistake to introduce the various limitations on payments and capital. It will most likely feed the fear among bank depositors that they will not be able to get their money," said Zsolt Darvas, a research fellow at Brussels-based economics think tank Bruegel.

"People and corporates will take out everything they can whenever they can."

Cypriot Foreign Minister Ioannis Kasoulides said he expects to lift the capital controls in about a month.

Philip Suttle, chief economist at the Institute of International Finance, was not so sure. "We're probably looking at years not months," he said.

LONG TERM CONTROLS?

Restrictions introduced in Iceland in 2008 to cope with its banking and economic crisis remain in place today.

When Argentina faced a system-wide crisis 12 years ago depositors rushed to withdraw funds. On the second day, more than $2 billion was withdrawn, or nearly 3 percent of deposits. The following day Argentina froze deposits for 90 days, and controls were extended for a year, an action known as "corralito" (little pen).

"It depressed the initial pace of withdrawals but did not decrease the eventual amount," Darvas said. That showed restrictions can lengthen the duration of the crisis and delay the return to normalised capital controls, he said.

The Argentinian panic was intensified by the country's failure to agree a bailout with the International Monetary Fund.

By contrast, Cyprus closed the banks while it was finalising a 10 billion euro ($13 billion) international deal.

It is the first in Europe's single currency zone to impose losses on bank depositors, but prevented the country going bankrupt and dropping out of the euro, which would have made a bank run inevitable.

ECB President Mario Draghi's promise last year to do whatever it takes to save the euro is also helping confidence, although critics of the Cyprus deal said it had re-established the link between weak banks and weak sovereigns and could scare depositors.

NO EASY FIX

Scholars say there is no easy way to prevent a run.

Freezing deposits has been a common policy response, simply to stop the bleeding. Limiting the freeze to Cyprus's two biggest banks, Bank of Cyprus and Cyprus Popular Bank, could have been an option.

A second policy is often a rescheduling of payments, so that savers have to wait longer to take out money or pay a penalty for early withdrawals.

When hundreds of Britons snaked around branches trying to take money out of mortgage lender Northern Rock in September 2007, British politicians admitted they were slow to react and reassure savers, allowing the run to continue for four days.

It came as a shock but it was a logical reaction as soon as people became concerned about the bank's health, because there was confusion how protected customers were, the online platform crashed and there was high profile media coverage and images of other people panicking, people close to the situation at the time said.

An industry leader said it made Britain look like a "banana republic", and the panic ended only after the government said it stood behind all deposits. It did not restrict withdrawals, but it had the benefit that there were healthy big banks next door.

But even after queues disappeared, a "silent run" continued at Northern Rock as online and postal account customers continued to retreat, and in the modern era more damage could be inflicted by this kind of exodus, especially if bigger corporate customers lose confidence.

THREATS

Another threat is that inflows, such as employee pay checks, could shudder to a halt if an economy shifts to more cash payments.

Cyprus has limited cash withdrawals to 300 euros per day, banned the cashing of cheques and said its central bank will review commercial transactions over 5,000 euros and scrutinise transactions over 200,000 euros on an individual basis. People leaving Cyprus can take only 1,000 euros with them.

Deposits in Cyprus stood at 46.4 billion euros at the end of February, down 6 percent from the start of 2011, as part of a pullback by savers from euro zone trouble spots for safer havens in Nordic countries, Britain and Asia.

Bank of Cyprus and Popular Bank - also known as Laiki - had deposits of 27.9 billion euros and 17.9 billion euros respectively at the end of September, according to their most recent data. Bank of Cyprus's deposits were already down 15 percent in less than two years, and Laiki's had plunged 30 percent.

Laiki said 56 percent of deposits were from retail customers. Almost a quarter was from international corporate customers and the rest came from corporate and investment banking customers and wealthy private clients, who are likely to have been quicker and more able to retreat than retail savers.

Savers will not be allowed to withdraw cash from term deposit accounts under the new restrictions either. Bank of Cyprus said that 58 percent of its deposits at the end of 2010 were available on demand or within a month, but 22 percent could be accessed in 1-3 months and a fifth could only be taken out with at least 3 months' notice.

The capital restrictions raise a number of other problems for Cyprus, not least the threat that restricting corporate transactions will severely hurt trade, the threat of legal challenges and the cost of maintaining controls.

Cyprus's membership of a currency union means it will have less flexibility to act than Iceland, Britain, Malaysia or the United States have had in the past. "That's what makes the situation in Cyprus so fragile and so difficult," the IIF's Suttle said.

A series of mis-steps by officials in Nicosia and Brussels mean it has also missed the crucial need to offer a cast-iron guarantee to savers.

Savings of more than 100,000 euros will incur big losses under this week's rescue plan. Deposits below that level are guaranteed, but a Nicosia proposal 12 days ago to impose a levy on all deposits showed customers there is no certainty.

(Additional reporting by Helen Popper in Buenos Aires; editing by Alexander Smith and Philippa Fletcher)

http://www.globalpost.com/dispatch/news/thomson-reuters/130328/bank-run-history-shows-capital-limits-can-feed-the-fear