How to Protect Yourself from Bank Bail-Ins

The global financial crisis changes many people’s perceptions of the safety and trustworthiness of banks. The citizens of countries like Greece and Cyprus found out rapidly that their money was not safe in their own financial institutions and that, instead of a government bail-out, they were faced with a bail-in. Subsequently, I wanted to give my readers some key steps in How to Protect Yourself from Bank Bail-Ins.

Action Plan to Protect Your Finances

1. Use different banks across multiple jurisdictions
2. Don’t assume that a major bank is any safer than a small bank
3. Keep your deposits under bank guarantee limits
4. Regularly check the public financial statements of the institution
5. Setup a Google Alert for any news or announcements regarding your bank
6. Utilise gold as an alternative hedge for wealth and protection

Read on to see our action plan for asset protection (from Banks).

Introduction to the Risk of Bank Bail-Ins

Frankly, the global financial crisis intrigued me as much as it sickened me. One of the tenets of capitalism is that all actors should be treated equally, and this means, in practice, that risky behavior should be punished by the market.

Unfortunately, any such punishment never seemed to appear in the banking industry. For years, banks focused solely on profits, and never once thought about the potential for risk. Okay, they might have thought about it but they certainly didn’t change their actions in regards to risky derivatives and misunderstood MBS products. However, you get the point…senior management was focused only on profits.

Looking back, I can certainly understand why that was the case because the intersection of banking and government is a very strange place indeed. The GFC initially had me believing that there would be mass bank failures, as there should have been given the functioning of capitalism, but alas what we saw was a massive government-led bail-out program.

Instead of the sound of air rapidly leaving a deflating balloon what I started hearing was the phrase ‘too big to fail’. What happened next was truly astounding to me as an economist and keen market analyst.

Governments around the world, under the guise of the World Economic Forum (WEF), and other quasi-governmental organizations, opined that the bailouts had created a moral hazard in the form of incentivizing risky banking behavior.  You would think that they would act to at least limit the potential for future bailouts. However, that wasn’t really on the agenda, and they were more interested in keeping the status quo whilst limiting their need to pay for any future mess.

Instead, the major regulators and western governments agreed that the way forward in any major bank failure was not a bail-out, but a bail-in where account holders would need to take a haircut.

That’s right…they never fixed the bank’s behavior…they just shifted everyone’s risk onto you the account holder.

What is a Bank Bail-In?

A failing financial institution may be considered too important, and too critical to the economy, to be allowed to fail (I disagree). Typically, banks under distress would be able to access bailout money from the government in exchange for either equity or debt. This allows the bank to maintain operations whilst they look to move any toxic debt off their balance sheets.

However, the new mechanism for a distressed bank to recapitalize is not a bailout but a bail-in. This is where, instead of receiving money from the government, they effectively steal funds from account holders in exchange for, at that time, worthless preference shares in the bank.

Typically, this occurs above a certain deposit amount and, in the case of Cyprus, was any accounts above US$100k. If there is an FDIC or other form of government bank guarantee, then that would normally be the limit that they will bail-in funds at.

At this point, you should be as outraged as I am by the concept of the banks, and the government, taking their risk and making it yours. Proponents of bail-ins claim that this is good for the depositor as they are unsecured creditors and would have got nothing anyway. However, that view glosses over the fact that the consequences are, ultimately, borne by the depositor. It also creates the moral hazard that I discussed earlier.

Unfortunately, bail-ins have quietly made their way into law all around the world and slipped into most banks’ terms and conditions. Subsequently, they have the legal (but not moral) right to, effectively, strip you of your assets in return for worthless stock or debt instruments. All the while, they fail to address the actual risky business behavior that led the bank to this position in the first place.

Must be nice to face no consequences for a failure whilst still reaping massive bonuses.

How Can a Bail-In be Legal?

Firstly, this differs from country to country and the reality is that many of the bail-in laws and procedures are yet to actually be tested in a court of law. However, many governments have quietly changed laws to allow a bail-in to be the primary source of recapitalization for a bank.

Additionally, financial institutions are regularly updating their account terms and conditions and most people, understandably, never actually read them. The bank account agreements typically give the bank the right to explicitly bail-in your funds in the event of a potential serious default.

Subsequently, it is becoming difficult to find banks that do not have bail-in provisions within their contracts. Government can also retroactively change the legislation, with urgency, during a ban run thereby allowing them to avoid the costly bailouts of the past.

In short, it’s legal because the banks and governments say it is. As mentioned previously, I view the intersection of banking and government, and some of the decisions they make, to be crony capitalism and devoid of any morals.

What is a Bank or FDIC Guarantee and Does it Protect Me

The primary model for bank stability is the U.S. Federal Deposit Insurance Corporation and their role is to ensure bank stability and handle receiverships. Basically, they offer a deposit insurance scheme that covers U.S. depositors up to US$250,000 in the event of a bank failure. Other western nations around the world offer similar schemes with different deposit amounts.

On the face of it, this protects depositors up to a certain defined amount. However, the reality is that it is unknown if the FDIC could withstand the potential liability of a failure of something as big as a Bank of America or Wells Fargo. During the GFC the primary actor involved was the Federal Reserve, with their TARP loans, so it was never clear if the FDIC could have paid out the huge amounts if required.

This is classic counter-party risk and assessing the FDIC, or your country’s deposit guarantor is difficult as it comes down to the political will to follow through with the scheme. I would argue that a bail-in is much more likely in the current economic environment as compared to a multi-billion-dollar insurance payout.

Ultimately, the deposit guarantee schemes are there to provide faith in the system but they have not yet really been tested. Additionally, many countries either have zero insurance scheme or the amounts are low enough to offer little in the way of safety.

How Does Gold Help Protect Yourself from Bank Bail-Ins

Physical gold is a sought-after metal that offers protection and hedging against forces such as inflation. It is readily convertible into cash almost anywhere in the world. Having part of your wealth in physical precious metals is well-advised if you have the ability to store it securely, either in a deposit box, or a safe.

As far as bail-ins are concerned, gold is outside the scope of what a bank can bail-in even if it is stored at a safe deposit box facility owned by the bank. Subsequently, there are plenty of benefits to holding precious metals including having part of your wealth outside the traditional banking sector.

Is a Bank Failure Actually Realistic?

Never suggest that it can’t happen. Banking and financial services is a competitive industry which has seen quite a bit of consolidation over the past decade. This has pushed smaller banks into riskier instruments at a time where we are likely to see some serious risks in the global economy.

The reality is that bank runs and collapses definitely happen and the west is now entering high inflation territory. This means that we are likely to see significant interest rate hikes in the next 2-years and this will expose many banks to currency risks. Subsequently, we are about to see how effective their hedging strategies and risk management procedures have been.

In fact, there is so much macro-economic driven risk floating around the markets that even pundits are wondering if we could see another GFC in the next few years.

How You Should Diversify Your Risk

It’s important to start thinking in terms of the concentration risk of where you have your money and assets placed. As always, I preach never trusting a single person with your wealth management and spreading your assets around multiple jurisdictions.

There are some basic steps you can take to minimize your risk:

1. Use different banks across multiple jurisdictions

You can minimize your risk by using different banks across the world as this helps to reduce your political and economic risk. Countries operate on economic and business cycles and a recession, and crash, in the U.S. may not equate to a collapse in the Cayman Islands.

2. Don’t assume that a major bank is any safer than a small bank

Some of the riskiest bets during the lead-up to the global financial crisis were taken by the major wall street banks. Subsequently, it pays not to assume that they are safer purely based on their size. The reality is that they love their access to risky assets as they provide a bigger return to the bank and….hell….why wouldn’t they when their losses are going to be covered.

3. Keep your deposits under bank guarantee limits

Although I’m not sure how reliable the FDIC would be during a systemic collapse it still pays to give yourself the best fighting chance. Subsequently, make sure any accounts you might have are below the FDIC, or government guarantee, limit.

4. Regularly check the public financial statements of the institution

It is true that financial statements and audit reports never give you the full view of what’s going on behind the scenes in a company. However, they are better than nothing and most major banks have their audit reports fully available online. Do yourself a favor and start flicking through their balance sheet, and the IFRS notes at the end, so you can familiarize yourself with their financial position.

5. Setup a Google Alert for any news or announcements regarding your bank

When you have multiple bank accounts all around the world it can be difficult to keep track of major news. The easiest way I have found is to set up a Google alert for your bank and, in that way, you can keep abreast of the latest news and announcements.

6. Utilize gold as an alternative hedge for wealth and protection

I’ve already covered this, but it’s a great idea to have around 10% – 15% of your total wealth in precious metals. Not only do they act as a great hedge against inflation, but they are also effectively convertible cash. Make sure that any holdings you have are physical, and not paper-based, and that they are stored in a secure location.

Summary on How to Protect Yourself from Bank Bail-Ins

Ultimately, this article is not designed to scare you into sticking your money under the mattress but it should provide you with something to think about regarding counter-party risk. Banks are definitely a ‘counter party’ that we take for granted as being unfillable. However, the reality is that, in many cases, they are poorly run and not the bastions of trust that they used to be.

At the heart of what I have covered here is diversification of your asset holdings. However, taking this to the next step is the concept of flag theory where you live, bank, do business, and hold a passport in separate jurisdictions. This is really the strategy that will largely free you from the risk of not only bank failures but also changes to your personal freedom.

Feel free to reach out to our team if you need any clarification or assistance with the above.

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