Risk immunity leads to banking abuse


The Eurogroup Chairman’s hint that creditors should foot banking rescues has come as a shock to investors. Financials are nose-diving at the prospect of suffering extensive hair-cuts should entities become bankrupt. Capitals around Europe have reacted angrily at an ill-placed comment running contrary to the official statement that the Cyprus way out was never to be replicated elsewhere.

Yet, there is ample room to question why should banking escape from the standard treatment imposed on any undertaking. In case of failure, one expects shareholders to bear the brunt and eventually lose all their money. Should that squeeze prove unable to match cumulated losses, creditors stand next in the pipeline. They usually snatch a snippet of their original investment.

Why should banking creditors enjoy the privilege of full immunity to risk? This striking feature is often linked to the pivotal role the financing system plays in anchoring the whole economy. Any doubt on its ability to pay back would feed into inordinately higher credit costs. So conventional wisdom favours providing a safe haven for those engaged in this business, taxpayers standing as the obvious candidates for mending wreckages.

Cynics even point to supervision as a kind of insurance contract relieving creditors from all nasty surprises. After all, central bankers hold a paramount responsibility in monitoring this business. For all its merit, this argument seems largely unconvincing. It amounts forcing the traffic authorities to pay for your car crash simply because they exert a control on the way you drive.

Thus, the only plausible reason for deviating from common market discipline would rest on the spill-over effect that facing investors with their ill-choice would inflict on credit cost. Undoubtedly should wrong decisions on how you place your money involve the possibility of losing it, a higher premium should reward such a riskier environment. But does it make sense to ring-fence lenders from any nasty upheaval? Certainly not as they only resort to the easy-going rescue window should things go wrong. When cashing dividends they invoke the sacred nature of private property and the enhanced efficiency free-market provides.

Both claims appear as utterly biased should they apply only to fair weather conditions. If freedom to engage in business is to be taken as cornerstone principle it should also play when turmoil and tempest ruins your concern. Risk immunity on the other can only lead to deep-rooted inefficiencies when allocating of resources. Any economy, save for a Soviet one, is run under the healthy guiding rule that smart decisions are rewarded and wretched ones get penalised by the market. The fact banking all too often escapes from this basic discipline explains why it runs its business much alike a casino with the key difference that no gambler is poised to lose his money, that nasty task falling on ordinary people outside the premises.

About the Author

JP Marin Arrese
Juan Pedro Marín Arrese is a Madrid-based economic analyst and observer. He regularly publishes articles in the Spanish leading financial newspaper 'Expansión'.

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