What happened to deposits at the Co-op?

Poring through the Annual Report from the Co-op Bank provides some useful information about what happens to bank deposits when an institution is under stress and the effect of the government’s guarantee on bank deposits.

It’s worth saying at the outset that not all bank deposits are guaranteed by the government. Deposits by companies in particular are not guaranteed and, unsurprisingly, corporate deposits in the Co-op collapsed by 42% in 2013.

It could have been worse. Take a look at this from The Telegraph on the week that the hedge funds took over. The Co-op put a cap on internet transfers by business customers blaming “heightened security”. Imagine if they hadn’t been hacked the same week as the hedge funds were completing their purchase, who knows how much more money would have left the bank.

There’s more to the story, because digging deeper into the Annual Report we can see that there was also a retail deposit run: Co-op Bank’s under 12 month deposits collapsed by 22% from £32 billion to £25 billion over the course of the year.

This decline would almost certainly have been stronger without the government’s deposit guarantee in the background, but the Co-op also leveraged the deposit guarantee to take some action of its own. It shored up its deposit base by offering a much higher rate than the other banks for term deposits. The longer-term deposit base (over 12 months) rose by £1 billion in the first half of the year, then Co-op stepped up the interest rate even more and mopped up an additional £3.3 billion of deposits in the second half of the year. This was crucial for their survival, because in the same period they lost £5 billion of shorter term deposits.

This strategy did cost the Co-op some money. The higher interest rate they paid on term deposits cost £29 million in the first half of the year and then a whopping £93 million in the second half. To put that into context, it amounts to over a quarter of the extra £400 million Co-op Bank needs still needs to raise.

But at the same time this business strategy (made possible by the government’s deposit guarantee) allowed the bank to stay liquid long enough for new buyers, hedge funds, to take control of the bank and guide it further towards safety. It also benefitted the Co-operative Group, which managed to keep a 30% share in the bank, something that the shareholders in neither Bradford & Bingley nor Northern Rock were able to do back when those institutions were failing.

What policy questions does this raise for the government’s deposit guarantee? The guarantee certainly is expensive – the IMF recently estimated that the cost to governments worldwide of providing deposit guarantees is $590bn. It also distorts competition, for example, preferring lenders who are also deposit-takers over peer-to-peer services.

Obviously the reason that the deposit guarantee exists at all is because government does not want to leave bank depositors without protection. That being so, its options are providing a deposit guarantee or standing ready to bail-in.

If it does the former, then there is a chance, and it paid off with the Co-op, that there isn’t a terminal run on deposits and hence enough time for new capital to be brought in to effect a rescue. It’s likely though that this is only true for small and medium sized banks. If the Co-op had been much bigger, regardless of the deposit guarantee, the government probably would have been the only potential rescuer. (The Co-op hadn’t sold any of the new bail-in bonds, so its failure didn’t test if these new bonds offer greater protection). At the very least, it would have had to provide the immediate rescue, undertake repair and then look for a buyer.

In other words, the wisdom of the deposit guarantee is premised on its role in the rescue of smaller banks exclusively and, more than that, the case for it stands or falls on whether hedge funds and bond-holders are better owners of a troubled small bank like the Co-op rather than the government. Is that true? Well, soon we’ll be able to look at the evidence. We know that there is by this stage around £6bn of equity in the similarly-sized banks (Northern Rock, Bradford & Bingley) that the government bailed out. How much equity will there be in the bank bailed out by the market in a few years’ time?

This post was edited 17:05 08/05/2014.


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