15 September 2023

ECON: CMDI reform: What are the implications for depositors?

Some savers and investors can lose money when a bank fails. The recent proposal for a reform of the EU bank crisis management and deposit insurance (CMDI) framework changes how bank resolution authorities have to treat deposits and how deposits rank in insolvency relative to other claims.

Some savers and investors can lose money when a bank fails. The recent proposal for a reform of the EU bank crisis management and deposit insurance (CMDI) framework changes how bank resolution authorities have to treat deposits and how deposits rank in insolvency relative to other claims. These changes may significantly alter outcomes for uninsured depositors. They are not all straightforward and this briefing tries to parse them and their implications systematically.
When a bank fails, European law protects most depositors up to an amount of 100.000 euro. This applies irrespective of whether the failed bank ends up in insolvency proceedings or resolution. Above this amount, deposits may take losses, as may the unprotected deposits from financial and public entities. This happens when losses exceed equity and debt ranking below the deposits.
There are important trade-offs to consider around losses for uninsured depositors. On the one hand, such losses may simply be what results when liquidating or resolving an over-indebted bank. Uninsured deposit can also, as other liabilities, help absorb losses, facilitating the resolution of a failed bank so that its critical functions can continue to operate for the benefit of the wider economy when equity and subordinated debt are exhausted. Moreover, the risk of such losses may make uninsured depositors prudent, giving them incentives to monitor the risks of banks and requiring higher interest from riskier banks or eventually withdrawing deposits from them, which in turn might discipline bank management to avoid excessive risk. Finally, avoiding losses for depositors will typically imply someone else bearing the loss instead.
On the other hand, such losses impose hardship on households and firms, and may be disruptive to their lives and plans. Individuals without regular income might finance their livelihood out of larger deposits and firms may rely on larger deposits for payroll and other larger future payments. Losses on one bank’s deposits with another bank might spread trouble across the financial system. Rapid deposit withdrawals might be...

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