Something I proposed in my earlier post was giving small creditors, including depositors, priority in bankruptcy. Suppose a bank had 1 billion in equity finance, 5 billion in bonds, and 10 billion in small deposits. It starts with 16 billion in assets, but the value of the assets goes down to 12 billion. The government steps in (or the bondholders), and the payout would be, under my scheme, 0 to equity, 2 billion to bonds, and the full 10 billion to deposits. If the government steps in reasonably quickly, deposit insurance is redundant, though we could still have it.
I'd like to find out more, but apparently that's not the Northern Rock picture, though. Instead, it was something like this (all numbers are totally imaginary, even in scale-- I use them because concrete numbers are easier to follow than X, Y, Z where X>Z, etc.). The bank had 1 billion in equity finance, 5 billion in overnight loans from other banks, and 10 billion in small deposits. It started with 16 billion in assets, but the value of the assets went down to 12 billion. The other banks noticed first, and refused to re-loan their 5 billion. Instead, Northern Rock sold 3 million in assets and the government lent it 2 billion. Now, Northern Rock is left with 1 billion of equity finance, 2 billion in government loans, 10 billion in deposits, and 9 billion in assets. My scheme would not be any help, because the big creditors have already gotten out their money.
Nor would my scheme have helped even had the government not made the emergency loans. Here is a story for what might have happened then. The bank had 1 billion in equity finance, 5 billion in overnight loans from other banks, and 10 billion in small deposits. It started with 16 billion in assets, but the value of the assets went down to 12 billion. The other banks noticed first, and refused to re-loan their 5 billion. Instead, Northern Rock sold 3 million in assets for 3 billion, and another 8 billion at the fire-sale price of 2 billion to repay the 5 billion in short-term money. Northern Rock would then be left with 1 billion of equity finance, 10 billion in deposits, and 1 billion in assets.
The solution seems simple: don't let banks borrow more than their entire equity capital in the short-term markets. But I don't know banking-- maybe they have to to operate. Later the same day. I found a Reuters page which has the Northern Rock balance sheet info. I expect thsi includes the 20 billion or so pounds of government emergency funding. It looks as if deposits actually *are* a small part of funding, and that the assets would easily pay back the depositors. (I haven't included the asset numbers here because I don't think they're reliable--- on the books they seem to exceed liabilities comfortably, so they must not be written down enough).
*The bank uses four sources for funding. Balances for each segment were: --Retail 24.4 billion pounds (23.2 percent of total) --Securitisation 45.7 billion pounds (43.6 percent) --Non-retail 26.7 billion pounds (25.5 percent) --Covered bonds 8.1 billion pounds (7.7 percent). *The bank had total customer account liabilities of 30.1 billion pounds, consisting of retail balances of 24.4 billion and other customer accounts of 5.8 billion. ... *Bank liabilities totalled 110.1 billion pounds, including: --Customer accounts 30.1 billion pounds --Debt securities in issue 71 billion pounds --Deposits by banks 3.7 billion pounds --Derivative financial instruments 2.9 billion pounds.
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