The BSP’s One-Two Punch: Can RRR Cuts and PDIC Deposit Insurance Avert a Liquidity Crisis?

Historical research on bank runs indicates that the reason people run is run is not fear of people running. People typically ran when the bank was already insolvent. Healthy purpose of closing the bank before the bank lost even more money. True, the losses were unevenly distributed, depending on whether you got on the front of the line or the back of the line. In a way, that provides a useful incentive mechanism: monitor your bank and don't rely on other people to monitor it for you—Lawrence White

In this issue

The BSP’s One-Two Punch: Can RRR Cuts and PDIC Deposit Insurance Avert a Liquidity Crisis?

I. From Full Reserves to Fractional Banking: The Risks of a Zero-Bound RRR

II. Has the BSP’s "Easing Cycle"—Particularly the RRR Cut—Eased Liquidity Strains?

III. Bank Assets: A Tale of Contradictions: Booming Loans and Liquidity Pressures

IV. Bank Credit Boom Amid Contradictions: Soaring Credit Card NPLs as Real Estate NPLs Ease

V. Investments: A Key Source of Liquidity Pressures

VI. Hidden Risks in Held-to-Maturity (HTM) Securities: Government Debt

VII. Slowing Deposit Growth and the Structural Changes in the Banking System’s Asset Distribution

VIII. Liquidity Constraints Fuels Bank Borrowing Frenzy

IX. PDIC’s Doubled Deposit Insurance: A Confidence Tool or a Risk Mitigant?

X. Conclusion: Band-aid Solutions Magnify Risks

The BSP’s One-Two Punch: Can RRR Cuts and PDIC Deposit Insurance Avert a Liquidity Crisis?

Facing the risks from lower bank reserve requirements, the BSP may have pulled a confidence trick by doubling deposit insurance. But will it be enough to avert the ongoing liquidity stress?

I. From Full Reserves to Fractional Banking: The Risks of a Zero-Bound RRR 

Full reserve banking originated during the gold standard era, where banks acted as custodians of gold deposits and issued paper receipts fully backed by gold reserves. This system ensured financial stability by preventing the expansion of money beyond available reserves. However, as banks realized that depositors rarely withdrew all their funds simultaneously, they began lending out a portion of deposits, leading to the emergence of fractional reserve banking.

Over time, governments institutionalized this practice, largely due to its political convenience—enabling the financing of wars, welfare programs, and other government expenditures. This shift was epitomized by 1896 Democratic presidential candidate William Jennings Bryan's famous speech in which he declared, "You shall not crucify mankind upon a cross of gold!" 

Governments reinforced this transition through the creation of central banks and an expanding framework of regulations, including deposit insurance. Ultimately, these policies culminated in the abandonment of the gold standard, most notably with the Nixon Shock of August 1971. 

While fractional reserve banking has facilitated economic growth by expanding credit, it has also introduced significant risks. These include bank runs and liquidity crises, as seen during the Great Depression, the 2008 financial crisis, and the 2023 U.S. banking crisis; inflationary pressures from excessive credit creation; and moral hazard, where banks engage in riskier practices knowing they may be bailed out. 

The system’s reliance on high leverage further contributes to financial fragility. 

The risks of fractional reserve banking are amplified when the statutory reserve requirement (RRR) approaches zero. A zero-bound RRR effectively removes regulatory constraints on the proportion of deposits banks can lend, increasing liquidity risk if sudden withdrawals exceed available reserves. 

This heightens the probability of bank runs, making institutions more dependent on central bank intervention for stability. 

Additionally, a near-zero RRR expands the money multiplier effect, increasing the risks of excessive credit creation, exacerbating asset-liability mismatches, fueling asset bubbles, and intensifying inflationary pressures—ultimately turning individual failures into systemic vulnerabilities that repeatedly require central bank intervention. 

Without reserve requirements, banking stability relies entirely on the presumed effectiveness of capital adequacy regulations, liquidity buffers, and central bank oversight, increasing systemic dependence on monetary authorities—further assuming they possess both full knowledge and predictive capabilities (or some combination thereof) necessary to contain or prevent disorderly outcomes arising from the buildup of unsustainable financial and economic imbalances (The knowledge problem). 

Moreover, increased reliance on these authorities leads to greater politicization of financial institutions, fostering inefficiencies such as corruption, regulatory capture, and the revolving door between policymakers and industry players—further distorting market incentives and deepening systemic fragility. 

Consequently, while a zero-bound RRR enhances short-term credit availability, it also raises long-term risks of financial instability and contagion during crises. 

At its core, zero-bound RRR magnifies the inherent fragility of fractional reserve banking, increasing systemic risks and reliance on central bank intervention. By removing a key buffer against liquidity shocks, it transforms banking into a highly unstable system prone to crises. 

II. Has the BSP’s "Easing Cycle"—Particularly the RRR Cut—Eased Liquidity Strains?

Businessworld, March 15, 2025: THE PHILIPPINE BANKING industry’s total assets jumped by 9.3% year on year as of end-January, preliminary data from the Bangko Sentral ng Pilipinas (BSP) showed. Banks’ combined assets rose to P27.11 trillion as of end-January from P24.81 trillion in the same period a year ago. Month on month, total assets slid by 1.2% from P27.43 trillion as of end-December. 

In the second half (2H) of 2024, the Bangko Sentral ng Pilipinas (BSP) launched its "easing cycle," implementing three interest rate cuts and reducing the reserve requirement ratio (RRR) on October 25.

A second RRR reduction is scheduled for March 28, 2025, coinciding with the Philippine Deposit Insurance Corporation (PDIC) doubling its deposit insurance coverage, effective March 15.

Yet, despite these measures, the Philippine GDP growth slowed to 5.2% in 2H 2024—a puzzling decline amid record-high public spending, unprecedented employment rates, and historic consumer-led bank borrowing. 

Has the BSP’s easing cycle, particularly the RRR cuts, alleviated the liquidity strains plaguing the banking system? The evidence suggests otherwise. 

III. Bank Assets: A Tale of Contradictions: Booming Loans and Liquidity Pressures 

Philippine bank assets consist of cash, loans, investments, real and other properties acquired (ROPA), and other assets. In January 2025, cash, loans, and investments dominated, accounting for 9.8%, 54.2%, and 28.3% respectively—totaling 92.3% of assets.

Figure 1

Loan growth has been robust. The net total loan portfolio (including interbank loans IBLs and reverse repos RRPs) surged from a 10.7% year-on-year (YoY) increase in January 2024 to 13.7% in January 2025.

As a matter of fact, loans have consistently outpaced deposit growth since hitting a low in February 2022, with the loans-to-deposit ratio accelerating even before the BSP’s first rate cut in August 2024. (Figure 1, topmost graph)

Historical trends, however, reveal a nuanced picture.

Loan growth decelerated when the BSP hiked rates in 2018 and continued to slow even after the BSP started cutting rates. Weak loan demand at the time overshadowed the liquidity boost from RRR cuts. (Figure 1, middle image)

Despite the BSP reducing the RRR from 19% in March 2018 to 12% in April 2020—coinciding with the onset of the pandemic—loan growth remained weak relative to deposit expansion. 

It wasn’t until the BSP's unprecedented bank bailout package—including RRR cuts, a historic Php 2.3 trillion liquidity injection, record-low interest rates, USD/PHP cap, and various bank subsidies and relief programs—that bank lending conditions changed dramatically. 

Loan growth surged even amid rising rates, underscoring the impact of these interventions. 

Last year’s combination of RRR and interest rate cuts deepened the easy money environment, accelerating credit expansion. 

The question remains: why? 

IV. Bank Credit Boom Amid Contradictions: Soaring Credit Card NPLs as Real Estate NPLs Ease 

Authorities claim credit delinquencies remain "low and manageable" despite a January 2025 uptick. Since peaking in Q2 2021, gross and net NPLs, along with distressed assets, have declined from their highs. (Figure 1, lowest chart)

Figure 2

This stability is striking given record-high consumer credit—the banking system’s fastest-growing segment—occurring alongside slowing consumer spending.  (Figure 2, topmost window)

While credit card non-performing loans (NPLs) have surged, their relatively small weight in the system has muted their overall impact.

Real estate NPLs have paradoxically stabilized despite a deflationary spiral in property prices in Q3 2024.

Real estate GDP fell to just 3% in Q4—its lowest level since the pandemic recession—dragging its share of total GDP to an all-time low. (Figure 2, middle visual)

Record bank borrowings, a faltering GDP, and price deflation amidst stable NPLs—this represents 'benchmark-ism,' or 'putting lipstick on a statistical pig,' at its finest.

Ironically, surging loan growth and low NPLs should signal a banking industry awash in liquidity and profits.

Yet how much of unpublished NPLs have been contributing to the bank's liquidity pressures?

Still, more contradictory evidence.

V. Investments: A Key Source of Liquidity Pressures 

Bank investments, another major asset class, grew at a substantially slower pace, dropping from 10.7% YoY in December 2024 to 5.85% in January 2025.

This deceleration stemmed from a sharp slowdown in Available-for-Sale (AFS) assets (from 20.45% to 12% YoY) and Held-for-Trading (HFT) assets, which, despite a 22.17% YoY rise, slumped from December’s 117% spike. This suggests banks may have suffered losses from short-term speculative activities, potentially linked to the PSEi 30’s 11.8% YoY and 10.2% MoM plunge in January. (Figure 2, lowest chart)

Ironically, the Financial Index—comprising seven listed banks—rose 15.23% YoY and 0.72% MoM, indicating that losses in bank financial assets stemmed from non-financial equity holdings.

Figure 3

Despite easing interest rates, market losses on the banks’ fixed-income trading portfolios remained elevated, improving (33.5% YoY) only slightly from Php 42.4 billion in December to Php 38 billion in January. (Figure 3, topmost pane) 

VI. Hidden Risks in Held-to-Maturity (HTM) Securities: Government Debt 

Yet, HTM assets declined just 0.5% YoY. Given that 10-year PDS rates remain elevated, HTMs are likely to reach new record highs soon. (Figure 3, middle image)

Banks play a pivotal role in supporting the BSP’s liquidity injections by monetizing government securities. Their holdings of government debt (net claims on central government—NcoCG) reached an estimated 33% of total assets in January 2025—a record high.  (Figure 3, lowest graph)

Figure 4

Public debt hit a fresh record of Php 16.3 trillion last January 2025. (Figure 4, topmost diagram)

Valued at amortized cost, HTM securities mask unrealized losses, potentially straining liquidity. Overexposure to long-duration HTMs amplifies these risks, while rising government debt holdings heighten banks’ sensitivity to sovereign risk.

With NCoCG at a record high, this tells us that banks' HTMs are about to carve out another fresh milestone in the near future.

In short, losses from market placements and ballooning HTMs have offset the liquidity surge from a lending boom, undermining the BSP’s easing efforts.

VII. Slowing Deposit Growth and the Structural Changes in the Banking System’s Asset Distribution

Deposit growth should ideally mirror credit expansion, as newly issued money eventually finds its way into deposit accounts.

Sure, the informal economy remains a considerable segment. However, unless a huge amount of savings is stored in jars or piggy banks, it’s unlikely to keep a leash on the money multiplier.

The BSP’s Financial Inclusion data shows that more than half of the population has some form of debt outside the banking system. This tells us that credit delinquencies are substantially understated—even from the perspective of the informal economy

Yet, bank deposit liabilities grew from 7.05% YoY in December 2024 to 6.8% in January 2025, led by peso deposits (7% YoY), while FX deposits slowed from 7.14% to 6.14%. Peso deposits comprised 82.8% of total liabilities. (Figure 4, middle image)

Since 2018, deposit growth has been on a structural downtrend, with RRR cuts failing to reverse this trend. (Figure 4, lowest visual)

Figure 5

The gap between the total loan portfolio (excluding RRPs and IBLs) and savings widened, with TLP growth rising from 12.7% to 13.54% YoY, while savings growth doubled from 3.3% to 6.8%. (Figure 5, topmost graph)

How did these affect the bank’s cash reserves?

Despite the October 2024 RRR cut, cash reserves contracted 1.44% YoY in January 2025. In peso terms, cash levels rebounded slightly from an October 2024 interim low—mirroring 2019 troughs—but this bounce appears to be stalling. (Figure 5, middle chart)

The ongoing liquidity drain has effectively erased the BSP’s historic cash injections.

The bank's cash and due-to-bank deposits ratio has hardly bounced despite the RRR cuts from 2018 to the present! (Figure 5, lowest pane)

Figure 6

Liquidity constraints are further evident in the declining liquid-to-deposit assets ratio. (Figure 6, topmost pane)

In perspective, the structural changes in operations have led to a pivotal shift in the distribution of the bank's assets. (Figure 6, middle graph)

Cash’s share of bank assets has shrunk from 23.1% in October 2013 to 9.8% in January 2025.

While the share of loans grew from 45.3% in November 2010 to a peak of 58.98% in May, it dropped to a low of 51.6% in March 2024 before partially recovering.

Meanwhile, investments, rebounding from a 21.42% trough in June 2020, have plateaued since the BSP’s 2022 rescue package.

Still, the Philippine banking system continues to amass significant economic and political clout, effectively monopolizing the industry, as its share of total financial resources reached 83.64% in 2024. How does this mounting concentration risk translate to stability? (Figure 6, lowest chart)

VIII. Liquidity Constraints Fuels Bank Borrowing Frenzy 

In addition to the 'easy money' effect of fractional banking's money multiplier, banks still require financing for their lending operations.

Figure 7

Evidence of growing liquidity constraints, exacerbated by insufficient deposit growth, is seen in banks' aggressive borrowing from capital markets. 

Bank borrowing, comprising bills and bonds payable, reached a new record of PHP 1.78 trillion in January, marking a 47.02% year-over-year increase and a 6.5% month-over-month rise! (Figure 7, topmost diagram) 

Notably, bills payable experienced a 67% growth surge, while bonds payable increased by 17.5%.  The strong performance of bank borrowing has resulted in an increase in their share of overall bank liabilities, with bills payable now accounting for 5.1% and bonds payable for 2.43% in January. (Figure 7, middle pane) 

In essence, banks are competing fiercely among themselves, with non-bank clients, and the government to secure funding from the public's strained savings. 

Moreover, although general reverse repo usage has decreased, largely due to BSP actions, interbank reverse repos have surged to their second-highest level since September 2024. (Figure 7, lowest chart) 

The increasing scale of bank borrowings, supported by BSP liquidity data, reinforces our view that banks are struggling to maintain system stability. 

IX. PDIC’s Doubled Deposit Insurance: A Confidence Tool or a Risk Mitigant? 

The doubling of the Philippine Deposit Insurance Corporation's (PDIC) deposit insurance coverage took effect on March 15th. 

The public is largely unaware that this measure is linked to the second phase of the reserve requirement ratio (RRR) cut scheduled for March 28th. 

In essence, the Bangko Sentral ng Pilipinas (BSP), through its attached agency the PDIC, is utilizing the enhanced deposit insurance as a confidence-building measure to reinforce stability within the banking system. 

Inquirer.net, March 15, 2025: The Philippine Deposit Insurance Corp. (PDIC)—which is mandated to safeguard money kept in bank accounts —finally implemented the new maximum deposit insurance coverage (MDIC) of P1 million per depositor per bank, which was double the previous coverage of P500,000. The expanded MDIC is projected to fully insure over 147 million accounts in 2025, or 98.6 percent of the total deposit accounts in the local banking system. In terms of amount, depositor funds amounting to P5.3 trillion will be safeguarded by the PDIC, accounting for 24.1 percent of the total deposits held by the banking sector. To compare, the ratio of insured accounts under the old MDIC was at 97.6 percent as of December 2024. In terms of amount, the share of insured funds to total deposits was at 18.4 percent before. It was the amendments to the PDIC charter back in 2022 that allowed the state insurer to adjust the MDIC based on inflation and other relevant economic indicators without the need for a new law. (bold added)

ABS-CBN News, March 14: PDIC President Roberto Tan also assured the public that PDIC has enough funds to cover all depositors even with a higher MDIC. The Deposit Insurance Fund (DIF) is around P237 billion as of December 2024. The ration of DIF to the estimated insured deposits (EID) is 5% this 2025, which Tan said remains adequate to meet potential insurance risks. (bold added) 

Our Key Takeaways: 

1) An Increase in Compensation rather than Coverage Ratio, Yet Systemic Coverage Remains Low

-The total insured deposit amount is capped at PHP 1 million per depositor.

98.6% of accounts are fully insured, up from 97.6% previously.

-The insured deposit amount increased to PHP 5.3 trillion (24.1% of total deposits) from PHP 3.56 trillion (18.4%) prior to the MDIC.

2) Systemic Risk and Vulnerabilities

-Most of the increase in insured deposits stems from small accounts.

-Large corporate and high-net-worth individual deposits remain largely uninsured, maintaining systemic vulnerability.

3) PDIC’s Coverage Limitations

-The PDIC only covers BSP-ordered closures, excluding losses due to fraud.

-If bank failures are triggered by fraud (e.g., misreported loan books, hidden losses), depositor panic may escalate before the PDIC intervenes.

-Runs on solvent banks could still occur if system trust weakens.

Figure/Table 8 

4) Mathematical Constraints on PDIC's Deposit Insurance Fund (DIF) and Assets

-The PDIC's 2023 total assets of PHP 339.6 billion account for only 1.74% of total deposits. (Figure/Table 8)

-The Deposit Insurance Fund (DIF) of PHP 237 billion represents a mere 6.7% of insured deposits.

-PDIC assets and DIF account for 3.46% and 2.42% of the deposit base of the four PSEi 30 banks.

-In the event of a mid-to-large bank failure, the DIF would be insufficient, necessitating government or BSP intervention.

5) The Systemic Policy Blind Spot

-Such policy assumes an "orderly" distribution of bank failures—small banks failing, not large ones. In reality, tail risks (big bank failures) drive financial crises, not small-bank failures.

6) Impact of RRR Cuts on Risk-Taking Behavior

-The second leg of the RRR cut in March 2025 injects liquidity, potentially encouraging higher risk-taking by banks.

-Once again, the increase in deposit insurance likely serves as a confidence tool rather than a genuine risk mitigant.

7) Rising risk due to moral hazard: The increased insurance may encourage riskier behavior by both depositors and banks.

8) Consequences of Significant Bank Failures

-If funds are insufficient, the Bureau of Treasury might cover the DIF gap. Such a bailout would expand the fiscal deficit, with the BSP likely to monetize debt.

-A more likely scenario is that the BSP intervenes directly, as the PDIC is an agency of the BSP, by rescuing depositors through liquidity injections or monetary expansion.

In both scenarios, this would amplify inflation risks and the devaluation of the Philippine peso, likely exacerbated by increased capital flight and a higher risk premium on peso assets. 

X. Conclusion: Band-aid Solutions Magnify Risks 

The BSP’s easing cycle has fueled a lending boom, masked NPL risks, and propped up government debt holdings, yet liquidity remains elusive. Cash reserves are shrinking, deposit growth is faltering, and banks are borrowing heavily to stay afloat. 

The PDIC’s insurance hike offers little systemic protection, leaving the banking system vulnerable to tail risks. A mid-to-large bank failure would likely burden the government or BSP, triggering further unintended consequences. 

As contradictions mount, a critical question persists: can this stealth loose financial environment sustain itself, or is it a prelude to a deeper crisis?

 

Quote of the Day: How Fractional Reserve Banking System Causes Bank Runs

Economist Tim Worstall writing at the Forbes eloquently explains how the central bank- fractional reserve banking system causes bank runs and originated the 2008 crisis or the Great Financial Crisis

To explain this we need to take a step backwards: we can usefully, if not wholly accurately, divide investors into two types. Those who invest with their own money, those who are unleveraged, and those who invest with borrowed money, the leveraged investors. Further, among the leveraged investors we would want to distinguish between the banks who are doing this (at least, in a fractional reserve banking system we want to) and the others. And the danger comes when those banks, those people working with the deposits made into the banks, invest in either illiquid or volatile assets.

Liquidity is a problem because those depositors can come along at any time and ask for their money back. And banks borrow short and lend long: the things they invest in are notably more illiquid than the deposits they take to finance them. That’s how we get bank runs: people turn up for their money, the bank says that actually, they lent it to someone to buy a house, and then panic starts and everyone wants their money back right now.

Volatility is a problem because they’re using leverage: if prices move so much that the bank loses its capital then it still owes the same amount to depositors but it is also bust. Cue bank run again. What happened to Lehman Brothers was this second, what rocked the other Wall Street banks was the first.

Bottom line: liquidity and volatility problems are mainly symptoms of imbalances from highly leveraged systems brought about by the central bank fractional reserve banking. 

Bulgaria’s Bank Runs: The Europe Commission Rides to the Rescue

With stock markets on a bullish shindig, the idea of financial instability has almost been out of the picture. But wait, one of Europe’s poorest countries just suffered TWO bank runs on "two of the country's biggest lenders" that has prompted the European Commission (EC) to ride to the rescue. 

From the Financial Times:

Bulgaria’s banking system appeared to be stabilising late on Monday after the EU approved a Lev3.3bn (€1.7bn) emergency credit line from the central bank, following runs on two of the country’s biggest lenders in a week.

The public as scapegoats…

The Bulgarian National Bank had warned on Friday of an “attempt to destabilise the state through an organised attack against Bulgarian banks”, as Bulgarians withdrew Lev800m from branches of First Investment Bank, the country’s third-biggest lender.

Those withdrawals came just days after a run on Corporate Commercial Bank, the country’s fourth largest bank.

Six people were arrested over the weekend, accused of sending electronic warnings that FIB was about to collapse; two were indicted on Monday for spreading false information on banks.

Oops, but there is a political dimension… (bold mine)

Rosen Plevneliev, Bulgaria’s president, also announced late on Sunday that after talks with party leaders he would dissolve parliament by July 25 and then name a caretaker administration, ahead of early elections called for October 5. That move helped ease political uncertainty that had fuelled the crisis…

Despite strong fiscal management and a stable exchange rate backed by a currency board arrangement pegging the lev to the euro, Bulgaria is criticised by EU partners for weak governance resulting from close ties between business, politicians and the judiciary.

Corpbank reportedly will be nationalized.

Why would a truly sound banking system be subject to destabilization by merely false information?

The dean of the Austrian school of economics Murray N. Rothbard explains

The answer lies in the nature of our banking system, in the fact that both commercial banks and thrift banks (mutual-savings and savings-and-loan) have been systematically engaging in fractional-reserve banking: that is, they have far less cash on hand than there are demand claims to cash outstanding...

This means that the depositor who thinks he has $10,000 in a bank is misled; in a proportionate sense, there is only, say, $1,000 or less there. And yet, both the checking depositor and the savings depositor think that they can withdraw their money at any time on demand. Obviously, such a system, which is considered fraud when practiced by other businesses, rests on a confidence trick: that is, it can only work so long as the bulk of depositors do not catch on to the scare and try to get their money out. The confidence is essential, and also misguided.

So all it takes is for political uncertainty to surface to expose on the shroud of tenuous confidence from a fractional banking system which has been blamed on to the public.

The bailout means resources from European taxpayers will be used as subsidy to Bulgarian banks.

Yet with almost every nation engaged in their homegrown variety of bubbles, it is just a wonder what would happen if today’s colossal imbalances unravels? Will there be massive bank runs in many countries simultaneously? If so, does the respective governments have resources to bail them out? If not, will multilateral institutions also have resources for these rescues? Or will there be a massive recourse to save banks via deposit levies?

Kazakhstan’s Devaluation Triggers Bank Runs

A few days back I wrote about Kazakhstan’s surprisingly huge devaluation despite what mainstream would see as strong statistical data. 

As one would realize, Kazakhstan’s dilemma has not been revealed by the current and trade balances but on her currency tenga, forex reserves, external debt and importantly M3. And another thing, given the 19% devaluation, this shows that the alleged low inflation figures have also been patently inaccurate.

Well my suspicion seems right, the devaluation exposed on Kazakhstan’s debt problems via a run on three banks

From EuroAsianet.org

Kazakhstan’s central bank is appealing for calm as rumors that some financial institutions are in trouble following last week’s currency devaluation have provoked a run on three banks.

On February 19 the National Bank sent text messages to the public urging people to disregard the “false information” and not succumb to panic.

“All Kazakhstani banks have sufficient funds in national and foreign currency,” the messages read; people should not submit to “provocations” and “keep calm.”

Large queues formed at some banks in the financial capital, Almaty, for a second day on February 19 as customers rush to withdraw funds, fearing a bank collapse.

Media and officials blame it on rumors.

But logic tells us that if the banking system stands on a firm ground then they wouldn’t be vulnerable to rumors. 

The reason banks are prone to runs aside from Kazakhstan’s existing debt problems has been the roots of the monetary system: central bank fractional reserve banking standard.

"The answer lies in the nature of our banking system", writes the great dean of Austrian economics Murray N. Rothbard, that’s because “they have far less cash on hand than there are demand claims to cash outstanding.”

Professor Rothbard further explains:

This means that the depositor who thinks he has $10,000 in a bank is misled; in a proportionate sense, there is only, say, $1,000 or less there. And yet, both the checking depositor and the savings depositor think that they can withdraw their money at any time on demand. Obviously, such a system, which is considered fraud when practiced by other businesses, rests on a confidence trick: that is, it can only work so long as the bulk of depositors do not catch on to the scare and try to get their money out. The confidence is essential, and also misguided. That is why once the public catches on, and bank runs begin, they are irresistible and cannot be stopped.

Given the recent bank run Thailand, it has been interesting to see what seems as increasing frequency of bank runs in emerging markets or failing financial institutions such as in China.

More signs that emerging markets could be the modern day version of "subprime". 

We live in very interesting times

Signs of Emerging Bank Runs?

One can sense trouble when banks impose limits on depositors withdrawal (or even ask depositors reasons why the have to withdraw large amounts of their own money) as with the recent case of HSBC.

More from Simon Black of the Sovereign Man.

It’s happening again. This time HSBC branches in the UK are putting limits on customer withdrawals.

Bank employees there have been telling customers that they first must demonstrate to the bank’s satisfaction WHY they want to withdraw their own money. The bank has simply decided in its sole discretion that it won’t give people their own money back.

This is positively revolting– a breach of a most sacred form of trust between a bank and its customers. It would have been unthinkable just 10-years ago. But today it’s par for the course.

Banks across most of the ‘developed’ world have razor thin liquidity and capitalization ratios—meaning that their margins of safety are extremely low.

If just a small percentage of their assets lose value, they’ll go under. Or, if just a small percentage of their customers want their deposits back, they won’t be able to pay up.

This is ultimately what’s happening to HSBC. It turns out their UK operations are in severe financial trouble, posting a major capital shortfall of over $100 billion.

This should come as no surprise. Less than a year ago, in response to how poorly capitalized British banks were, the banking regulators announced that it would allow banks to use creative accounting to boost their numbers.

In one method that was explicitly condoned by regulators, banks were authorized to count FUTURE earnings (i.e. profit that they may or may not earn in years to come) towards their capital TODAY.

It’s like calculating your net worth based on how much you -think- you might be earning 20-years from now.

This is fraud, plain and simple. And I wrote about this numerous times last year.

Of course HSBC is not alone. With few exceptions, most banks across Europe are in a similarly precarious position– highly illiquid and thinly capitalized.

This isn’t rocket science– it’s what broke banks do. We saw what happened in Cyprus last year when banks got “bailed-in” by their customers.

Read the rest here

In a world of central banking fractional banking system, only a fraction of reserves are held by banks to service depositor’s demand for cash. 

If or when there will be a surge of (simultaneous) withdrawals, banks with insufficient funds either resort to imposing limits or turn to their respective central banks for assistance. If the public senses the latter then this would only aggravate public’s demand to access their deposits. This happened to UK's Northern Rock in 2008 which led to the firm's bankruptcy and eventually was nationalized. 

HSBC’s actions, thus, reveal of possible signs of renewed banking distress via a “quasi” bank run.

Yet the common notion that depositors own or has full access to their money deposited with banks are mistaken. As economics Professor David Howden explains at the Mises Blog

Option clauses, for example, were widely used in the Scottish “free banking” era as a way to get depositors to stop asking for their money. A bank could elect not to hand over a deposit when asked, but would at least remunerate the customer for this inconvenience. At the time this was widely seen as problematic, as it drove a wedge between the motivations of depositors (have their cash safe and available) and bankers (use depositor funds and remain solvent).

Today’s banks don’t even do this – they just change the rules of the game half-way through. Depositors think they have full access to their money when they make a deposit. Not only that, they think they are the owners of their money. Wrong on both counts. According to the law of most lands, when you deposit your money in a bank it becomes property of the bank

(bold mine)

More signs of periphery to core dynamics?

Quote of the Day: The Whole Banking Business is Corrupt

The whole banking business is corrupt from top to bottom today. Part of the problem is that banks are no longer financed by the individuals who start them, putting their personal net worth on the line. Now, they are all publicly traded entities – just like all brokerages – playing with Other People's Money. Management has no incentive to do anything but pad their wallets, so they pay themselves gigantic salaries and bonuses, and give themselves options. These people aren't shepherding their money and that of clients they know personally. They've got zero skin in the game. 

This is true all over the world, not just in the US and Europe. All these banks are going to blow up, and not just in far-off, little countries.

This quote is from investing guru and philosopher Doug Casey at his eponymous website Casey Research 

Quote of the Day: The Roots of the Too Big To Fail Doctrine

For fractional reserve banking can only exist for as long as the depositors have complete confidence that regardless of the financial woes that befall the bank entrusted with their “deposits,” they will always be able to withdraw them on demand at par in currency, the ultimate cash of any banking system. Ever since World War Two governmental deposit insurance, backed up by the money-creating powers of the central bank, was seen as the unshakable guarantee that warranted such confidence. In effect, fractional-reserve banking was perceived as 100-percent banking by depositors, who acted as if their money was always “in the bank” thanks to the ability of central banks to conjure up money out of thin air (or in cyberspace). Perversely the various crises involving fractional-reserve banking that struck time and again since the late 1980s only reinforced this belief among depositors, because troubled banks and thrift institutions were always bailed out with alacrity–especially the largest and least stable. Thus arose the “too-big-to-fail doctrine.” Under this doctrine, uninsured bank depositors and bondholders were generally made whole when large banks failed, because it was widely understood that the confidence in the entire banking system was a frail and evanescent thing that would break and completely dissipate as a result of the failure of even a single large institution.

(italics original) 

This is from Austrian economics professor Joseph Salerno at the Mises blog

Central Bank Fractional Banking System: Bank Runs or Inflation

The incumbent central bank fractional banking system means a choice between bank runs and price inflation.

The great dean of Austrian school of economics Murray N. Rothbard explained. (bold mine)

1. Why fractional reserve banks are uninsurable

The answer lies in the nature of our banking system, in the fact that both commercial banks and thrift banks (mutual-savings and savings-and-loan) have been systematically engaging in fractional-reserve banking: that is, they have far less cash on hand than there are demand claims to cash outstanding. For commercial banks, the reserve fraction is now about 10 percent; for the thrifts it is far less.

This means that the depositor who thinks he has $10,000 in a bank is misled; in a proportionate sense, there is only, say, $1,000 or less there. And yet, both the checking depositor and the savings depositor think that they can withdraw their money at any time on demand. Obviously, such a system, which is considered fraud when practiced by other businesses, rests on a confidence trick: that is, it can only work so long as the bulk of depositors do not catch on to the scare and try to get their money out. The confidence is essential, and also misguided. That is why once the public catches on, and bank runs begin, they are irresistible and cannot be stopped.

We now see why private enterprise works so badly in the deposit insurance business. For private enterprise only works in a business that is legitimate and useful, where needs are being fulfilled. It is impossible to "insure" a firm, even less so an industry, that is inherently insolvent. Fractional reserve banks, being inherently insolvent, are uninsurable.

2. Money Printing as camouflage. The political choice of inflation over bank runs.

What, then, is the magic potion of the federal government? Why does everyone trust the FDIC and FSLIC even though their reserve ratios are lower than private agencies, and though they too have only a very small fraction of total insured deposits in cash to stem any bank run? The answer is really quite simple: because everyone realizes, and realizes correctly, that only the federal government--and not the states or private firms--can print legal tender dollars. Everyone knows that, in case of a bank run, the U.S. Treasury would simply order the Fed to print enough cash to bail out any depositors who want it. The Fed has the unlimited power to print dollars, and it is this unlimited power to inflate that stands behind the current fractional reserve banking system.

Yes, the FDIC and FSLIC "work," but only because the unlimited monopoly power to print money can "work" to bail out any firm or person on earth. For it was precisely bank runs, as severe as they were that, before 1933, kept the banking system under check, and prevented any substantial amount of inflation.

But now bank runs--at least for the overwhelming majority of banks under federal deposit insurance--are over, and we have been paying and will continue to pay the horrendous price of saving the banks: chronic and unlimited inflation.

The political choice of inflation over bank runs can be seen via the loss of US dollar’s purchasing power.

Since the establishment of the US Federal Reserve in 1913, one US dollar in 1913 has an equivalent of buying power of $23.45 today according to the BLS inflation calculator. This means the US dollar have lost nearly 96% of their purchasing power. Chronic and unlimited inflation indeed.

The other implication is that the choice of inflation over bankruns means a subsidy to banks at society's expense.

 

3. Abolish the central banking system and ancillary regulators. Restore sound money

Putting an end to inflation requires not only the abolition of the Fed but also the abolition of the FDIC and FSLIC. At long last, banks would be treated like any firm in any other industry. In short, if they can't meet their contractual obligations they will be required to go under and liquidate. It would be instructive to see how many banks would survive if the massive governmental props were finally taken away.

Emerging Markets Eye Insurance Against the US Dollar, Euro

Aside from the pledge to assist in the rescue of the EU, key emerging markets led by the BRICs and South Africa discussed insurance options that goes around the US dollar.

From the China Money Report,

The BRICS countries said on Monday that they’re considering setting up a foreign-exchange reserve pool and a currency-swap arrangement as financial problems threaten to spread across the global economy.Leaders of the five-member group —Brazil, Russia, India, China and South Africa— also said BRICS is “willing to make a contribution” to increase the International Monetary Fund’s ability to rescue troubled economies. President Hu Jintao joined his counterparts from other BRICS nations on Monday morning in the Mexican resort city Los Cabos ahead of the start of the G20 Summit.

According to the Chinese Foreign Ministry, the leaders discussed the currency swap and foreign-exchange reserve pool ideas and tasked their finance ministers and central bank chiefs to implement them, according to China’s Foreign Ministry.

Swap arrangements, which allow nations’ central banks to lend to each other money to keep markets liquid, and the pooling of foreign-exchange reserves are contingency measures aimed at containing crises such as the one roiling the eurozone, analysts said.

Zhang Yuyan, director of the Institute of World Economics and Politics affiliated with the Chinese Academy of Social Sciences, said the new mechanisms established by the emerging markets themselves, who “know their current conditions and demands
much better”.

Amid the global economic slowdown, the pooling of foreign-exchange reserves will help BRICS countries to fight the lack of market liquidity, beef up their immunity to financial crises and boost global confidence, Zhang said.

Contributions to this “virtual” bailout fund, as Brazil’s Finance Minister Guido Mantega put it, would be tied to the size of each BRICS member’s currency reserves, he said. The five leaders also discussed BRICS’ participation in replenishing the IMF’s lending capital. Hu said the G20 should encourage and support the eurozone countries’ adoption of fiscal controls and spending cuts as efforts to improve confidence in world markets. The leaders also urged the IMF to carry out promised reforms of its quota and governance systems. Mexico, which was hosting the G20 Summit on Monday and Tuesday, has said it will use the meeting to press the world’s largest economies to increase IMF resources and build the fund’s capacity to intervene in the European debt crisis.

While these may be constitute added signs that much of the world seem to be getting antsy with the unfolding events in the developed economies, swaps and foreign reserve pools won’t do much when the whole paper money system goes into flame.

The reason for this is that much of the world’s banking and financial system remains anchored on fiat currencies of the western world, where the US dollar and the euro constitute 90% of global reserve currencies (see chart from Wikipedia.org).

Besides, the monetary system of emerging markets operates from the same fractional reserve system as their developed peers, which means that like their developed peers, EM politicians will be seduced to used inflationism to achieve political goals.

Instead, what these economies should do would be to ramp on gold acquisition, and possibly consider a quasi-gold standard possibly through a gold based currency board (as proposed by Professor Steve Hanke) or a return to the gold standard or allow for currency competition with the private sector (free banking, free currency competition as proposed by Ron Paul and Professor Lawrence White).

Since any of the proposed monetary reforms would entail restriction in political actions and simultaneously require massive liberalization of respective economies, these won’t likely be palatable with incumbent political agents, who under such circumstances, lose much of their current privileges (Europe’s deepening crisis are manifestations of these).

Thus, it would likely take a deeper crisis (most likely a currency crisis) to force real reforms in the system.

Will the Eurozone’s Deposit Insurance Policies Hasten the Unraveling of the Euro?

The great dean of the Austrian school of economics Professor Murray N. Rothbard once called deposit insurance a swindle. (bold emphasis mine)

The very idea of "deposit insurance" is a swindle; how does one insure an institution (fractional reserve banking) that is inherently insolvent, and which will fall apart whenever the public finally understands the swindle? Suppose that, tomorrow, the American public suddenly became aware of the banking swindle, and went to the banks tomorrow morning, and, in unison, demanded cash. What would happen? The banks would be instantly insolvent, since they could only muster 10 percent of the cash they owe their befuddled customers. Neither would the enormous tax increase needed to bail everyone out be at all palatable. No: the only thing the Fed could do — and this would be in their power — would be to print enough money to pay off all the bank depositors. Unfortunately, in the present state of the banking system, the result would be an immediate plunge into the horrors of hyperinflation.

Current crisis in the Eurozone seems to be partly actualizing what Professor Rothbard warned about: Europeans appear to be awakening from the “swindle” and have intensified demand for cash, which has been putting severe strains on the EU’s fractional reserve banking system.

From Bloomberg, (bold emphasis mine)

The threat of Greece exiting the euro is exposing flaws in how banks and governments protect European depositors’ cash in the event of a run.

National deposit-insurance programs, strengthened by the European Union in 2009 to guarantee at least 100,000 euros ($125,000), leave savers at risk of losses if a country leaves the euro and its currency is redenominated. The funds in some nations also have been depleted after they were used to help bail out struggling lenders, leading policy makers to consider implementing an EU-wide protection plan.

“These schemes were not designed to deal with a complete meltdown of a banking system,” said Andrew Campbell, professor of international banking and finance law at the University of Leeds in the U.K. and an adviser to the International Association of Deposit Insurers. “If there’s a systemic failure, there needs to be some form of intervention.”

With European officials openly discussing a Greek exit from the euro for the first time, savers in Spain, Italy and Portugal may start to withdraw cash on concern that those countries will follow Greece and their funds will be devalued with a switch to a successor currency. None of those nations has the firepower to handle simultaneous runs on multiple banks.

Pulling Deposits

Households and businesses pulled 34 billion euros from Greek banks in the 12 months ended in March, 17 percent of the country’s total, according to the ECB.

Deposits at banks in Greece, Ireland, Italy, Portugal and Spain fell by 80.6 billion euros, or 3.2 percent from the end of 2010 through the end of March, ECB data show. German and French banks increased deposits by 217.4 billion euros, or 6.3 percent, in the same period. Bank-deposit data for April will be released starting this week.

Using the Argentina crisis as precedent…

Savers pulled 27 percent of deposits from Argentina’s banks between 2000 and 2003 during a currency crisis, Nedialkov wrote. If Ireland, Italy, Portugal and Spain follow a similar pattern, about 340 billion euros could be withdrawn, he estimated.

Companies have already started to remove cash from southern Europe as soon as they earn it. Many already are sweeping funds daily out of banks in those countries and depositing it overnight with firms in the U.K. and northern Europe, according to David Manson, head of liquidity management at Barclays Plc in London, who advises company treasurers.

If the scale of bank run escalates, will the ECB, then, resort to massive inflationism to the point of hyperinflation just to rescue their banks??

Reasons Why The US Could Play A Major Role In Greece's Bailout

In last week's report Why The Greece Episode Means More Inflationism, we conjectured that perhaps the US taxpayers could play a tacit role in the Eurozone's efforts to bailout Greece.

Then came recent news reports which revealed that Wall Street seem to have had lent a hand in the shielding of Greece's liabilities via the use of currency swaps since Greece joined the EU.

According to the New York Times, ``In 2001, just after Greece was admitted to Europe’s monetary union, Goldman helped the government quietly borrow billions, people familiar with the transaction said. That deal, hidden from public view because it was treated as a currency trade rather than a loan, helped Athens to meet Europe’s deficit rules while continuing to spend beyond its means."

David Kotok of Cumberland Advisors suspects that perhaps there is more than meets the eye, (bold highlights mine)

``It appears that Greece clandestinely attempted to use currency swaps as a deferral technique to project their payment obligations into the future and to hide them. Greek officials claim to the contrary; they say the transactions were reported. But an initial scan of the reports that were used in the early part of this decade does not find them. Hmmmm?

``Let’s make this clearer for readers: the use of this type of swap accomplishes the movement of debt off the balance sheet and into the currency balances. There can be legitimate economic reasons for this type of transaction as an offset to trade flows. And the same transaction can be used for outright deception if the user wants to hide a rising debt ratio.

``Now an investigation is underway by Europe’s statistical office, Eurostat. News reports have also been confirmed that Greece has a history of using this allegedly deceptive technique in the past. We now know it was done in 2001 and was contemporaneous with other actions that Greece was taking so it could become the twelfth member of the Eurozone.

``It also appears that these transactions were arranged through Goldman Sachs and that subsequently GS hedged its position to a neutral one by shorting or constructively shorting Greek debt. Did Goldman act improperly? That now also is a subject of debate. Investigations are certainly coming. Witch-hunting about Goldman Sachs and their book of derivatives is very popular these days. We expect to see more of it on both sides of the Atlantic Ocean.

``There will be much EU political outcry about this transaction which currently is measured at 1 billion euro. The key question for markets revolves around whether or not this is a single event or if there are more such transactions that will be revealed in the books of Greece or other EU member states."

Based on the above, there could be three reasons that would prompt for the US via the US Federal Reserve to intervene:

one, Wall Street has more exposure (perhaps indirectly) to the Greek (PIIGS) than is publicly known or declared and

two, there could be official efforts to cover the tracks of Wall Street's subterfuge.

three, to ensure the US dollar hegemony (by ensuring the survival of Wall Street who serve prime agents of the Federal Reserve and their alternate egos in Europe)

Congressman Ron Paul raised the same concerns; (bold highlights mine)

``Is it possible that our Federal Reserve has had some hand in bailing out Greece? The fact is, we don’t know, and current laws exempt agreements between the Fed and foreign central banks from disclosure or audit.

``Greece is only the latest in a series of countries that have faced this type of crisis in recent memory. Not too long ago the same types of fears were mounting about Dubai, and before that, Iceland. Several other countries (Spain, Portugal, Ireland, Latvia) are approaching crisis levels with public debt as well. Many have strong ties to Goldman Sachs and the case could easily be made that default could have serious implications for big US banking cartels. Considering the ties between the Fed and these big banks, it is not outlandish to wonder if the US taxpayer is secretly bailing out the entire world, country by country, even as our real unemployment tops 20 percent...

``This global financial crisis is a predictable result of secretive central banking and unsound fiat currency. Governments are entirely committed to this system of fiat money and fractional reserve banking for obvious reasons: it enables them to do what they love most, namely, spend hoards of money with near impunity. Without the limitations of sound money, governments will spend without limit. They will spend money to hire their cronies, pay off special interests, give out favors, create dependence and generally distract from the terrible job they do at their chief mandate, which is to protect the liberties of the people. Fiat money is a blank check to government, which is very dangerous, and we are witnessing the death throes of the system as the bills come due and the underlying capital is squandered away."

The ramifications of which appear to be headed in the direction of our much feared 'Mises Moment'.