By Liam Vaughan and Gavin Finch – May 29, 2012 4:01 PM PT

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.

A pedestrian passes a “Grexit” headline on a newspaper displayed at a street kiosk in Athens. 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. Photographer: Kostas Tsironis/Bloomberg

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“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 theInternational 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 SpainItaly and Portugalmay 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.

“Contagion fears might compel individuals in Portugal, Ireland, Italy and Spain to withdraw bank deposits due to concerns over solvency, redenomination, or otherwise,” UBS AG (UBSN) Chief Investment Officer Alexander Friedman said in a May letter to client advisers. “This could spark a major banking collapse, requiring truly unprecedented action from the ECB.”

Even after boosting capital and building up liquidity buffers of more than 1 trillion euros over the past two years, lenders may be unable to survive a system-wide bank run without political intervention, either in the form of a pan-European deposit guarantee or an expanded bank-bailout facility, Jernej Omahen, an analyst at Goldman Sachs Group Inc. (GS) in London, said in a May 22 report to clients.

“An EU-wide deposit-guarantee fund may prove to be the most important tool to preserve financial-market stability if Greece were to leave the euro area,” said Tobias Blattner, an economist at Daiwa Capital Markets in London.

Hollande, Monti

European leaders discussed regionalizing deposit guarantees as part of talks on reigniting growth in the euro area, EU President Herman Van Rompuy said after a summit in Brussels on May 24. French President Francois Hollande said after the meeting that he and Italian Prime Minister Mario Monti backed the plan. European Central Bank Executive Board member Peter Praet called for a similar scheme on May 25 as part of a financial union with one authority responsible for supervision and resolution of cross-border banks.

Policy makers also may consider cutting interest rates, buying more bonds through the EU’s Securities Market Program and starting a third longer-term financing operation to stem concerns that the currency may break up, Stefan Nedialkov, a London-based analyst at Citigroup Inc. wrote in a May 17 note.

Argentine Crisis

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.

“There is a spectrum of perceived risk, which starts with Greece on one end and Germany and the U.K. on the other,” Manson said. “Portugal, Italy and Spain are all somewhere in the middle of that spectrum. This trend of sweeping deposits north has been exacerbated by the current crisis.”

Redenomination Risk

EU policy makers last overhauled rules on deposit-guarantee plans in 2009 after a global banking crisis exposed discrepancies in the level of protection offered in different countries. They raised the minimum amount insured to 100,000 euros a person from 20,000 euros. National governments were also told to ensure that their programs were pre-funded with contributions from lenders rather than topped up after a bank collapses. The way lenders are charged for the funds and how much they have to pay varies from nation to nation.

No provision was made for the possibility that a country would leave the euro, said two people involved in establishing the rules who declined to be identified because the talks were private. That provides little assurance to depositors concerned that their savings in euros may be redenominated as well as that banks may fail.

“For a pan-euro deposit-guarantee scheme to ‘firewall’ deposits in Italy, Ireland, Portugal and Spain following a potential Greek exit, it needs to explicitly cover redenomination risk as well,” Ronit Ghose, a Citigroup analyst based in London, wrote in a May 25 report. That would cost more than 150 billion euros, he estimated.

‘Longer-Term Project’

The European Commission said in a July 2010 report that a pan-European deposit guarantee would be cheaper and more effective than individual national facilities, though legal issues made it a “longer-term project” to be reviewed by 2014.

The EU currently is weighing plans to force national governments to ensure that a minimum amount of money is immediately available to stabilize a bank in the event of a run. Under the proposals, to be published by the commission June 6, funds would be raised through annual contributions by banks. Lenders could be tapped for further financing in an emergency, then national central banks, before governments would be obliged to lend to each other as a last resort.

Member states could merge these requirements with existing national arrangements to guarantee bank deposits, and would also be required to pool financial resources when a cross-border bank is on the point of failure, according to a draft of the plans obtained by Bloomberg News on May 25.

Depleted Funds

In the meantime, concern is rising that existing national funds may struggle to honor their guarantees should the crisis worsen and sovereign borrowing costs remain elevated. Yields on 10-year Italian government bonds have jumped 1.09 percentage points to 5.77 percent from a March 9 low for the year. Their Spanish equivalents have increased 1.45 percentage points to 6.45 percent over the same period.

“Guarantees are still provided locally, by governments and agencies that have credit risk, reducing the value of the insurance,” Jonathan Glionna, a London-based analyst at Barclays, wrote in a May 22 note to clients.

Spain has dipped into its guarantee fund, which stood at 6.6 billion euros in October, to cover loan losses for buyers of failed banks. It used the facility to inject 5.25 billion euros into Caja de Ahorros del Mediterraneo when it agreed to sell it to Banco Sabadell SA in December. The deposit-guarantee program will also reimburse the bank-rescue fund for the 953 million euros it paid for a stake in Unnim Banc, which was sold to Banco Bilbao Vizcaya Argentaria SA. (BBVA) The country had 931.2 billion euros of deposits at the end of March, according to ECB data.

Politically Difficult

Italy’s deposit-insurance program is still unfunded, with banks pledging to contribute if and when necessary. Silvia Lazzarino De Lorenzo, a spokeswoman for Roberto Moretti, chairman of the Interbank Deposit Protection Fund, declined to comment. The country had 1.1 trillion euros of deposits at the end of March, ECB data show.

Portugal has a deposit fund of 1.4 billion euros collected from banks through annual contributions, according to Barclays. The country’s total deposits stood at 164.7 billion euros at the end of March, according to the central bank.

One option for an EU-wide insurance plan would involve Europe’s largest banks contributing 107 billion euros, or 1.5 percent of eligible deposits, to a fund over 10 years, according to proposals by Dirk Schoenmaker and Daniel Gros of the Centre for European Policy Studies, a Brussels-based research group.

Implementing such a program wouldn’t be difficult technically because it would be only a matter of harmonizing existing standards, said Simon Gleeson, a financial-services lawyer at Clifford Chance LLP in London.

“The real difficulty is that domestic consumers in countries like Germany will be forced to pony up for the failures of foreign banks,” Gleeson said. “That makes it politically very difficult.”

To contact the reporters on this story: Liam Vaughan in London at; Gavin Finch in London at

To contact the editor responsible for this story: Edward Evans at