What could go wrong with retirement funds? One risk is a bank bail-in.
What is bail-in?
We have all heard about bailouts where the government uses taxpayers money to prop up the banks when they run into trouble. Bailouts were applied during in the global financial crisis in 2008. Bail-in is when the bank’s creditors inject funds to prop up the bank. The creditors include the bank shareholders bondholders and depositors. Bail-in has been touted to be a better solution than bailout because it avoids the taxpayer from footing the bill. But surely a big chunk of the bank’s creditors are actually taxpayers? In that case, bail-in is just a way of circumventing the government as the middleman.
The G20 met in Brisbane in 2014 and rubber stamped bail-in policy which has since been written into law in many countries, and most people don’t even know about this. The exact bail-in laws do differ between countries and so you do need to do your own research into the situation in your particular jurisdiction (Start with this research paper)
Here are some of the factors to consider regarding bail-in structure.
- What is the trigger for a bail-in? The triggers are vague but essentially revolve around an institution being likely to fail.
- There is variation around what exactly can be bailed in. For example there are different types of creditors and each are treated differently (foreign versus local creditors, or shareholders versus bank depositors).
- Depositor insurance has been introduced in many countries, ranging anywhere from zero in New Zealand, to $250,000 in USA. This probably gives people a sense of security but conditions apply and this is where reading the fine print becomes really important.
- What circumstances does this insurance actually cover? Does it only kick in when a bank actually fails? If so then a bail-in actually occurs before a bank has failed and the funds are used to prop the bank up and prevent failure so does that mean that the deposits are still safe?
- The percentage of the haircut that the creditor takes also varies between different countries as well as different types of of creditors. In some instances just the bailed-in capital might be taken, whereas in other circumstances the funds might be converted into shares in the failing bank.
In New Zealand there is no deposit insurance at all and the term “bail-in” has been renamed “open bank resolution” This is how it works. If an unstable bank is allowed to fail, customers are totally locked out and it could be many months before they can get access to even a portion of their funds. Under the open bank resolution, the bank would close and some of the funds are frozen (we don’t know exactly how much is frozen). The bank could potentially reopen the next day, allowing customers to access the non-frozen portion of their account in order to pay their bills. The frozen money is then used to resolve the bank’s issues. Any of the frozen funds not used in the resolution may then be returned to the customer….assuming there is anything left over.
Bank bail-in risk
Ideally you want to deposit your cash in a bank that is not unstable or a risk of becoming unstable. How do retailer investors determine that? Although there is a lot of information it is difficult to sift through. Additionally, the interconnectivity of banks makes it difficult to quantify the exposed risk.
The derivatives exposure for Australian banks was over 37 trillion dollars in 2017 (compared to 15 trillion dollars in 2009). Even worse, each of the large US banks alone has a greater derivatives exposure than all of the banks in Australia. The risk of bank instability is not small.
Retirement fund structure
Retirement fund come in a range of flavors. Your workplace might provide a defined benefit or defined contribution pension scheme and they commonly match employee contributions. There are also tax favored funds and options for self-administered funds. Retirement funds are usually locked until a specified age. Managed funds allocate the majority of their capital in equities and bonds but cash is also a component. Some retirement funds do not allow investment in precious metals. For some, the only control they have over their workplace retirement fund is the contribution level and limited asset allocation choices.
Retirement fund risks
What could possibly go wrong with a retirement fund (aside from the standard risks that go along with investment)?
- Any portion of a retirement fund that is allocated to cash, bank stocks, or bank bonds might be vulnerable to bail-in.
- Negative interest rates. Indeed, the Bank of Ireland is charging 0.65% on pension fund accounts in response to negative interest rates.
- Currency devaluation is an important factor that is rarely considers. A retirement fund may have a nominal value of millions, however that’s not going to be much good if all it buys is a few chickens!
- A change in the retirement age or changes in the age at which you can access the funds will almost certainly be in the upwards direction.
- Changes in tax rules and fees can occur at ay time, usually in the direction that is not beneficial for the retiree.
These factors are out of our control. That is why it is important to have a plan b. If everything does tick along nicely, and the economic system remains strong, and currencies strengthen, consider your retirement fund to be a bonus. However if the issues discussed do occur, having alternatives that allow you to maintain the standard of living that you are used to will be crucial. That means having a separate form of retirement savings that you have greater control of.