Japan Loves The Bank Bail-In Model As well

Although difficult to spot trends in this uncertain and volatile climate, there is one crystal clear trend: bank bail-ins. They became “mainstream” in Cyprus in March of this year. The Europeans fell in love with the model right away as confirmed by European finance minister Jeroen Dijsselbloem. Only two months later the phenomenon is going global. Yesterday, Japan officially announced they would adopt the model when it would be required. The trend is spreading as fast as viral trends on the internet.

Yesterday’s newsflash out of Japan:

Japan’s Financial Services Agency will enact new rules that will force failed bank losses on investors, if needed, via a mechanism known as a “bail-in,” according to The Nikkei. Mitsubishi UFJ (MTU), Mizuho Financial (MFG) and Sumitomo Mitsui (SMFG) are among those proposing amendments to allow them to issue the types of preferred shares or subordinated bonds that would be used in such cases, the report noted. (source)

The bank bail-in model is being elaborated in detail as we speak. Last week, the Bank for International Settlements announced they are working on the template, i.e. a blueprint which outlines the steps to handle the failure of a major bank and associated conditions to be met for ‘bailing-in’ deposits. Eric Sprott (www.sprott.com) explained into more detail  the mechanism the BIS is setting up to recapitalize failed banks without the use of taxpayers’ money.

They propose a process whereby a bank, if it reached the point of failure, could transfer ownership to a newly created holding company over a weekend and be recapitalized. The bank would then be sold, enabling the market to determine the ultimate losses to previous equity holders and creditors. And, yes, this scenario includes losses for depositors above a guaranteed limit. Presto! A new bank with a clean balance sheet, ready to receive liquidity support from the prevailing central bank, without the need for handouts, bailouts, TARP programs, or any other form of government assistance. Previous debt and equity holders and depositors of this failed bank would be left with an equity position in the new entity.

In the same update, Eric Sprott discusses the impact for investors:

By law, when you put your money into a deposit account, your money becomes a liability of the bank. Above an insured amount, you become an ‘unsecured creditor’ with a claim against the assets of a bank if it were to fail; your deposits are now pooled with other assets and divided amongst other creditors. We urge investors to consider any deposits above the insured amounts to be only as safe as the credit-worthiness and capital structure of the bank indicates. Only by understanding where you are in the creditor ‘pecking order’ will you avoid a ‘Dijssel-Bomb’ in the next phase of the on-going financial crisis.

What does all this mean for precious metals? One would intuitively conclude that precious metals, in physical and allocated form, would be the ultimate protection. We believe it still is the case. But … in this environment with deflationary forces precious metals holders should be prepared to stomach lower prices. It remains unknown for how long this disconnect between decreasing prices and increasing protective value will go on. Clearly the market price of precious metals (which is determined by “the market”) does not reflect the price and value for small investors and individuals. It is important to understand this disconnect, and act accordingly.

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