The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
LONDON — Running out of cash — rather than insolvency — is what causes financial crises such as the euro zone’s. Yet the lion’s share of the effort by policy makers around the globe has been to shore up solvency not funding. Unless that changes, the world will lurch from crisis to bailout and back again.
Ireland’s bank crisis is only the latest example of how seemingly solvent institutions can be brought to the brink because they can’t fund themselves. It was only four months ago that Allied Irish Banks (AIB) and Bank of Ireland were given a clean bill of health in the European Union’s official stress tests. One weakness of these tests was that they only stressed solvency not liquidity, although that may be remedied next year.
Ireland’s banks didn’t have a large enough base of retail deposits. AIB’s and BoI’s loan-to-deposit ratios are just above 160 percent. That made them excessively dependent on wholesale money. When that dried up, they had to turn to the European Central Bank. When deposits from corporate customers also started to flee, emergency action was required.
Sadly, this is an all-too-familiar story. Funding was the Achilles’ heel of banks that went to the brink in 2008. The likes of Lehman Brothers, Northern Rock, Washington Mutual, Royal Bank of Scotland and Fortis may have had inadequate equity. But death through insolvency is a slow one. Death, or near-death, through lack of liquidity is a rapid one.