Why should governments bail out banks? Why not

PRO: Why banks should be bailed out

Bailing out banks is not exactly popular, but there are weighty reasons why bankruptcy is dangerous.

The Republic of Austria is now involved in three banks. In autumn 2008 Kommunalkredit was saved from bankruptcy with the nationalization; at the end of 2009 the Carinthian Hypo Alpe Adria had to be absorbed. With VBAG, a third problem child has now been added, which Finance Minister Maria Fekter will probably have to deal with for even longer. Criticism of the government's bailout policy is growing. One should also let ailing banks die, is one demand.

Four reasons why this is not necessarily a good idea:

  • Bankruptcy would have been much more expensive

The rescue package for the ailing Volksbanken AG amounts to more than one billion euros. The alternatives to the involuntary partial privatization of the bank would have been much more expensive, say SP Chancellor Werner Faymann and VP Vice Chancellor Spindelegger. According to Faymann, the state deposit insurance fund would have come into play in the event of bankruptcy. In the worst case, this would have cost Austria up to ten billion euros. In addition, according to government accounts, there would have been liabilities - which would have increased the overall risk to 13 billion euros. Even if these worst-case numbers are questionable, the costs would have been significantly higher.

  • Bank failures are a game with fire

Taxpayers' money for banks again? The resentment of the population is growing. But it is not as easy to let a bank die as it sounds at first. The functioning of the banking system depends on the trust of customers. The bankruptcy of a large Austrian bank would seriously shake this confidence. A chain reaction could result. Because when one bank goes bust, other banks that have lent it a lot of money have to write off the value of those loans on their balance sheets. As a result, their equity is shrinking and the risk of further bankruptcy increases. In the special case of ÖVAG, this would have affected some of the 62 Volksbanks in the federal states. You should have been the first to pay for ÖVAG's savings balances - as a result of the three-tier deposit guarantee system.

  • Rescue yes, but with conditions

The US brought the world to the brink of financial collapse in 2008. But the US example also shows that a bank bailout can cost less than expected. The state forced the necessary capital on the banks and demanded shares in return. In this model, the existing shareholders will share in the rescue costs, because their stake in the bank will be diluted by the capital increase. In addition, the state receives something in return and can even earn money if the share price rises again. In the current case of VBAG, the bank will receive 480 million euros in the course of a capital increase, of which the federal government will contribute 250 million euros. The state share is 49 percent, so that the previous main shareholders retain control. The ÖVAG share is to be sold by 2017, which would put money back in the cash register for the state.

  • Banks pay their own bailout

According to VP Finance Minister Fekter, the rescue of VBAG should not be financed mainly through taxpayers' money. Therefore, the government will increase the bank tax introduced last year by 25 percent. This special tax has so far brought in 500 million euros annually, which flow directly into the budget. Now a special fund is to be set up, into which the banks will bring in 125 million euros annually (as the additional 25 percent). The tax is due regardless of whether financial institutions make a profit or a loss. And that should also hold up legally. The Constitutional Court recently declared that the state does not have to distinguish between "good" and "bad" banks.

>> CONTRA: Why banks should also die

"Pros and cons"

The "PRO and CONTRA" series is a collection of arguments for and against a current topic that does not reflect the opinion of the authors.