This Ominous Risk to Your Capital Is Growing

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If there's one thing that concerns everyone it's a threat to their capital.

So you'll be interested to know that the risk of a new type of strategy to capitalize faltering banks keeps growing every day.

It's a strategy that's been tried before, with just enough "success" to be dangerous, and it puts your hard-earned capital at risk.

I've promised to keep you abreast on the evolution of this insidious way for governments to offload risk. Also I wanted to update you on how to protect yourself against these measures impacting your portfolio.

Today I have news on both fronts that's both unsettling and enlightening.

But let's start right now at the beginning, and look at how your capital may be at risk, and what's so alarming...

Their "Solution" Impacts You - Badly

Since not everyone is familiar with the term "bail-in," let's take a look at what it means.

A bank bail-in is when an ailing bank's creditors are tapped to help repair its balance sheet. This "help" can take many different forms, but in general is associated with having creditors restructure or write down their debt obligations.

This normally includes shareholders and bondholders.

Don't confuse bail-in with a bail-out. The latter is when the government uses taxpayer money to help save an ailing bank.

It's a topic I've addressed here and here.

But since the Cypriot financial crisis of early 2013, depositors have been added to the list of creditors, and this is the crux of my deep concerns. You see, this has been tried before, and the results were pretty scary...

The first suggestion to save ailing Cypriot banks was a one-off levy on deposits of 6.7% up to €100,000 and 9.9% for higher deposits, on all domestic bank accounts.

But there was massive pushback, and the deal failed to gain approval from the Cypriot parliament.

The final "solution" was an over 45% haircut for deposit amounts over and above the €100,000 insured minimum at the affected banks. Thanks to some sly moves, this deal didn't even require parliament's approval.

Bail-ins are a major threat because central planners are doing everything within their powers to leave savers with no alternatives.

Right now, finance officials are working hard towards an agreement that will make the bailing-in of creditors the new norm in dealing with "too big to fail" (TBTF) financial institutions.

That's the purview of the Financial Stability Board (FSB), an international body set up in the wake of the 2008-2009 financial crisis, to develop and recommend changes to deal more effectively with TBTF financial institutions.

Back in September 2013 the FSB published the report, "Progress and Next Steps Toward Ending 'Too-Big-To-Fail,'" for presentation to the G-20.

In it, the FSB confirms that "Substantial headway is being made in the implementation of the Key Attributes across FSB jurisdictions, as demonstrated in the United States by the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act..." It also highlights progress in other FSB jurisdictions like Australia, France, Germany, Japan, Netherlands, Spain, Switzerland, and the UK.

More importantly, the FSB confirms that the G-20 endorsed the "Key Attributes of Effective Resolution Regimes for Financial Institutions." These "Key Attributes" are meant to facilitate resolving TBTF problems, by "...using mechanisms for losses to be absorbed ...by shareholders and unsecured and uninsured creditors." (Emphasis mine.)

In a post-Cyprus world, you can certainly include bank depositors as unsecured creditors, at least for amounts above deposit-insured limits.

But desperate times can lead to desperate measures. Remember, the initial proposal in Cyprus would have confiscated funds from each and every account in the nation, including the insured portion.

So consider yourselves forewarned. Here's why...

Shifting TBTF Risks Puts Us at Risk

The largest of these banks will need to issue billions of dollars' worth of new bonds to shore up their capital to meet new requirements. That will go some way to help protect them against bankruptcy.

But TBTF banks are so interdependent and (still) so over-leveraged thanks to the fractional reserve banking model and risky investing, even small impairments to their capital can quickly lead to insolvency.

Relatively unscathed by the financial crisis, Canada's banking system gets top marks for safety. But in July, Moody's lowered the outlook for Canadian banks from stable to negative, citing recent bail-in laws.

Governments know their constituents no longer have any tolerance for bail-outs with taxpayer funds. So bail-ins are quickly becoming the new norm.

Worldwide, bail-in legislation is advancing quickly. The FSB hopes to have proposals ready for finance ministers to present at the November G-20 pow-wow in Brisbane, Australia.

Legal regimes in Japan, China, and a few other nations are impeding progress, since many of their banks are heavily depositor-funded. It will be a harder sell, but likely to fly nonetheless.

Germany, often a conservative holdout in financial matters, expects to pass new legislation by November that will force creditors to pony up when failing banks require support.

Here too, the aim is to have shareholders and creditors, rather than taxpayers, bear rescue costs. However in this case, German legislation will be in effect by 2015, a full year ahead of European requirements.

An Unconventional Bank, a Real Bail-in Remedy

How can you protect yourself against the coming bail-in regime?

You already know that your first line of defense is to become your own central bank; protect yourself by owning and investing in hard assets like gold, silver, energy, and real estate, by holding plenty of cash, and by holding some assets internationally.

Soon though, you may be able to deposit your money in a truly innovative kind of bank; one that doesn't magically multiply deposits ten times over, and then lend all of that out at inflated rates.

A while back I told you to watch for what may well become the world's safest bank.

In October 2011 Eric Sprott, a Canadian billionaire resource guru, bought a controlling interest in Ontario currency trading house Continental Currency Exchange Corp.

Sprott's stated goal was to structure Continental Bank to take deposits, but not make loans or risky investments. To generate income, the company would instead look to offering currency exchange services and selling precious metals.

Sprott also envisions one day allowing customers to hold their deposits in gold or silver-backed accounts. Checks could be written against those accounts to make purchases, which would then be debited, just like any other account.

Well Continental Bank is a big step closer to reality. Late last year, Continental was granted its federal bank charter. In March, the company finalized the location for its head office.

Continental Bank may only be a small player at its outset, but backing from billionaire Eric Sprott and a common sense business model will exponentially increase its odds of success.

What's more, it will likely never require a bail-in, and that I think will attract a lot of clients. I also expect it to draw the attention of competitors. It wouldn't surprise me to see Continental's business model emulated elsewhere.

Before long, you may be able to deposit your money at a bank that simply will not lend it out. And wouldn't that be refreshing.

Like it or not, bail-ins will be a major part of future bank recapitalizations, meaning your deposits could be at risk of confiscation.

Cyprus was a successful trial balloon.

It's time to be on the lookout to protect your assets, and to find a safer banking alternative.

About the Author

Peter Krauth is the Resource Specialist for Money Map Press and has contributed some of the most popular and highly regarded investing articles on Money Morning. Peter is headquartered in resource-rich Canada, but, as editor of Real Asset Returns, he travels around the world to dig up the very best profit opportunity, whether it's in gold, silver, oil, coal, or even potash.

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