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May 21, 2014

Greek tragedy and the siren song of the fine print

Originally published in Financial World

Robert Jenkins tells a cautionary tale to foreign banks operating in Greece

Few financiers study the history of finance. This ensures that the tried and true will continue to surprise. Might a long-ago event in Vietnam hold lessons for Europe? As the Greek saga unfolds, it might be useful to recall the case of Trinh vs Citibank.
Forty years ago, the North Vietnamese army marched into Saigon. [1] Shortly before, the staff of the Saigon branch of Citibank hurriedly locked up and left.
Five years later, a customer of Citi Saigon surfaced in the US. He produced a savings passbook and petitioned for payment at Citibank headquarters. Citibank said, ‘sorry, please read the fine print. We need not give your money back if prevented from doing so by changes in local law’.
The customer, Ngoc Quang Trinh, hired a lawyer and sued. His argument: ‘we kept our money with you because you said you were both global and safe. Otherwise, we would have banked with a local bank’. The jury found in favour of Trinh. Citi appealed. Citi lost. Force majeure not withstanding, the court placed the risk of financial loss on the home office of the deposit taking foreign bank and not on the shoulders of the individual depositor.
“A bank which accepts deposits at a foreign location becomes a debtor,” it opined, “not a bailee with respect to its depositors…fairness dictates that the parent bank will be liable for those deposits which it was unable to return abroad [in this case Vietnam].” [2]
How might this be relevant to Greece? Many nervous Greek citizens have moved money from their domestic bank to the Greek branch of foreign banks. If the drachma returns, will deposits be automatically converted to drachmae? Probably. If so, will Greek depositors line up for their euros at the Frankfurt office of the respective foreign bank? Wouldn’t you? Other Greeks have travelled outside Greece to open accounts in euros. If the new Greek government were to make such deposits illegal, would the EU cooperate in returning or re-denominating such flight capital? Absurd? Twenty years ago would you have predicted Swiss cooperation in tax evasion cases?
Now what about the loans made by “foreign banks” to Greeks and Greek enterprises? Will they remain euro loans funded by euro deposits or drachmae loans funded by a euro liability? If there is any question as to which, the bank will have a foreign exchange risk – probably long drachmae / short euros. Add in a 50 per cent devaluation of the drachma and the bank will have a write-down of half the value of the loan.
This is yet another aspect of sovereign risk. More properly labelled “cross-border risk” it covers not only the risk that the sovereign might not pay, but also that the private sector might be prevented by law and currency changes from doing so.
This possibility helps explain why the European banking system fragmented following the last brush with a eurozone bust-up. Lenders outside the periphery reduced their cross-border exposure to borrowers based in Greece, Portugal, Spain and Italy. They accomplished this by limiting their euro lending to the amount of locally sourced euro deposits. Therefore, should a German bank’s euro lending in Greece becomes drachmae, at least its deposit liabilities to Greek nationals also become drachmae. Whatever the currency – euro or drachmae – assets and liabilities would be equal and offsetting. Foreign exchange risk is thereby avoided. That is the logic.
But what if Greek nationals with a euro account with Deutsche Bank Athens are able to claim euro reimbursement from Deutsche’s headquarters in Frankfurt? Ah! Then the German bank would once again have a drachmae asset but an unexpected euro liability. Of course, the bank could refuse to pay. It would most certainly refer to the fine print and force majeure. It may well work. But it did not last time.
In 2012, Greece was saved by the troika because the consequences of Grexit were too horrible to contemplate – both for the Greeks and their creditors. At the time of writing, bailout is back on the table but the troika appears more relaxed about the
possibility of a Greek exit. The marketplace most definitely is. The negotiations look set to continue to June. During this time, parties on all sides will make calculations as to the potential fallout from failure. They would be well advised to include a healthy provision for the unknown, unexpected and the futility of the fine print.

1. Now Ho Chi Minh City.

2. Ruling of the US Sixth Circuit Court of Appeals, 8 July, 1988.

Robert Jenkins is a senior fellow at Better Markets and adjunct professor, finance, at London Business
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