Icesave ruling raises important moral hazard questions

http://www.guardian.co.uk/business/blog/2013/jan/28/icesave-ruling-moral-hazard-questions

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The Icesave spat between London and Reykjavik is finally over. For four and a half years lawyers from both sides have tested every permutation of settlement in an attempt to determine how best to split the bill after Britain stepped in to guarantee £5.3bn of UK deposits with the online bank account.

Plebiscites in 2010 and 2011 saw stubborn Icelanders twice reject their own government's plans to repay their portion of guarantees. The bank behind Icesave, Landsbanki, was a private bank, they argued. Not our problem.

The diplomatic route exhausted, the dispute threatened to put Iceland on a collision course with the Europen Commission, which backed Britain. Had the court upheld complaints against Iceland, it could even have threatened the nation's membership of Efta, that curious club of semi-detached European nations.

Instead, the decision in favour of Iceland has thrown a far more troublesome spotlight on the legal relationship between all European states and the guarantees purportedly offered by their banks to retail depositors.

What advice would George Osborne today offer ordinary retail savers thinking of placing their savings with an online account offered by a bank based in a financially weak European member state? And what sanction might a financially stretched government face if its desperate banks went chasing foreign deposits, knowing the accompanying guarantees were flimsy?

There are important moral hazard questions here. Revised EU rules are urgently required.