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Saturday, March 16, 2013

Cyprus bails-in depositors to reduce cost of Eurozone bailout - a turning point in the Eurozone crisis?

Well, we said it was going to have an impact well beyond its size (0.2% of Eurozone GDP).

Overnight, the Eurozone and Cyprus took the unprecedented step of announcing a tax on depositors in order to raise the necessary funds to recapitalise Cypriot banks and reduce the cost of a bailout. Have no doubt, this is a very radical measure and one that, admittedly, we did not believe would happen for just that reason.

Here are the details of the plan:
One-time 9.9% levy on deposits over €100,000
6.75% levy on deposits below that level
Cypriots hit by the deposit levy will be given bank shares of equal value
Increase in corporate tax rate to 12.5% (from 10%)
€1.4bn in privatisations
€10bn bailout loan (likely including the IMF)
Cypriot debt to GDP to be at 100% in 2020
The seizure of deposits will happen over the weekend, while there is conveniently a bank holiday on Monday in Cyprus. Depositors will be unable to move funds, even electronically, before the move is complete on Tuesday (more on this further down). As we said, this is clearly an unprecedented move and the fallout will be interesting, below we list the key points to watch as this progresses.

This will hit normal Cypriot taxpayers hard: Perhaps the most surprising (and worrying) point of the deal is that even those with deposits below €100,000 will be hit. Cypriots will receive bank shares in return but surely after this move they will decline in value quickly and are no comparison to a deposit in terms of risk and liquidity.

Banks and funds have escaped somewhat: With all the focus being on ‘illicit’ Russian deposits it seems that the usual steps of bailing in bank creditors and sovereign creditors have been skipped, this will make the point above even more painful. As we noted in our analysis yesterday, writing down bank creditors or sovereign creditors would be tricky and yield little monetary benefit. However, it is still strange that when taking a step as radical as this the Eurozone did not force some losses on banks and those holding sovereign debt, even as a gesture to the taxpayers who are now footing the bill. The fallout of this politically could be serious (see next point).

The Cypriot government position looks almost untenable: During the recent election campaign and the start of the negotiations the new Cypriot government flat out rejected a deposit tax, even just on foreign depositors. It has now rolled over and accepted one on domestic depositors as well. Surely, it cannot last out its 5 year term. It is not yet clear whether new elections could be on the cards, but the potential for civil unrest is significant – not only is the Cypriot population footing much of the bill but since there is still a Eurozone loan they will also likely face austerity conditions.

Germany put its foot down: By many accounts, Germany entered the negotiations with a radical stance, arguing from the start for a large hit to depositors. It is clear that, with elections looming, the German government is no longer willing to simply foot the bill to avoid contagion. This could be a very important turning point for the Eurozone crisis.

Does this move break EU rules on capital controls and/or deposit guarantees? As noted above, it seems that depositors will be blocked from withdrawing their funds from banks. For other EU depositors this surely amounts to a form of capital control – strictly forbidden under the EU Treaty. Furthermore, as Sharon Bowles MEP has been tweeting, this move makes a mockery of the current EU rules on deposit guarantees below €100,000. The Eurozone may protest that the bank shares given in exchange are of the same value, but this is a very thin argument. Either of these issues could be challenged at the European Court of Justice.

It seems some lessons of Greece et al. have been learnt: As our flash analysis yesterday showed, our main concern with Cyprus was that the Eurozone has failed to learn lessons from its experience in Greece et al. Clearly, the need to put debt back on a sustainable footing has been realised – although 100% debt to GDP in 2020 is still not entirely sustainable, we will wait for more details before passing final judgement on this.

Contagion could be significant: The Eurozone is arguing that Cyprus is a one-off – sound familiar? This is unlikely to hold. The on-going backstop of the ECB OMT will help, as will the fact that the bailout countries already have funding secured. That said, with many of their debt levels still do looking unsustainable ,it is very possible that depositors could become increasingly skittish.

Such a radical move was necessary because the Eurozone lacked more precise tools: Cyprus is a cut and dried case of where a bank resolution fund would have solved most of the problems. The fund could have bailed out the banks directly and restructured the financial sector without burdening the state or depositors. The state’s funding gap could have been covered by privatisations and tax increases, and possibly a very small international loan. It should not be lost on the Eurozone or anyone else, that this situation partly arose due to complacency and a failure on the part of Eurozone leaders to move swiftly to correct the structural flaws in the Eurozone.

This decision is ultimately a very mixed bag. On the one hand the Eurozone has taken a radical step to try and put debt on sustainable footing rather than just proceeding with a massive taxpayer funded bailout (although it must be remembered Cyprus is still getting a bailout worth almost 60% of GDP). That said, the decision to force the losses on all depositors is a radical and politically explosive one. The fact that losses were not enforced all round, on banks and funds, leaves a bad taste in the mouth. On a wider scale, the fact that Germany is no longer willing to provide bailouts at any cost must mark a big change in the crisis. With Italy and Spain still mired in political and economic problems this point will surely be in the back of their minds from now on. Can German approval of access to the ESM and OMT be taken for granted anymore? It may be that Cyprus is small enough to be a special case, but that cannot be a given.

In terms of forcing a change in the Eurozone crisis it seems that Cyprus may be the straw that broke the camel’s back.

10 comments:

Anonymous said...

Germany's stance is the beginning of the end. This time for good. Prepare for take-off.

Joe L

phlegyas1404 said...

This story about haircuts on bank deposits is by far the worst financial headline I've read on a week-end since the 15th of September 2008. We might want to prepare ourselves for pictures of Spaniards lining up at the banks on Monday. It is simply not acceptable to force losses on depositors and not on banks or funds. In my opinion, "explosive" is a inappropriate. This decision is outraging.
Thank God I do not work on a trading floor or in the financial services sector. If this goes south, and even though Cyprus is tiny, the authorities should have ambulances on stand by downtown in Manhattan and on Mayfair.

Jesper said...

This sub-heading:
"Such a radical move was necessary because the Eurozone lacked more precise tools:"
and what you listed under it is what eurocrats have been arguing and they are wrong.

A rescue fund funded by banks? A rescue fund funded by banks is not an example of the mythical 'free lunch'. It does not exist. The difference will be that banks will be putting their losses on the economy by charging fees on taxpayers before they fail instead of by being bailed out by taxpayers after they fail.

The link that should be cut is between taxpayers and failed banks. Hitting the taxpayer with losses by routing them through a federal superstate instead of through the regular state is not a change for the better. Economists are fond of the 'tragedy of the commons' theory. Spreading the cost of bank-failures like eurocrats are suggesting would be an example of 'the tragedy of the commons' with the predictable result (even more likely given the quality of the caretakers) of: even bigger future losses.

Capital flows were and are enabled through banks and the problem is with the banks and how they were run.
Structural flaws? What? Which?
If the structural flaws are that banks are run by corrupt and/or incompetents then that is something that unfortunately cannot be legislated away.

jon livesey said...

Those who the Gods would destroy, they first make mad.

The worst mistake here is the obvious one. If they had set the limit for the haircut at E500k, or if they had exempted accounts under E100k from a haircut, this would have been politically acceptable.

A very high threshold could have been sold as hitting only those rich enough to afford it. Exempting accounts under the limit from a haircut could have been sold as the EU showing some compassion for people of limited means.

However, the choices take manage to be the most toxic politically that they could have found.

jon livesey said...

The Economist has a very good analysis of this bailout. in addition to the obvious questions of fairness and the effect on small savers, they point out that now euro-zone countries will be all the more reluctant to ask for a bailout for their Banks.

Yet some countries, notably Spain, badly need bailouts to clean up their Banking systems. And if you compare the drop in house prices in Ireland, with the much smaller drop in Spain, I think you have to conclude that the position of Spanish Banks is going to get quite a bit worse before it gets better.

Anonymous said...

In my innocence, I always believed that shareholders of an enterprise should be the first in line to take any hit if a business is in trouble. Bank depositors are creditors and those with assets under €100,000 are ostensibly secured creditors.

This solution seems to be, as described elsewhere, politically toxic and may yet illustrate the law of unintended consequences.

John McClane said...

This is theft, pure and simple. Nobody's money is safe anymore.

Rik said...

1. As mentioned earlier the levy from residents in taxtreaty countries (other than Cyprus itself) is not allowed. At least not in the OECD standard treaty which is followed in 90+% of the cases.
It is a tax so you need something that relates the source/basis to your country. Owned by a foreigner in a foreign sub is hardly that.

2. This is simply eroding the bankguarantee system, which is EU law. seen the way the ECJ reacts on things like inderectly keeping women out, I expect a challenge.
Also the relation senior debt-accountholders stinks considerably so might give also rise to some challenges.
Seniority rules are broken, doubtful if that goes well with right to property.

3. Did they inform the Russians that they will extend the loan and lowe rthe interest. It would not be the first time that they are spending other people's money with informing them first.

4. Tax revenue 10 to 12.5%. No way in this world that will generate 200 Mn annually. 2.5% rise would be 200 Mn total company profit would have to be 8 Bn which is half GDP. Looks way too high.

5. Financially the levy is very risky. Markets will see it as no junior debt (see SNS) or bankaccount is safe in the PIIGS. Hard to see it otherwise.

Anyway rumours this was going to happen had been around for a couple of weeks. Dijsselbloem's 10 Bn only could mean accounts would be cut, otherwise the maths simply didnot work. Imho not the small local accountholders but if you still held an account there you are simply an outright moron and outright morons should be butchered if anyone has to be butchered of course. You do risky things you might have to pay the price, simple as that.
But anybody or any company who/which would still hold a bankaccount in any other PIIGS or Slovenia will have to think twice. Not good for Target2.

6. To the spirit of the rules this is a default for CDS and other truggers. Wonder if that is fully clarified. As well as the rating.

Anonymous said...

This will prove to be a spectacular home goal for the EU.

To steal depositors' wealth secretly and unobservaed via inflation is one thing. This is like being mugged in the street in broad daylight.

I was never in any doubt that the EU was a nascent fascist entity. This proves it without any doubt.

Cyprus Banking said...

The Cyprus bailout had proven one thing, the bailout shows that banks can be wound down.