It’s been a while coming, but Cyprus has finally joined the ranks of nations to receive a sovereign bailout. Over the weekend the Eurogroup met and approved a €10 billion package for Cyprus. This was significantly less than the original request and had come with some extremely controversial requirements including a partial bail-in of bank depositors. Russia is also involved with a re-finance of a €2.5bn loan granted in 2011 at a longer maturity.
The package is expected to be in place by the end of April, but it dependent on Cyprus’s government ratifying the deal through parliament. As usual, being an IMF backed deal (no details as yet) , there is also additional fiscal conditionality including increasing corporate tax rates and a privatisation scheme to sell national assets, as with Greece.
The controversy, however, is obviously the fact that for the first time in the euro-crisis depositors are taking a hit:
To raise close to six billion euros, bank deposits of over 100,000 euros will be taxed with a 9.9 percent levy before the banks open on Tuesday. Monday the 18th is a bank holiday, and the accounts are currently frozen, effectively ambushing all local account holders. A second one-off tax of 6.75 percent will be applied to smaller savings accounts.
People who are trying to use their online banking systems are only seeing account balances, all other orders are blocked. According to reports, depositors will be repaid with shares in Laiki, a proposal rejected by one business consultant who says it will dilute the share value to an unacceptable level.
Angry reactions have started coming from savers and bank account holders, who are resentful at the suprise tactic and the fact that their hard-earned savings will be slashed by 10 percent.
So this is somewhat like what the Spanish banks did by stealth, only this time it will be by government decree. The one-off tax, or theft if you prefer the term, is expected to raise €5.8bn and in return deposit holders receive share in banks. As the terms were announced the Cypriot government moved to ensure there was no capital flight out of Cyprus before the levy could be implemented.
Many of the large deposit holders in Cypriot banks are Russian and British nationals, and that is how the Cypriot President is hoping to frame the bail-in. That is, foreigners paying to save Cyprus. The fact is, however, that this will effect an army of small Cypriot deposit holders who are being punished to keep the Cypriot banking system alive.
The full statement from the Cypriot President justifying for the action is below.
It is well known that the deep economic crisis and the state of emergency in which the country has found itself did not come about in the last fortnight since we have undertaken the administration of the country.
The state of emergency and critical nature of the times do not allow me, as they do not allow anyone, to embark on a blame game.
In the extraordinary meeting of the Eurogroup, we faced decisions that had already been taken and came across faits accomplis through which we were faced with the following dilemmas:
On Tuesday, March 19 we would either choose the catastrophic scenario of disorderly bankruptcy or the scenario of a painful but controlled management of the crisis, which would put a definitive end to the uncertainty and restart our economy.
A possible choice of the catastrophic scenario option would have the following consequences:
1. On Tuesday, March 19, immediately after the holiday weekend, one of the two banks in crisis would cease to operate, since the European Central Bank, following the decision already taken, would terminate the provision of liquidity. The second bank would suspend its work, and neither could avoid collapse. Such a phenomenon would instantly lead 8.000 families to unemployment.
2. The State would be obliged to compensate depositors in response to the obligation regarding guaranteed deposits. The capital required in such a case would amount to about 30 billion euros, which the State would be unable to pay.
3. A proportionate amount corresponding to the deposits of thousands of depositors for deposits over 100.000 Euro, would be led to a vicious cycle of asset liquidation, and these depositors would suffer losses of over 60%.
4. Such an uncontrolled situation would push the whole banking system into collapse with all the attendant consequences.
5. Thousands of small and medium enterprises, and other businesses would be driven to bankruptcy due to their inability to trade.
As a result of the above, the service sector would be led to a complete collapse with a possible exit from the euro. That, in addition to the national weakening of Cyprus, would lead to devaluation of the currency by at least 40%.
The second choice was the controlled management of the crisis, through the decisions taken and which can be summarized as follows:
1. Ensuring the liquidity of the banks and the rescue of the banking system through their recapitalization.
2. Rescuing 8.000 jobs in the banking sector and thousands of others which would be lost as a corollary of not maintaining the operations of banks.
3. Total rescuing of deposits, with just the exchange of a small percentage of savings with shares of the two banks. Currently, these shares do not have their full value, but with the economic recovery they will repay most it not all of the amount that will be cut.
4. This option results in a drastic reduction of public debt, makes it manageable and sustainable and relieves future generations from the burden of repayment.5. It saves provident and pension funds and avoids taking other tough measures such as wage and pension cuts that were put on the negotiations table.
6. It avoids further recession and the risk of the vicious circle of a second memorandum.
We are not aiming to gloss over the situation. The solution chosen may be painful, but it was the only one that would allow us to continue our lives without adventures. It’s a decision that leads to the historic and permanent rescue our economy.
In the next few hours we will all have to take responsibility. Tomorrow I will address the Cypriot people.
So we wait on the vote from the Cypriot parliament, which as I type has been postponed:
The Cyprus government has postponed an emergency session of parliament to debate and vote on a controversial levy imposed as part of an EU bailout deal. Several parties have said they will not back the tax.
Cyprus’s President Nicos Anastasiades on Sunday postponed an emergency parliament session which had been called to debate and vote on a rescue package worth at least 10 billion euro ($13.08 billion), struck by eurozone lenders early Saturday.
Time is running out. Banks open Tuesday morning.
Of note is the current state of the Cypriot economy which, as we’ve seen in the case of other nations that have received bailouts, can now be expected to worsen significantly. Cypriot GDP is already down nearly 2.5% over the previous year, and unemployment is climbing steadily and industrial production is falling.
Apart from the obvious question of outright civil disobedience in response, the question for me is what this does to overall euro-area bank stability. I’ve discussed previously the deposit flows and the Target2 system, and in some cases the ECB has had to create emergency lending facilities to ensure the financial sectors in the weaker economies can still function against the tide of cross-border deposit transfers. This in itself was part of the problem of tying weak sovereign governments to their banking systems due to collateral requirements of these facilities.
This new action in Cyprus sets the precedent for further action of its kind and has the potential to re-ignite the deposit outflows in weaker nations as we have seen previously. If you were a depositor in a Greece, Italian, Spanish of Portuguese bank you would surely be questioning whether the next round of bailouts for that country wasn’t coming for your deposits.