Depositors in Cypriot banks awoke on Saturday morning to learn a harsh lesson. A guarantee is only as strong as your counterparty. With the Cypriot banking system requiring €10-12 billion of bailout funds – some 60% of GDP – the government has been forced to accept burden sharing with depositors. Depositors who went to bed Friday night believing their savings were safe awoke Saturday to find that it has been proposed that those with deposits below €100k in the bank will be “taxed” at 6.75%; those with deposits above €100k will be “taxed” at 9.9%, contributing approximately €6bn to the bank bailout in total. This is regardless of supposed depositor insurance schemes. Depositors will receive equity in their respective banks by way of compensation and potentially bonds entitling those who leave their money in the banks for 2 years to a share of Cyprus’ future gas revenues. The remaining €4-6 billion will likely come from the Troika.
If press reports are to be believed this was a ‘take it or leave it offer’ from the Troika with German and Finnish finance ministers unwilling to go to their respective parliaments without depositor burden sharing. This highlights the very real current challenges of domestic politics within the European Economic and Monetary Union and raises further issues.
Firstly, there are significant political challenges to be faced. Domestic opposition to this deal is likely to be significant, not least as it will be seen to be disproportionately harsh on domestic savers – who had believed their deposits were protected up to €100k, and favourable to wealthy non-Cypriot depositors who reportedly hold huge sums offshore in the banks. It can be argued that those with over €100k in deposits with the banks should bear the brunt of any proposed bail-in. With a small parliamentary majority, the Cypriot government may struggle to pass the necessary legislation. Approval will also need to be sought from Eurozone member states.
Secondly, alongside the recent expropriation of junior bond holders at SNS Reaal the attitude towards tax funded bailouts appears to be hardening. Whilst this crisis has already witnessed both equity and debt written down, the rubicon of depositor burden sharing has now been crossed. Precedent now exists for this approach over the socialisation of losses across the Eurozone as a whole. Whilst the Troika will endeavour to play its significance down, unintended consequences may still materialise.
Thirdly, the Cypriot situation serves as a reminder of the current fragmented approach of depositor guarantee schemes across Europe. Depositor guarantees are only as strong as the sovereigns providing them. In the case of Cyprus with a banking system seven times the size of its economy, clearly those guarantees were worth very little. With depositor rates currently paying very little across Europe it is unlikely to take much to prompt a change in investor behaviour.
Fourthly, it raises real questions about depositor preference. With only circa €2bn of Cypriot bank debt outstanding, policymakers have judged this too small in and of itself to recapitalise the banking system. That may be true. However by favouring senior debt over depositors it does beg the question whether the individual on the street is in theory better off owning higher yielding bank debt than depositing cash.
Fifthly, the ECB has apparently threatened that if the measures are not agreed, then it would withdraw European Liquidity Assistance (ELA) funding for Laiki Bank, Cyprus’ second largest bank, leaving the Cypriot sovereign with the bill for the entire banking sector and having to pay out on deposit insurance in full. This highlights the extent to which a number of banks in Europe remain reliant on ECB funding, and that if that funding is withdrawn then their collapse is inevitable.
Finally, we have yet another example of a country being forced to face a stark choice between ceding sovereignty to Brussels or facing financial ruin. The Eurozone project continues to ask a great deal of its citizens. Bailouts don’t – and won’t – come cheap.
The Cyprus deal will be in the headlines for the next few days. We can’t help but think that the markets will be listening to Cypress Hill – Insane In The Brain for the next week or so. Maybe the Troika should too.