Monday, 18 March 2013

ECB mess up in Cyprus

Why does the Eurozone’s bail-out of Cyprus and its banks matter, when the island contributes only 0.2% of the EU GDP?   Up until a couple of days ago it didn't matter and we were expecting the European Central Bank (ECB) to swot this annoying fly with ease, but we should have known better.  Rather than find the full amount required to restructure the Island and its banks, €17 billion, they have appeased German taxpayers and come up with a deal for €10 billion.  Both of these numbers are insignificant in the scheme of things.  This change of heart now raises a number of important questions that hang over the multi-trillion € restructuring required in Spain, Italy and France.

The ECB grabbed the €7 billion bail-out saving from the clients of Cyprus’s outsized banks. As expected a one-off 10% levy will be imposed on all deposits over the insurance threshold of €100,000 before banks reopen after a bank holiday on Monday, hitting wealthier savers. What had not been anticipated was a 6.75% 'haircut' for all other savers. Perhaps the Cypriot government wanted to spread the pain around rather than penalise non-resident depositors and de-stabalise its important relationship with Russian.  This crass local decision could now set off a series of events that impact the global economy.

Some insurance scheme

The ECB are still facing the restructuring cliff with the much larger economies of Spain, Italy and France, all of whom need support.  This deal in Cyprus sends a strong signals to the rest of Europe that: all savings are at risk, shareholders / bond holders are to be protected and within this framework of unfairness almost any tactic might be employed.  This could have three important results:

  1. Large number of savers will start to withdraw their savings from banks, further weakening the already broken banking sector.  This will have the effect of lowering bank liquidity ratios, which the ECB are so keen to increase.
  2. There could be further political unrest over the escape trick the bond holders (other banks in the EU) have pulled to avoid any 'haircut'.  A sense of unfairness could become the spark for political crises that will finally trigger a full blow economic melt down
  3. Perhaps most dangerous of all is that no one will know what to expect next time. If the ECB's restructuring tactics vary from country to country how do other States prepare themselves politically and economically for this restructuring?  Well, they can't and probably won't!
As the home-made bomb thrown in Sarajevo in 1914 sparked the Great War in Europe, let's hope a €6 billion mistake doesn't light the touch paper on a multi-trillion € financial crisis that the ECB was empowered to contain.

Get more doom and gloom from the FT

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