The last minute deal done in Brussels to cement the €15.6bn bail-out for Cyprus is, as
with everything in Europe, something of a fudge. The bail-out is required to re-finance both
the Cypriot banks and the Government. The troika of the IMF, the EU finance
ministers and the ECB have agreed to hand over €10bn of the loot but only if
Cyprus can find the other €5.6bn. Given that the country is bust the only
immediate source of finance left on the island is private capital held by the
insolvent banks. The Cypriot government
have decided that they cannot raid (tax) all deposit holders so the money will
be raised exclusively from savers with bank deposits in excess of €100,000 (the insurance
limit). The blanket ‘tax’ will take no
account of income or the value of other assets (property, stocks, etc.) and
will probably have a disproportional impact on overseas investors who were
attracted to Cypriot banks by the benign regulatory regime and overly generous
interest rates. Many of these investors
are Russian and they may well have to take a haircut of over 20%. Quite apart from the distasteful precedent of
getting foreigners investors to finance the bail-out, the solution raises some other
important questions.
Since the ECB put together its fighting fund to rescue the
failed economies in the Eurozone there has been a principle that Banking debt
and reconstruction would be separated from government solvency. So in Spain a number of banks have been
bailed out in advance of the deal to resolve government indebtedness. With Cyprus there was apparently no
willingness to use European Stability
Mechanism (ESM) money directly to recapitalise the banks,
even though that is being done successfully with the Bankia in Spain. By linking government debt and banking debts
the troika risk the flight of capital from fragile banks all over Europe. If you had over €100,000 in an Italian bank this morning
what would you do? The answer is - move
it to Switzerland! This may be a good time to buy shares in UBS!
The second major issue is that to successfully raid private
deposits in Cyprus the government will have to put in place capital controls to
ensure the banks don’t lose deposits.
Russian depositors were threatening to remove their spoils if they are
subjected to any kind of a haircut. Any
significant fight of capital would quickly render these organisations insolvent;
as almost no amount of capital is
sufficient for a bank which has lost the confidence of its depositors. These temporary capital controls replicate
what happened in the Icelandic banking crisis, where temporary controls have
proven impossible to remove.
Interestingly to have these controls within the borders of a “single
currency” is in breach one of the basic principles of a single currency; as by
introducing capital controls Cyprus is creating its own currency within the
Eurozone.
So the results for the Troika is the worst of all
worlds; they have had to inject money
into Cyprus at the same time as guaranteeing its exit for the Eurozone, they
could have saved themselves €10bn and simply pushed Cyprus into
default! Additionally, they have
probably destroyed any confidence the wider European public might have in the
ESM.
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