Video: Guy Foster talks to Bloomberg - Will Cyprus Contagion Spread Across Europe?
It has been a long weekend for European investors waiting to find out what the market’s reaction will be to the Cyprus bailout deal.
By way of a reminder, Cyprus requested a bailout deal of €17bn last year – a relatively modest sum compared to the credit extended to Greece but problematic nevertheless. Cyprus’s banks hold deposits totalling some 800% of its GDP, making it unfeasible that it might bailout its own banking sector.
This outsized deposit base rendered a €17bn bailout imprudent as it would raise sovereign debt close to 200% of GDP. Furthermore, the widespread belief that a meaningful pool of the deposits in Cypriot banks comprises proceeds from Russian money laundering made the idea of bailing out the Cypriot banks particularly unappealing.
Bailing out, in this context, means making new loans to secure the position of the existing creditors. The alternative is bailing in which involves cancelling some of the bank’s obligations to restore its solvency. In this context it is important to remember that everyone who makes a deposit in a bank, whether it be the proceeds of a heist or their hard earned pay, is a lender to that institution.
Given that a fully fledged bail-out poses these issues for sustainability and moral hazard, the most obvious solution would be for depositors to share some of the burden, a move so far resisted in other bailout situations. Fortunately for the average Cypriot household, their deposits of up to €100,000 are covered by the EU deposit insurance scheme. Unfortunately in this case this insurance has been bypassed.
Shockingly savers are set to suffer a 6.75% ‘tax’ on deposits of less than €100,000 and 9.9% of larger sums. By labelling the levy as a tax, rather than a haircut, depositors lose their protection. This is clearly highly controversial as it shakes faith in eurozone deposit insurance. Read the full Market Perspective