|Chart: Even before the planned cuts Cyprus's GDP is contracting fast. Source: Statistical Service of the Republic of Cyprus|
- Last week we learned that the Cypriot government wanted to tax all of the country’s bank deposits, thus subverting the deposit insurance which covers the first €100,000 of all eurozone deposits.
- Commentators expressed outrage and the market fell, although only to a muted extent as it was widely assumed this policy would be too controversial to implement.
- Following a frenetic week, policymakers hammered out a deal that spared insured depositors from pain.
It has been noted that a bank resolution regime is planned for the future of the eurozone to formalise the method for using deposits to bail-in the banks. Cyprus now stands as a test of that process – albeit one which has taken place before the technology has been finessed.
The calm reaction from the market was taken as a vindication of the bail-in process by the President of the Eurogroup, Jeroen Dijsselbloem. He is unfortunately misreading the signals as, if the market concludes that eurozone bank deposits of above €100,000 are truly at risk, then it will react more violently.
The implication would be that, when making a deposit above the insured threshold, savers would need to assess creditworthiness. Most depositors won’t be skilled enough to make that judgement and banks could hardly spare the resources to engage in due diligence with so many depositors.
Governments regulate banking systems and so are best placed to ensure that such recapitalisations are not necessary. Whilst undermining confidence in banks might push more funds into equities (which offer a different set of risks), ultimately the effect on the economy would be contractionary.
Savings are required to fund investment within an economy and so flows out of banks would be akin to a further tightening of monetary conditions in the eurozone. Mr Dijsselbloem’s colleagues have attempted to reassure the markets that the nuclear option taken in Cyprus does not foretell the future of European banking. Further ambiguity on this matter should be avoided as it is likely to continue to weigh on European assets.
Head of Portfolio Strategy