New Stage in Eurozone Crisis: Cyprus Forced to Cover Bailout from Individual Bank Deposits

Lines formed at ATMs in Cyprus after news of bank levy broke

This is a topic on which I know very little, but I thought we should have a thread on it anyway.

On Saturday morning, news broke that the terms of a bailout of banks in Cyprus would require a levy on individual depositors–including those holding small accounts. People immediately rushed to ATMs to withdraw as much cash as possible before the deal was voted on. The most accessible article I found on this is by Edward Harrison of Credit Writedowns blog, posted at Alternet: Hell Breaks Loose in Europe as Banking Crisis Unfolds: Depositors’ Money May Be Seized.

Saturday morning we learned that after hours of tense negotiation, Europe has hammered out a 10bn euro “bailout” of Cyprus. I put the term bailout in quotes because the key feature of this deal is the bail-in of Cypriot depositors to the tune of 5.8bn euros, about a third of Cyprus’ GDP. This means that depositors went to sleep on Friday night and woke up Saturday to find that their money, deposited safely in Cypriot banks, had been seized and used to “bail out” the country. While the bail-in became official EU bank rescue policy during the Spanish crisis last summer, bank depositors were never mentioned at that time. I see this as an extreme measure which, if the European banking crisis continues elsewhere, will have very negative implications for bank depositor confidence in other European periphery countries.

There has since been a revision in the amounts to be deducted–I’ll get to that later on.

Back to Harrison:

Cyprus’ finance minister Michalis Sarris said large deposit withdrawals would be banned. Jörg Asmussen, a German member of the ECB board and a key ally of Angela Merkel, added that the part of the deposit base equivalent to the actual bail-in levies would be frozen immediately so the funds could be used to pay for the “bailout”….

Some of the bailout lenders like the IMF had actually been calling for Cyprus to seize all deposits larger than 100,000 euros. So this falls well short of those demands. Nonetheless, a rubicon has been crossed. Not only are senior bank debt lenders now on the hook before a single penny of European Union loans or guarantees flow to busted eurozone countries, but so are subordinated debt holders and so are even depositors. As an EU citizen, you must now believe that any lending exposure you have to a bank whether as a bond lender or deposit lender can be seized and confiscated by government, no matter how small the exposure. The FT notes that “[e]ven Ireland, whose banking sector was about as large relative to its economy as Cyprus’ when it was forced into a bailout in 2010, never considered such a measure.

Read much more at the Alternet link.

Here’s an FAQ on the crisis published at Fortune earlier tonight. The scary introductory paragraphs after the jump:

Why is a dot-sized European country causing outsized effects? Because what starts in Cyprus, a tiny isle of 1.1 million people, could soon spread to London or New York or Hong Kong, making misery for many millions more.

Cyprus experienced severe turmoil this weekend after its prime minster agreed to force a tax on all bank deposits in order to receive a bailout. The prospect of a tax set off a run on ATMs and made observers worry that financial contagion could spread throughout the contient and then beyond. Below, a guide to understanding about how this island is roiling markets worldwide.

According to The Economist, the deal for the “bail-in” was sealed in London, without the knowledge of Cypriot citizens or their government.

Unbeknown to the Cypriot delegation members as they entered the hulking Justus Lipsius summit building in Brussels on Friday night, their fate was already sealed: their German counterparts wanted about €7bn for the estimated €17bn bailout of their country to come from deposits in the country’s banks.
“They were hand in hand with Finns, who were much more dogmatic,” said one senior eurozone official involved in the 10-hour marathon talks that stretched until 3am on Saturday morning. “Had that not happened, full bail-in,” the official added, using the terminology for wiping out nearly all Cypriot bank accounts.

Cyprus’ recently elected president president Nicos Anastasiades was prevailed upon to accept the bail-in, but asked that the levy for smaller depositors be reduced.

Mr Anastasiades was left reeling by the response to his request for modest adjustments, according to Cypriot officials. Wolfgang Schäuble, the German finance minister, said Nicosia would immediately have to raise as much as €7bn from depositor haircuts. A stunned Mr Anastasiades decided to walk out. “The president said, ‘I can’t do that’,” said one member of the Cypriot delegation. “You’re trying to destroy us. Even if I agree to it, I can’t pass it [through parliament].”

But Mr Anastasiades soon learnt storming out was not an option. The European Central Bank had another shock for him: the island’s second-largest bank, Laiki, was in such bad shape that it no longer qualified for the eurosystem’s emergency liquidity assistance – the cheap central bank loans that teetering eurozone banks need to run their day-to-day operations.

The message, delivered by the ECB’s chief negotiator, Jörg Asmussen, meant that if no deal was reached, Laiki would collapse, probably bringing the island’s largest bank down with it, and saddling Nicosia with a €30bn bill to reimburse accounts covered by the country’s deposit guarantee scheme. It was money Nicosia did not have. All of the island’s account holders would be wiped out.

Aren’t you glad we live in a country that controls its own currency? A vote had been planned on this deal in Cyprus today, but it was postponed in response to the public anger. Anastasiades gave a speech today in which he tried to calm enraged Cypriots. From Business Insider:

Cyprus President Nicos Anastasiades just addressed the nation in a dramatic Sunday night speech regarding the bailout of Cyprus, which will see a one-time tax on everyone with cash in Cypriot banks.

The basic gist of his message is this:

Cyprus is in a huge crisis, and the country was given two choices, blackmail style.

Either the government could get no help, and see a complete collapse of the economy and the financial system, as the banks ran out of money.

Or Cyprus could take the “bailout” deal, which involves the painful tax on everyone’s deposits.

Here’s Krugman’s take on the deal as of early afternoon Sunday: The Cypriot Haircut.

OK, I didn’t see that one coming. With all the problems in Greece, Italy, Spain, and Portugal I wasn’t watching Cyprus. But that’s where the big euro news is this weekend; in return for a bailout, Cyprus is supposed to impose a large haircut — that is, loss — on all depositors in its banks.

You can sort of see why they’re doing this: Cyprus is a money haven, especially for the assets of Russian beeznessmen; this means that it has a hugely oversized banking sector (think Iceland) and that a haircut-free bailout would be seen as a bailout, not just of Cyprus, but of Russians of, let’s say, uncertain probity and moral character….

The big problem, however, is that it’s not just large foreign deposits that are taking a haircut; the haircut on small domestic deposits is a bit smaller, but still substantial. It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying “time to stage a run on your banks!”

According to what I’ve read, Russian depositors hold about 20% of the money in Cyprus’ banks. correction, Reuters reports that half of depositors in Cyprus banks are Russians!

Here’s the latest update on the revised “bail-in” amounts from Calculated Risk:

Update: There is a plan to revise the deposit tax, from Matina Stevis “Exclusive: plans to revise #cyprus deposit tax on wires: under 5% for €0-100k, under 10% for €100-500k, around 13% for €500k+”

More background info at the link.

So that’s what I know so far. I welcome reactions from all and sundry, including those who actually understand this stuff.

I’ll end with an assessment of the precedent that is being set by this action. From The Economist.

BAIL-OUT weekends are back, but the latest rescue, of the tiny island of Cyprus, has crossed a rubicon in hitting bank deposits. At Schumpeter, a colleague runs down the details….As the post goes on to note, in addition to the unfairness of the deal it seems an unnecessarily risky move. At present, most economic writers appear to be focused on the contagion risk: the possibility that depositors in larger economies might worry for the value of their savings, leading to panic and self-fulfilling crises elsewhere. On the face of things, that seems an unlikely scenario. Cyprus looks a unique case, both in terms of its circumstances and size. Bank runs in Spain or Italy would be fatal for the euro zone, and depositors there can reasonably expect leaders to go to great lengths to ensure that they don’t occur. It is worth noting, of course, that when it comes to panic, expectations of what a government will do are less important than expectations of what fellow depositors will do. It would nonetheless be surprising to see a follow-on outbreak of deposit flight around the periphery.

The more damaging effect may be the continued erosion of faith in the legitimacy of democracy in the euro zone.

If nothing else, this is likely to put an end to the bull market of recent weeks. Asian markets have already opened way down.