Blog Post

It is not yet too late to drop the idea of capital controls in Cyprus

The Cypriot finance minister Michael Sarris yesterday announced that Cyprus would introduce capital controls (see an FT report here). He announced that measures would be “very differentiated” according to the situation of the bank and as loose as possible in order to allow for a restart of the economy.

By: and Date: March 27, 2013 Topic: European Macroeconomics & Governance

The Cypriot finance minister Michael Sarris yesterday announced that Cyprus would introduce capital controls (see an FT report here). He announced that measures would be “very differentiated” according to the situation of the bank and as loose as possible in order to allow for a restart of the economy. He acknowldeged that for some foreign and liquid banks with "transient" funds, "detailed and strict" capital controls would make little sense. The government also fears that a rigid regime of capital controls could further panic depositors. After 7 days, the measures would be re-evaluated.

We see these announcements with great concern as in our reading effectively they will amount to far reaching limitations on access to deposits, payment restrictions and cross-border capital controls, which risk sending a fatal signal to the markets that could very well trigger future bank runs elsewhere (see FT post here). These are our main concerns.

1) The measures seem to cover many banks if not all of them. In fact, even for foreign banks that are liquid, some forms of controls will be imposed. Effectively, the controls are thus not limited to just one bank, the Bank of Cyprus, where temporary restrictions would make sense in order to fully pull-through the deposit-equity transformation. Instead, the administration appears to go for a broader approach.

2) There is no reason to believe that after 7 days depositors would be less concerned and panic would abide. On the contrary, having been restricted for another seven days in performing transactions means that panic is likely to have increased. We therefore expect that the capital controls will be continued beyond the seven days and there will be a lasting protest against the measures and public anger, feeding the Cyprus crisis. (We also see no reason for the choice of seven days in the first place as pure technical reasons can hardly justify such a period.)

3) But if controls last long, they would cause more damage and will be challenged on legal grounds. The free movement of capital in the European Union is a fundamental principle codified in the Treaty on the Functioning of the European Union (TFEU); see Article 63(1). While the TFEU allows countries outside the euro area to “take the necessary protective measures” when a sudden balance of payments crisis occurs (Article 144(1)), euro-area countries do not have such a right. Artilce 65(1b) acknowledges the right of all EU Member States to “take measures which are justified on grounds of public policy or public security”, but on the one hand, it is not clear if the current Cypriot situation qualifies for such concerns. In addition, Article 65(3) states that such meaures “shall not constitute a means of arbitrary discrimination or a disguised restriction on the free movement of capital and payments as defined in Article 63.” Therefore, we conclude that there is no legal basis in the TFEU for introducing restrictions on capital and payment flows in euro area member states. If the restrictions will be challenged and the European Court of Justice will decide against the measures, a decision which will probably take some time, then the compensation of the unduly restricted depositors may constitute a huge burden and such a decision could evoke a new crisis.

4) A significant control effort is contemplated. Ultimately, we understand that this could result in many discretionary decisions on which payments will be allowed and which ones are not allowed. While a non-discriminatory approach may have been agreed with the Eurogroup, we see a significant risk of a misuse of the controls.

5) An administratively managed payment system is unlikely to provide the desired capital allocation. The very idea is, of course, to limit panic-driven deposit transfers but to allow for payments justified on economic transaction grounds. In practice, it is difficult to observe the motive for a payment. Therefore, the system will not deliver an appropriate payment flow.

Given the circumstances and the alternative options, such as an immediate exit from the euro with dramatic consequences, the final deal for Cyprus was rather sensible (see our post here). But an eventual introduction of lasting payment and capital controls would do a lot of harm and can destabilise the situation. Deposits are guaranteed up to €100,000 and depositors should be given full access to their savings. A massive bank run will likely take place in any case, but with the emergency liquidity assistance (ELA) of the ECB, the situation can be manageable. After the siutaion has stabilised, deposits also started to return to eg Greek banks and we expect the same for Cypriot banks. But if lasting payment and capital controls are introduced (except perhaps a 2-3 days control of the Bank of Cyprus for insured deposits, to allow for a proper merger with the “good” part of the failed Laiki Bank, and the freezing of uninsured deposits at the Bank of Cyprus till recapitalisation of the bank is completed), we see very little prospect for returning confidence in Cypriot banks.

The bail-in of uninsured depositors of the failed Laiki bank, and a partial deposit/equity swap of uninsured deposits of the Bank of Cyprus is unlikely to cause much harm elsewhere in Europe, because Cyprus is so special (see eg the same view from a key market thought-leader, Marco Annunziata, here). Also, bailing-in uninsured deposits in Denmark in 2011 did not case harm elsewhere (see our post on this here). But an eventual imposition of payments and capital controls in Cyprus would signal that a fundamental principle of monetary union can be discarded with the assistance of the Eurogroup and the ECB. That would set a really dangerous precedent. It is not yet too late to drop this idea.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

Jun
23
14:00

How to spend it? A closer look at the recovery plans

In this event, participants will take a closer look at the recovery plans submitted by EU countries.

Speakers: Zsolt Darvas, Alex Patelis and Maarten Verwey Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

Jun
29
14:00

EU debt vs national debts: friends or foes?

The EU will become into a major issuer of safe assets in the coming years. How will this interact with the debt issuance of European sovereign debts?

Speakers: Grégory Claeys, Yves Jacob, Gert-Jan Koopman, Pablo de Ramón-Laca and Imène Rahmouni-Rousseau Topic: European Macroeconomics & Governance
Read about event More on this topic
 

Past Event

Past Event

Conference on the Future of Europe: Vehicle for reform versus forum for reflection?

At this policy dialogue organised by the research project EU3D, panellists will discuss different options and what they may entail while revisiting the debates on the future of Europe at national and EU-level that have been conducted thus far and their patterns, including preliminary findings on national parliamentary debates.

Speakers: Sergio Fabbrini, John Erik Fossum, Magdalena Góra, Vivien Schmidt, Manfred Weber and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 16, 2021
Read about event More on this topic
 

Upcoming Event

Jul
8
12:00

Investment firepower for the recovery: a conversation with Philippe Donnet, CEO of Assicurazioni Generali

At this event the CEO of Assicurazioni Generali, Philippe Donnet will be in conversation with Guntram Wolff, Director of Bruegel.

Speakers: Philippe Donnet and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic
 

Blog Post

The Conference on the Future of Europe: vehicle for reform versus forum for reflection?

The approach of the European Union’s institutions to the Conference on the Future of Europe is muddled, with risks for the outcome.

By: Sergio Fabbrini, John Erik Fossum, Magdalena Góra and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 15, 2021
Read article Download PDF More on this topic More by this author
 

External Publication

The Value of Money, Controversial Economic Cultures in Europe: Italy and Germany

A discussion of Italian and German macro-economic cultures and performances.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: June 10, 2021
Read article More on this topic More by this author
 

Blog Post

Inflation!? Germany, the euro area and the European Central Bank

There is concern in Germany about rising prices, but expectations and wage data show no sign of excess pressures; German inflation should exceed 2% to support euro-area rebalancing but is unlikely to do so on sustained basis.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 9, 2021
Read about event More on this topic
 

Past Event

Past Event

The Recovery and Resilience Fund: Accelerating the digitalisation of the EU?

How can new EU funds financed by EU borrowing supplement national digital and green funding and EU funds available from the standard seven-year EU budget to accelerate digitalisation?

Speakers: Sam Blackie, Zsolt Darvas, Maria Teresa Fabregas Fernandez, J. Scott Marcus and Ben Wreschner Topic: European Macroeconomics & Governance Date: June 8, 2021
Read article More on this topic More by this author
 

Blog Post

Quo vadis, Swiss-European Union relations?

Switzerland’s decision to abandon talks on a framework agreement with the European Union will have far reaching consequences. The outline of future relations now depends both on the EU’s response and on domestic developments.

By: Stefanie Walter Topic: European Macroeconomics & Governance Date: June 7, 2021
Read about event More on this topic
 

Past Event

Past Event

Women, Covid-19 & The EU Recovery Plan

How can we ensure that the recovery plan doesn’t leave women behind when 84% of working women in the EU aged 15-64 are employed by services that were predominantly impacted by Covid-19 restrictions?

Speakers: Mary Collins, Maria Demertzis, Alexandra Geese, Jacob Funk Kirkegaard, Dan Mobley, Naomi O'Leary and Emma Rainey Topic: European Macroeconomics & Governance Date: June 2, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Belarus: a test for Europe’s foreign policy?

The forced landing of an internal EU flight is just the latest development in the President of Belarus’ efforts to cling to power.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: June 1, 2021
Read article More on this topic More by this author
 

Blog Post

What Swiss voters expect to happen next, after EU talks fail

Proponents and opponents of the Swiss-EU institutional framework agreement have different takes on the impact of a success or failure of the agreement.

By: Stefanie Walter Topic: European Macroeconomics & Governance Date: May 31, 2021
Load more posts