Blog Post

Dramatic days ahead in Cyprus

The Cypriot parliament's Tuesday evening rejection of the bank levy on bank deposits, which was a key condition for financial assistance from the EU/IMF and continued European Central Bank support to the Cypriot banking system, was dangerous. At stake are nothing less than a complete meltdown of the Cypriot banking system and a possibly uncontrolled exit from the euro area.

By: Date: July 23, 2013 Topic: European Macroeconomics & Governance

This column was previously published in Expansión.

The Cypriot parliament’s Tuesday evening rejection of the bank levy on bank deposits, which was a key condition for financial assistance from the EU/IMF and continued European Central Bank support to the Cypriot banking system, was dangerous. At stake are nothing less than a complete meltdown of the Cypriot banking system and a possibly uncontrolled exit from the euro area.

European partners, the European Central Bank and the IMF rightly demanded the involvement of Cypriot depositors in the rescue. Without such involvement, financial assistance to Cyprus would have to be about 100 percent of Cypriot GDP, seriously undermining public debt sustainability.

Also, there is suspicion of money laundering, which lowers the inclination of European partners to absorb part of the bank losses in Cyprus. One has to add that tax rates were so low in Cyprus and the deposit rates so high, that financial investments were much more profitable than in most other euro-area countries. Term deposits yielded 4.5 percent in Cyprus in January 2013, while German savers hardly got 1 percent. Giving-back something from these gains should be seen as fair, when the Cypriot banking system has a capital shortfall of about 50 percent of GDP.

It was therefore right to demand the involvement of Cypriot depositors in the rescue. But the 15/16 March Eurogroup agreement had two major flaws. First, it should not have involved deposits below the €100,000 amount guaranteed by deposit insurance. This was not necessary and generated public anger. It potentially also undermines trust in deposit guarantee systems throughout Europe. Second, senior bondholders were not involved, even though the amount of such bonds is miniscule. The damage has been done. European policymakers were busy on 18 and 19 March blaming each other rather than recognising that all participants in the 15/16 March Eurogroup meeting are collectively responsible.

But the Cypriot parliament had the chance to correct the errors. After realising that involving small depositors was a mistake, the euro-area partners sent the message to Nicosia that the burden could be shifted to large depositors only. Cypriot lawmakers did not back them; instead, they voted down the whole idea, at least for the time being.

Without a quick and credible solution, deposits will flee Cyprus on the first day that banks open after the current bank holiday. The prospect for such a solution is limited, and therefore the risks are very high.

What’s next? European partners can hardly backtrack completely. Telling Germans that their money will be used to fully save the highly profitable deposits in Cyprus, some of which are thought to be of dirty origin, is not something the Bundestag will be happy to swallow. Also, if that was to happen, politicians in other countries may also decide on blackmail. Euro-area partners could make a small bargain, such as providing €1.3bn more – the amount of tax which was supposed to be collected from depositors below the €100,000thershold – but the scope is very limited. The Governing Council of the ECB will also face a difficult decision on whether to continue to support a banking system which is practically bankrupt, without a prospect of shoring-it up properly.

Russia may step in instead. Michalis Sarris, Cyprus’s finance minister, has travelled to Moscow to seek assistance. If that should be given, Cyprus will likely have to pay a high price for it. The losses have to be absorbed by someone if depositors in Cypriot banks are to be protected in full. Russia may demand high compensation, such as control over the gas fields under the Cypriot waters. That would have geopolitical consequences as well.

The current bank holiday in Cyprus cannot be extended for too long and freezing deposits once the bank holiday is lifted is not a good option either. A new deal has to be agreed urgently. The first best option is reconsidering the issue in Cypriot parliament: the bank levy has to be passed on large deposits, while preserving deposits up to €100,000 in full. The prominent role of the Cypriot financial system is probably over anyway, so the goal should be to minimise the damage and the safeguard Cyprus’s membership of the euro area. Euro-area partners may provide a little bit more money, such as the €1.3bn mentioned above. The parliamentary decision has to be accompanied by the publication of a credible plan by euro-area partners and the Cypriot government to shore-up the island. Probably deposits will flee even in this case, but with the support from the euro-area partners and the ECB, the initial turbulence could be survived.

If a reasonable compromise is not reached, the Cypriot parliament does not reconsider, euro-area partners do not backtrack, and Russia does not step in, then we will witness a full meltdown of the financial system of Cyprus, bringing misery to its citizens. It could also endanger Cyprus’s membership of euro-area, bringing even more harm to the Cypriots. There has to be an agreement.


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

Sep
1
12:30

The EU recovery fund - state of play and outlook

Bruegel Annual Meetings, Day 1- In this session we will discuss the EU recovery fund, its state of play and outlook.

Speakers: Nadia Calviño, Karolina Ekholm and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

Sep
2
10:00

Conversation on the recovery programmes

Bruegel Annual Meetings, Day 2- In this session, we discuss the recovery programmes.

Speakers: Maria Demertzis, Henry Foy and Tadeusz Kościński Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event
 

Upcoming Event

Sep
2
13:00

European banks: under global competitive pressure?

Bruegel Annual Meetings, Day 2 - European banks have lost stature and remain generally low-profitability, low-valuation in comparison to their global peers. Is that a problem? If so, what can EU policymakers do to address it?

Speakers: José Antonio Álvarez Álvarez, Mairead McGuinness and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Upcoming Event

Sep
2
15:45

Blending physical and virtual: shaping the new workplace

Bruegel Annual Meetings, Day 2 - This panel will cover the changes the COVID-19 pandemic made to our workplaces, and what to expect in the near future.

Speakers: Nicholas Bloom, Michael Froman, Mario Mariniello, Sara Matthieu and Luca Visentini Topic: European Macroeconomics & Governance Location: Academy Palace
Read about event More on this topic
 

Upcoming Event

Sep
3
10:15

Conference on the Future of Europe: envisioning EU citizens engagement

Bruegel Annual Meetings, Day 3 - 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.

Speakers: Caroline de Gruyter, Kalypso Nicolaïdis, Niclas Poitiers and György Szapáry Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Upcoming Event

Sep
3
09:00

The role of the EU's trade strategy for an inclusive and sustainable recovery

Bruegel Annual Meetings, Day 3 - We are delighted to welcome Valdis Dombrovskis, Executive Vice President of the European Commission for An Economy that Works for People to talk about Europe's trade strategy.

Speakers: Valdis Dombrovskis, Alicia García-Herrero and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read article
 

Blog Post

Will European Union recovery spending be enough to fill digital investment gaps?

The recovery facility will boost digital transformation, but questions remain whether it will be sufficient to achieve Europe’s digital ambitions.

By: Zsolt Darvas, J. Scott Marcus and Alkiviadis Tzaras Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 20, 2021
Read article Download PDF
 

Policy Contribution

A new direction for the European Union’s half-hearted semiconductor strategy

The EU needs a more targeted strategy to increase its presence in this strategic and thriving sector, building on its existing strengths, while accommodating its relatively low domestic needs.

By: Niclas Poitiers and Pauline Weil Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 15, 2021
Read article More by this author
 

Blog Post

Fit for 55 marks Europe’s climate moment of truth

With Fit for 55, Europe is the global first mover in turning a long-term net-zero goal into real-world policies, marking the entry of climate policy into the daily life of all citizens and businesses.

By: Simone Tagliapietra Topic: Energy & Climate, European Macroeconomics & Governance Date: July 14, 2021
Read article More on this topic
 

Blog Post

Fair vaccine access is a goal Europe cannot afford to miss – July update

European countries must do more to tackle the vaccine uptake gap. Vaccination data should be published at the maximum granularity level so researchers and local decision-makers can monitor progress.

By: Lionel Guetta-Jeanrenaud and Mario Mariniello Topic: European Macroeconomics & Governance Date: July 14, 2021
Read article More by this author
 

Blog Post

SPACs in the gap

Special-purpose acquisition vehicles could fill a gap in European equity markets and lure risk-averse investors off the sidelines.

By: Rebecca Christie Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 13, 2021
Read article More on this topic
 

Blog Post

A breakdown of EU countries’ post-pandemic green spending plans

An analysis of European Union countries’ recovery plans shows widely differing green spending priorities.

By: Klaas Lenaerts and Simone Tagliapietra Topic: European Macroeconomics & Governance Date: July 8, 2021
Load more posts