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.

View comments
Read article More by this author

Blog Post

Bank regulation in the European Union neighbourhood: limits of the ‘Brussels effect’

The EU model of financial market regulation is increasingly copied by third countries. In this context, the EU’s efforts to promote its model beyond its borders should take into account the underdevelopment of financial markets in many partner countries, and the often insufficient capacity of regulators and supervisors.

By: Alexander Lehmann Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: November 20, 2019
Read article Download PDF More by this author

Policy Contribution

Crisis management for euro-area banks in central Europe

Euro-area bank integration has decreased as post-financial crisis national rules require banks to hold more capital at home. It might be undermined further by bank resolution planning. Either a Single Resolution Board takes the lead for the entire banking group or independent local intervention schemes need to be developed for crisis resolution.

By: Alexander Lehmann Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: November 19, 2019
Read about event More on this topic

Past Event

Past Event

Better governance, better economies

This event will feature the presentation of the 2019 EBRD Transition report, which focuses on governance in the EBRD regions.

Speakers: Daniel Daianu, Beata Javorcik, Zsuzsanna Lonti and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Press Club Brussels Europe, Rue Froissart 95, 1000 Brussels Date: November 19, 2019
Read about event More on this topic

Past Event

Past Event

Improving regulatory policy formulation and institutional resilience in Europe

Are large differences in the resilience of individual economies related to differences in the quality of country-level institutions that shape the absorption and response to these shocks? At this event we'll discuss the evolution of labour markets, and the role of institutional design and good process.

Speakers: Arup Banerji, Maria Demertzis, J. Scott Marcus, Céline Kauffmann and Rogier van den Brink Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 13, 2019
Read article More on this topic More by this author

Opinion

Scholz's improved plan to complete the banking union

The head of German Finance has written in the Financial Times defending the need to deepen the banking union, now London is about to leave

By: Rebecca Christie Topic: European Macroeconomics & Governance Date: November 8, 2019
Read article Download PDF More on this topic

External Publication

A Primer on Developing European Public Goods: A report to Ministers Bruno Le Maire and Olaf Scholz

This report was prepared for the French and German Ministers of Finance.

By: Jean Pisani-Ferry and Clemens Fuest Topic: European Macroeconomics & Governance Date: November 8, 2019
Read article Download PDF

Policy Contribution

How to make the European Green Deal work

Ursula von der Leyen has proposed a European Green Deal that would make Europe climate neutral by 2050. With this Policy Contribution, the authors provide a first analysis on how to make this initiative work.

By: Grégory Claeys, Simone Tagliapietra and Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance Date: November 5, 2019
Read article More on this topic

Opinion

Politics, not policy will help Lagarde save the eurozone

Her success at helm of Europe’s central bank will depend on her ability to mend fences with hawkish policymakers.

By: Guntram B. Wolff and Rebecca Christie Topic: European Macroeconomics & Governance Date: November 4, 2019
Read about event

Past Event

Past Event

What industrial policy for the European Green Deal?

This event will be a workshop, aiming to look into the design and implementation process of the European Green Deal. Each session will be introduced by three short presentations aimed at launching the discussion among all workshop participants.

Speakers: Jos Delbeke, Bertrand Déprez, Markus Hess, Laura Piovesan, Megan Richards, Simone Tagliapietra, Mary Veronica Tovšak Pleterski, Kurt Vandenberghe and Reinhilde Veugelers Topic: Energy & Climate, European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 4, 2019
Read article More by this author

Podcast

Podcast

How to Spend it

Can governments make their fiscal policy go further? And are they trusted enough to try? This week The Sound of Economics asks if the quality of public spending is as important as the quantity.

By: The Sound of Economics Topic: European Macroeconomics & Governance, Global Economics & Governance Date: October 23, 2019
Read article More on this topic

Blog Post

Talking about Europe: La Stampa 1940s-2010s

An on-going research project at Bruegel seeks to quantify and analyse printed media discourses about Europe over the decades since the end of the Second World War. In this third blogpost, we carry out the exercise on 9.9 million articles from an Italian daily newspaper, La Stampa. The trend increase in the frequency of European related articles, previously found looking at the French and German press, is confirmed in the case of Italy.

By: Enrico Bergamini, Emmanuel Mourlon-Druol, Francesco Papadia and Giuseppe Porcaro Topic: European Macroeconomics & Governance Date: October 22, 2019
Read article More on this topic More by this author

Podcast

Podcast

The Art of the Brexit Deal

An emergency Brexit podcast to dissect today's tentative deal between the EU27 and the British Government, featuring Maria Demertzis, Guntram Wolff and Nicholas Barrett

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: October 17, 2019
Load more posts