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April 11, 2013 at 09:25 PM
When Cyprus approached the International Monetary Fund last summer to say that it might need a bailout, it had no idea what lay in store.
Already in trouble from its heavy purchases of Greek bonds, only a few years ago Cyprus had had a humming economy, fed in large part by a financial sector that thrived on substantial deposits from, among others, Russians who had made their money after the breakup of the Soviet Union and who parked billions in accounts and shell companies housed by Cyprus’s relaxed atmosphere.
However, the Greek crisis hit Cyprus hard. Its financial sector held assets eight times the size of its economy, and after the “haircut” imposed on those holding Greek bonds, the situation worsened as some of those large depositors began to move their money out of the country’s banks. Cyprus drew on Emergency Liquidity Assistance from its central bank to the tune of 9 billion euros, but after the country’s February elections the European Central Bank informed the new government that it would cut off additional ELA unless Cyprus worked out a bailout deal.
The deal finally offered in March shocked not just Cypriots, but people throughout the Eurozone and beyond. The troika—the European Union, the IMF, and the ECB—determined that for Cyprus to receive a 10-billion-euro bailout, it must contribute 5.8 billion euros to its own rescue. Since Cyprus, unlike Greece in earlier days, did not have many bondholders from which to get funds, the remaining option was to take the money from the bank’s depositors—something that had never been done.
Cyprus was the fifth nation to receive a bailout, but no other nation got hit with the terms that Cyprus did: originally all depositors were expected to help pay for the rescue, with small depositors paying a 6.75% levy and large depositors, with accounts over 100,000 euros, paying even more. That was so distasteful Cyprus tried, but failed, to get a helping hand from Russia, the source of so much of its money. Cyprus’s parliament voted down the deal, which then was revised so that only depositors with accounts over 100,000 euros were to be hit.
Still, the notion that small depositors with guaranteed savings could be expected to pay for a bailout at all raised fury in Cyprus. Large depositors, of course, weren’t happy either, especially since they could no longer move funds out of the country under the newly imposed capital controls designed to prevent runs on the banks.
Cyprus was a tax haven, and perhaps it was inevitable that there would be trouble once regulators began to pursue tax evaders and the institutions that supported them. After all, the U.S. brought down Switzerland’s oldest bank, Wegelin, that had been doing business based on privacy for 272 years. It also brought Switzerland to the negotiating table in an attempt to come to terms for the rest of its banks.
However, the trouble came, not from the U.S., but from Germany, which insisted that depositors had to pay for the bailout. Why? In part because Cyprus has a reputation for lax financial rules, despite the fact that it has in place all the regulations that were required for its entry into the Eurozone. It is one thing to have regulations, and entirely another to enforce them.
The facts that depositors with supposedly insured accounts were targeted, however briefly, and that large depositors are now on the hook for as much as 60% of their funds, have led to concerns elsewhere in the world, not just the Eurozone, that it could happen again—and to them. In fact, the U.K. has already moved to reassure its depositors that their money is safe.
