Hugo Dixon: Cyprus deposit grab sets bad precedent
By Hugo Dixon
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
Cyprus’ deposit grab sets a bad precedent. Money had to be found to prevent its financial system collapsing. But imposing a 6.75 percent tax on insured deposits – or even the 3 percent being discussed on Monday morning – is a type of legalised bank robbery. Cyprus should instead impose a bigger tax on uninsured deposits and not touch small savers.
Confiscating savers’ money will knock confidence in the banks. Trust in the government will also take a hit, since Nicosia had theoretically guaranteed all deposits up to 100,000 euros. Small savers should be encouraged not penalised. They are the quiet heroes of the financial system, who squirrel away their savings, not those who drag it down by engaging in borrowing binges.
Nicosia has not technically broken its promise to guarantee small deposits. That’s because it is not the banks which are failing to repay savers – something which would have triggered the insurance scheme. Instead, it is the government itself which is grabbing a slice of deposits. The pill is also being sugared by giving savers shares in the banks and some of the hoped-for revenues from a possible natural gas bonanza as compensation. That said, the mechanism is still an effective breach of promise.
There’s no denying that Cyprus needed a solution. The small Mediterranean island was on the brink. Its banking system – which had grown to eight times GDP on the back of inflows of Russian money and aggressive expansion in Greece – was technically bust. Its exposure to the Greek economy, Greek government debt and Cyprus’ own burst property bubble had seen to that.
Nicosia’s euro zone partners made clear there was no time to waste. They had chosen the date of their finance ministers’ meeting on Friday night, knowing that Cyprus already had a scheduled bank holiday this Monday. The country’s president says the European Central Bank was threatening to cut off liquidity on Tuesday if there was no deal. The banking system would have collapsed.
In total, Cyprus requires 17 billion euros – almost 100 percent of GDP – to rescue its banks and deal with the government’s own bills. If Nicosia had borrowed all that cash on top of its existing debt, it would have been carrying an unsustainable burden. It would have only been a matter of time before the debt needed restructuring.
Cyprus’ euro zone partners and the International Monetary Fund rightly decided not to lend it so much money, limiting the bailout to 10 billion euros. This means Nicosia should end up with debt equal to a manageable 100 percent of GDP in 2020.
The problem was where to find the extra 7 billion euros. Given that Germany and other northern European countries weren’t prepared to give a handout, there were two options: haircut the government’s own bondholders or hit bank creditors. The option of haircutting government debt – as Greece did last year – was rejected. Many bonds are held by Cypriot banks, so a haircut would just have increased the size of the hole in their balance sheets, meaning they would have needed an even bigger bailout. The Cypriot government’s credit would have been destroyed for little benefit.
So, by default, the banks’ creditors had to be tapped. Ideally, bank bondholders would have taken the strain. But Cypriot banks have hardly any bonds. So there wasn’t much money that could be grabbed there.
This, incidentally, rams home the importance of requiring all banks to have fat capital cushions – consisting either of equity or bonds that can be bailed in during a crisis. The sooner international regulators come up with a minimum standard for so-called “bail-in” debt, the better. Given that Cypriot banks didn’t have such a cushion, the remaining option was to hit depositors – for 5.8 billion euros.
There was even some rough justice in the policy. After all, up to half of the country’s 68 billion euros of deposits is held by Russians and Ukrainians – and some of this money is thought to be black money laundered through Cyprus.What’s more, the country’s banks have been paying high interest rates in recent months – in some cases up to 7 percent on euro deposits. That is clearly danger money. Depositors should have known there were risks attached to such high rewards.
If the deposit tax was confined to uninsured deposits, which are facing a 9.9 percent levy, such arguments would have merit. But the original plan was also to hit insured savers with a 6.75 percent tax. It would be better to get the money entirely from the 38 billion euros of uninsured depositors.
Following an uproar over the weekend, the Cypriot government was rethinking its plans which risked being voted down in parliament. The latest idea doing the rounds is that insured savers will be hit with a 3 percent levy and those with more than 100,000 euros being charged somewhere between 10-15 percent. This is clearly an improvement on the original proposal. But why not exempt insured depositors entirely? The tax on the uninsured would then have to be 15 percent.
The Cypriot government didn’t want to do this, because the uninsured deposits are disproportionately foreign and it is worried that such a high tax would undermine its status as an offshore financial centre. Even if there is domestic political logic in cushioning Russian mafia at the expense of Cypriot widows, such a policy is bad for the rest of the euro zone.
Provided the Cypriot parliament approves some plan and the banks open tomorrow, there probably won’t be any immediate contagion from Cyprus to other crisis countries. After all, banking systems in Greece, Spain, Portugal and Ireland have recently been recapitalised. Meanwhile, the combination of Cyprus’ relatively huge banking sector and the fact that it is perhaps small enough to experiment with make it a special case. But unless Cyprus’ insured deposits are totally exempted from this raid, citizens in the rest of the euro zone now know that, if push comes to shove, their savings could be grabbed too.