16 Mar 2013

Cyprus: ten huge consequences of the bailout of a small country

“We have taken immediate measures so that electronic transfers cannot take effect before banks reopen on Tuesday”.

Incredible words, from Cyprus’ finance minister of just two weeks in the early hours of this morning as reported to the Wall Street Journal.

Brussels has delivered a small bailout, large bail-in, with huge consequences. That’s the seven word summary of an epic decision and gamble made in Brussels re the financial rescue of Cyprus.

Cypriot contacts have told me that cash machines on the island have already been reprogrammed to print out a warning of the so-called “stability levy” which will see 6.75 per cent extracted by the Cypriot government from every bank account on the island, and 9.9 per cent if the deposits are more than 100,000 euros. This will raise a sum worth 5.8bn euros, or a third of Cyprus’s GDP, adding to a 10bn euro rescue from the Troika plus Russia possibly extending an existing 2.5bn euro loan (the Chetvyorka?).

Reuters is already reporting  the impact on some ordinary Cypriots:

“Co-op credit societies, normally open on Saturdays, were shut for business in the coastal town of Larnaca as depositors started queuing early in the morning to withdraw their cash.

“I’m extremely angry. I worked years and years to get it together and now I am losing it on the say-so of the Dutch and the Germans,” said British-Cypriot Andy Georgiou, 54, who returned to Cyprus in mid-2012 with his savings.
“They call Sicily the island of the mafia. It’s not Sicily, it’s Cyprus. This is theft, pure and simple,” said a pensioner.”

1. Cypriot households, families and widows, will pay the “stability levy” of 7-10 per cent of their life savings, wheras hedge funds and other bondholders that had bet on Cypriot government and bank debts will be made whole.

2. Cypriot banks were originally doing so well that in excess of 5bn euros of Greek deposits fled that country into Cyprus in 2010. It was the EU’s decision to haircut Greek government bonds that caused the Cypriot financial system problems. The EU did not want to repeat that haircut with Cyprus (“Greece is still a one-off”) so have shifted burden of adjustment to ordinary savers. I call it HSI – Household Sector Involvement.

3. Happily for them Greek depositors, are largely protected by this deal. An attempt to stop the virus of financial contagion.

4. UK depositors are the largest unprotected depositors in Cypriot banks, with just under £2bn. If all of it is housed then, the losses could be from £140m to £200m. The FSA did insist last year on UK deposits of most parts of Cypriot banking system be separated in a subsidiary. (UPDATE: 1530: UK treasury sources: “deposits in UK subsidiaries and branches aren’t affected”). So losses are unclear, but it seems likely that direct deposits in Cyprus, particularly from Brits of Cypriot origin, could be affected.

5. As a minor aside: UK interests may not be seen to have been fully represented yet again in the EU, at a meeting of the Eurogroup. Fuel for both Ukip and those arguing we are being sidelined. (See UPDATE to 4.)

6. Germany runs the Eurozone. We knew this. Sometimes they deny it. This is a result of German electoral politics. The Opposition SPD has been very hard line on German taxpayers’ money not being used to bailout “Russian oligarchs”. A straightforward bailout had the capacity to embarrass Chancellor Merkel with consequences for the election in September. This is the end result. On the Russian angle it’s worth reading Constantin Gurdgiev: 

7. Is the EU system of deposit protection worth anything when a member state can basically seize the deposits in a tax instead?

8. “Bail-ins” have been dabbled with under Mario Draghi, rhetorically, wheras they were ruled out by Trichet. Senior figures pointed to the frying of a small number of AngloIrish senior bondholders last month as a “precedent”. The calm in the markets since Draghi’s bazooka in September may have led to over-confidence.

Analogous operations have been occurring in the Netherlands and Spain. Bailing-in ordinary depositors is a different thing entirely however. The influence of Germany looms large here. Even above the ECB, it appears. Cypriot TV has run reports suggesting Germany “blackmailed” Cyprus with threats of euro exit and over emergency liquidity funding. Take it with a pinch of salt, but clearly in Cyprus they blame Germany. [UPDATE 1730: forget the pinch of salt. I’ve been told that German representatives told Finance minister Sarris words to the effect of ‘we’ve been watching to see if there has been any contagion for 90 days, there hasn’t, so this is take it or leave it’ [ie leave the euro]. Sarris should have told Germany that if there is no contagion, then it should accept Greek style bondholder haircuts (PSI on euro-jargon) to Cypriot government debt. It’s easy to say that sat in London.

9. Cyprus has been hard done by. Difficult to see how seizing deposits is consistent with its offshore financial centre strategy. The Russian money will be gone never to come back.

 (Pawel Morski speculates Latvia as the destination du jour). Entirely plausible that they’ll have to recapitalise Cypriot banks again. Cyprus was never is as bad a position as the other programme countries. It was pushed over edge by the Greek bond haircut and a mysterious explosion at a naval base which closed its main power plant.

10. Everything depends on the reaction of the Cypriot depositors. Will they feel relieved that they have only lost seven to ten per cent of their savings? Will they remove all their money when banks reopen on Tuesday, after a handily timed bank holiday on Monday? Will capital controls be instigated? What impact will this have on other depositors in programme countries? In Spain, there’s already a profound issue with 300,000 Bankia customers who lost all of what they thought were savings accounts, which turned out to be preference shares. This still has to get through Cyprus’ parliament this weekend. We are entering a new phase of this crisis.

UPDATE 1730: Parliamentary vote expected tomorrow afternoon. Presumably some of this deal could be voted down. A large protest is expected. Various pictures of broken cash machines, queues etc are circulating on social media. A good source in Cyprus confirmed to me that electronic bank transfers are currently blocked, and ATM withdrawals have been limited to €400 (that sounds high, or normal). I also failed to note here that the stability levy at least for Cypriot residents will be swapped for shares in Cypriot banks. A lot could yet move on this in the next 24 hours.