Cyprus is poised to impose a haircut on depositors in domestic banks despite them being covered by a deposit guarantee scheme, sparking concerns throughout the eurozone that deposits in other weak banks and countries are not safe.
Under the current plans, deposits beneath the €100,000 ($129,000) deposit guarantee threshold will be subject to a 6.75% 'one-off' levy, while any funds above will be subject to a 9.9% levy. Cyprus's president Nicos Anastasiades said depositors would not take a loss, however, as they would be "immediately allocated" shares in the bank to compensate them. The banks' bondholders will not take a loss, as the share of bonds was deemed too small to solve the problem.
The plans still have to be approved by the Cypriot parliament, which could be a challenge for the president since his party only controls 20 of the 56 seats. According to media reports, the parliament is currently thrashing out a deal that may make the levy more progressive and, in the meantime, Cyprus's banks remain closed. A bank run is already developing, however, as people withdraw as much money from ATMs as possible.
In a statement yesterday, Anastasiades said the alternative to the haircut was "potential coercion to exit the eurozone". The government legally justified the haircut on the basis that the two banks that need a bail-out are not yet bankrupt, while German opposition to a full €17 billion European bail-out package ensured that some funds would have to be raised internally.
Leaders may come to rue that decision. "Once the small-time depositors in Cypriot banks have lost 6.75% of their assets, what then is the incentive for them to leave any money in the Cypriot banking system? There is none," said Fathom, a consultancy, in a research note. "A run on Cypriot banks would be almost inevitable."
Once the small-time depositors in Cypriot banks have lost 6.75% of their assets, what then is the incentive for them to leave any money in the Cypriot banking system? There is none
Adding further to the public's ire, the Cypriot government had previously denied that such a levy was an option. "The government wants to reassure that a haircut on bank deposits or cuts in payroll and pensions will not be, in any case, an option," a government spokesman said in a statement on March 13. Days later the haircut was agreed.
The fear now is that the run may spread to other weak members of the eurozone periphery. Bond yields have already leapt up 50 basis points on 10-year Greek government bonds since Friday, and are also rising on Italian, Portuguese and Spanish debt.
Not all fear this, however. ABN Amro was upbeat, arguing that the Cypriot case was unique, as the Eurogroup had been quick to emphasise. "Cyprus does look like a ‘special case'," the bank said in a research note. "Together with the European Centra Bank's safety nets, this should limit contagion."
Financial assistance is likely to be provided by the European authorities in the second half of April. The International Monetary Fund has also indicated it will provide support, and Cyprus is currently in talks with the Russian authorities, as Cyprus had a large number of Russian depositors.
Vladimir Putin, the Russian president, was unimpressed by the Cypriot solution. He called the haircuts "unfair, unprofessional and dangerous", according to a spokesman for the Kremlin.