Cyprus Bailout Shocks The Eurozone

The Cypriot government announced plans to introduce a levy on all bank deposits in order to secure an EU bailout for its troubled banks. The initial proposal for all bank deposits to be levied with a 6.75% charge with accounts over €100,000 being subject to a charge of 9.9% was rejected by the Cypriot parliament. Banks in Cyprus were closed for over a week to prevent bank runs in this unprecedented debacle.

New proposals were agreed late on Wednesday to protect all deposits up to €100,000 as is consistent with EU regulations. Cyprus’s second largest bank, Laiki will be closed. All deposits of over €100,000 will be transferred to a “bad bank” and could be lost entirely. Those with smaller deposits at Laiki will see their balances transferred to the Bank of Cyprus. All lenders to Laiki will need to write off their investments as the bank is unable to honour its bonds. The recently elected president, Nicos Anastasiades has had a whirlwind start to his new role.

The Bank of Cyprus faces a huge restructuring with shareholders and bondholders being hit. Depositors with over €100,000 face a levy of approximately 30%. According to The Financial Times, Russian nationals hold more than €20 billion of the €68 billion deposited in Cypriot banks and are likely to be hit the hardest.

Much of the world will be watching the crisis unfold in Cyprus with interest. This unprecedented move by the EU is a sign that cash may no longer be safe in the bank, particularly in stricken economies such as Spain, Portugal and Greece which are likely to require future bailouts.

The upshot of the Cyprus bailout is that the second largest bank has actually gone bust. This is more akin to a default than a raid on savers. However, there are fears that this could be the beginning of the end for the Eurozone. The initial proposal to tax all deposits shows a blatant disregard for savers and the willingness of the EU to tax these individuals is a major concern, particularly since they appear to have ignored the fact that all accounts up to €100,000 (£85,000) must be protected under EU legislation. For a relatively minor member of the EU, the ramifications could be significant if they lead to contagion in the form of bank runs in larger countries such as Spain.

The crisis will have significant repercussions to the Cypriot economy. Cyprus was seen as a tax haven with many of its bank paying interest of 4% or more on bank deposits. The loss of confidence will inevitably lead to mass withdrawals from the country. The banks have been closed for over a week meaning that depositors have been unable to access their accounts during this time.  Transactions in Cyprus have been reduced to a cash only basis during this time with many people beginning to run out of money. Tough restrictions have been imposed on bank withdrawals since the banks reopened on Thursday and it will take some time for business to resume as normal. It is unclear whether Cyprus would have been better off having left the EU. Cyprus faces years of deep recession.

The stock market however, appears to sidestepped the issue of Cyprus and any potential Eurozone crisis. The S&P 500 rose to another record high on Friday. Perhaps equities are now considered to be the new safe haven for investors.