Cyprus Bank Crisis Signals More Debt Uncertainty For Euro Area

bank runOver the week-end new developments out of Cyprus concerning debt has led to lingering questions about how bailout packages are expected to be repaid in the 17 member euro area.

In January, a financial assessment of Cyprus’ financial health revealed a capital shortfall of around €17.5 billion with nearly €10 billion coming from its two largest banks, the Bank of Cyprus and Laiki Bank.

Since a bailout package for those banks would have driven the country’s debt above 140% of gross domestic product (GDP), an unacceptable level, Cyprus’ international creditors from the “Troika” (ECB, the European Commission, and IMF) recently decided that it would be more prudent for depositors in Cypriot banks to shoulder the financial burden.

The request for an international bailout for Cyprus was met with a controversial new demand: a new tax on bank depositors to help fund €10 billion ($13 billion) in bailout rescue money.

In exchange for €10 billion ($13 billion) in bailout rescue funds, Cyprus’ international creditors are imposing a one time tax of 6.75 percent on all bank deposits under €100,000 and 9.9 percent over that amount to raise €5.8 billion ($7.6 billion) from taxes on bank depositors, including small time savers.

The new tax would also impact wealthy Russian depositors who have stored large amounts of money into Cyprus’s banks and ultimately raise € 5.8 billion towards recapitalizing the nation’s banks and pay down the country’s debt.

Depositors will be compensated with the equivalent amount in shares in their banks along with a promise from Cyprus’ President Anastasiades that depositors who keep their deposits in Cyprus’ banks for the next two years will eventually be provided with bonds tied to potential revenues from natural gas.

A major natural gas discovery was recently found within Cyprus’ disputed ocean borders.

The new bailout rescue condition for Cyprus is controversial because it is the first one that dips into depositors’ savings accounts to finance a bailout package.

The controversial approach from Cyprus’ international lenders sparked a bank run in Cyprus on Saturday along with a new wave of unrest that culminated in a Cypriot man driving a bulldozer into an ATM machine located at a bank.

On Sunday Cyprus’ President  Nicos Anastasiades said he was in talks to try and limit the bailout’s impact on smaller savers in Cyprus.

President Anastasiades said if he hadn’t accepted the new tax on depositors, the European Central Bank would have ended their payments for emergency funds for the country’s top two largest banks which would have likely led to the collapse of the entire banking system.

“We would either choose the catastrophic scenario of disorderly bankruptcy or the scenario of a painful but controlled management of the crisis,” Anastasiades said in a statement.

The decision to accept the new bailout term of taxing depositors will soon be put to a vote before Cyprus’ parliament.

The vote was initially set for Sunday but was postponed until Monday which is a national holiday in Cyprus.

President Anastasiades’ Democratic Rally party has 20 seats in the 56-member assembly and will need support from other parties to approve the bailout package.

Some state media outlets in Cyprus reported on Sunday that if the new bailout package deal is successfully defeated, banks could be closed on Tuesday in order to avoid a bank run of massive cash withdrawals.

The new bailout tax measure on depositors is expected to begin on Tuesday.

Cyprus’ Financial Woes

In 2012 Cyprus’ economy suffered dramatically after Greece’s economy plunged and Greece’s leaders turned to Brussels for new bailout terms.

The two neighboring Mediterranean economies are closely tied to one another.

In June 2012 Cyprus was the fifth country in the euro area to formally request an international bailout after Cyprus’ lending institutions took on financial losses from the debt restructuring of Greece’s banks that resulted in Greek bondholders taking a haircut or write-down on their bond holdings.

Cyprus continues to have cash flow problems and is in need of receiving funds from their international creditors from the “Troika” or else Russia.

However, negative sentiment continues to re-surface across Europe, especially  in Germany, that Cyprus remains a growing haven for dirty Russian money where money laundering and lack of transparency are becoming commonplace an unacceptable in many circles.

Cyprus is an important financial hub for investors from Russia and Eastern Europe.

Germany’s Der Spiegel magazine estimates that the size of Russia’s deposits in Cyprus range from €8 billion up to €35 billion.

Although the economy of Cyprus amounts to less than half a percent of the 17-nation euro economy, there are fresh concerns that ongoing debt problems in weak economies of the euro area, specifically in Southern Europe, could lead to more tough positions taken by their international lenders to shoulder the debt burden.

However, European government officials on Sunday made it clear that that the tax on depositors was a one time tax for Cyprus due to the large size of its banking system relative to the small size of the country’s economy and wouldn’t be required elsewhere in the euro area.

 

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