Cyprus Prepares For Controls on Capital To Prevent Bank Runs

troikaNicosia, Cyprus

Protests continue to emerge across Cyprus as Cypriot banks prepare to open their doors for business on Thursday with new capital controls expected to be announced as early as today to prevent a massive bank run on their newly rescued but still vulnerable banks.

Disgruntled Cypriots have take to the streets to protest the €10 billion ($13 billion) international troika bailout that was ratified on Sunday and resulted in waves of banking job losses while rekindling fears that the restructuring of the country’s two largest banks, which were essentially insolvent before Sunday, will result in more economic pain for Cyprus.

Last week Cypriots took to the streets and protested an unprecedented troika based plan to raise the € 5.8 billion ($7.6 billion) it needs to secure a  €10 billion ($13 billion) through the implementation of controversial one time tax of 6.75 percent on all bank deposits under €100,000 and 9.9 percent over that amount.

Cyprus’ Parliament reacted quickly by unanimously voting down the troika based plan.

However, after the European Central Bank threatened to cut off Cyprus’ liquidity access while Russia spurned Cyprus’ request for € 5 billion in financial aid last Thursday, Cypriot lawmakers in Parliament had few places left to turn.

Desperate to save their economy from the brink of collapse, Cypriot lawmakers scrambled over the week-end to establish a new financial framework within the country to re-qualify for the €10 billion international bailout and avert a financial meltdown that could have easily led to Cyprus leaving the 17 member bloc euro-area.

What was finally agreed to at the eleventh hour on Sunday included a new plan to shut down the Popular Bank of Cyprus, also called Laiki Bank.

Bank deposits under €100,000 in the Popular Bank of Cyprus will be safely transferred to the Bank of Cyprus while all uninsured deposits above € 100,000 in both banks will be frozen and used to lower the large bank debts.

A loss of no more than 40 percent will be imposed on uninsured depositors above € 100,000 at the Bank of Cyprus.

Cyprus’ Over-sized Banks

Cyprus joined the European Union on May 1st 2004 but had to wait until January 1st 2008 to join the 17 member bloc euro area.

In the 1990’s after the fall of Communism, Cyprus attempted to shed its over reliance on the tourism industry to support their small economy.

Cyprus shifted gears, became more diversified, and established itself as a strong financial center in the region by accepting billions of offshore money from wealthy Russians, including Russian oligarchs, who wanted a safe destination to park their large sums of wealth.

Cypriot banks and its small economy, which lacked tight regulation and high taxes, seemed to be a perfect fit.

Cypriot banks grew quickly and expanded seven times the size of the economy. Moody’s estimates that about €31.5 billion ($40bln) has been loaned to Russian companies based in Cyprus.

Cypriot banks put their new capital to work and purchased large amounts of Greek bonds, never expecting that in late 2011 their Greek bonds would take a haircut or write off totaling over 50 percent face value loss as a pre-condition of Greece’s new EU bailout rescue plan.

In late 2011 as the global recession was hitting hard across much of the European Union, Cyprus lost access to bond market borrowing.

With a closed bond market and fears of insolvency growing louder by the day, tensions spread across Northern Europe about their taxpayer money being used to support a €10 billion ($13 billion) banking bailout rescue plan for Cyprus that could result in European bailout rescue money flowing out of Cypriot bank coffers and into the hands of Russian oligarchs.

The EU and the troika made a decision to play “hard ball’ with Cyprus by demanding a one time tax of 6.75 percent on all bank deposits under €100,000, a maneuver that impacts even small savers, and a 9.9 percent tax over that amount to qualify for the €10 billion ($13 billion) troika bailout rescue package.

But after the depositor tax proposal fell apart in Cyprus’ Parliament, a final proposal was agreed to and ratified in Brussels to freeze all uninsured Cypriot deposits above € 100,000 in both banks and impose a loss of no more than 40 percent on those uninsured depositors, the majority of whom are Russians.

The upcoming decision that will be reached in Cyprus about capital controls is expected to have far reaching implications for the banking system in Cyprus and banks in the 17 member bloc euro area.

It also opens up a new chapter for discussion about how banking rescue plans are handled in a European Union that is growing  less tolerant of European taxpayer money being used to fund large bank rescue packages.

 

 

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