Why Cyprus's rescue matters to us

 
People queue outside a branch of Laiki Bank in Limassol, Cypris (16 March 2013) People have begun withdrawing savings from Cypriot banks on Saturday morning

Cyprus may be one of the eurozone's tiniest economies - its third smallest - but for the next 48 hours or so, it may be the single currency area's most important.

The point is that there could be serious repercussions for other financially over-stretched economies, such as Spain's and Italy's, from the nature of Cyprus's 10bn-euro (£8.7bn) bailout - which includes, for the first time in any eurozone rescue, losses imposed directly on depositors in banks.

These losses, running to almost 6bn euros, stem from an emergency levy of 9.9% on bank deposits over 100,000 euros (£86,600) and 6.75% below that.

The levy serves as a caution to lenders to banks that they should take care where they place their funds and avoid banks which overstretch themselves - as Cypriot banks did.

But precisely the same arguments - for what is known as a "bail-in" by private-sector creditors - were put by liberal-market purists at the peak of the banking crises in Ireland and Spain.

In the end, eurozone governments were terrified that if lenders to Spanish and Irish banks were punished, there would be a devastating domino effect of withdrawals of funds from banks in other weaker economies - a domino effect that would jeopardise the survival of the eurozone.

So, reckless lenders to Spanish and Irish banks were not punished.

Fragile confidence

Why has the precedent been set with lenders - many of them Russian - to Cyprus's banks?

Partly because there is a widespread view that if caveat emptor should apply to well-heeled lenders to banks, then the lesson has to be taught some time.

And partly because of the hope and expectation that sufficient confidence has returned to economies with weakened banks, especially those of Spain and Italy, that those with big deposits in such banks will not immediately ask for their money back (even if the Cypriot levy could one day turn out to be a very painful precedent for them).

Now, it is true that the European Central Bank's deeds and words over the past year - the provision of emergency longer-term loans to eurozone banks and an offer of support to governments with clear plans to restore financial credibility - has staunched the worrying drain of funds out of Spanish and Italian banks.

But investors' confidence remains fragile. The ECB is regarded as having provided a sticking-plaster rather than a cure for what ails the eurozone. Italy is some way from having a stable government with a plan to fix its finances and uncompetitive economy. Many believe that Spain's banks have still not owned up to the full scale of the losses they face on reckless lending to property developers and businesses.

It is possible that Spanish banks, in particular, could be hit by an outflow of deposits. That would reinforce their dependence on emergency funding from the European Central Bank, which would act as further brake on the ability of Spanish banks to provide vital credit - and would represent a serious setback in the stabilisation of the currency union.

But if such an increase in financial stress is not caused by the spanking of Cypriot bank creditors, perhaps that should be seen as evidence that the acute financial phase of the euro crisis is over.

UPDATE 14:20: A well-placed official rings to tell me why investors should not be panicking that the punishment of Cypriot depositors is a precedent, or that lenders to Spanish and Italian banks will be spanked as well before too long.

He says the structure of the Cypriot bailout has been determined by German politics. (Aren't all eurozone bailouts fixed in that way?)

Here is the logic behind imposing a hefty levy on Cyprus deposits, according to this official:

1) Regulators and politicians are convinced that a vast amount of cash in Cypriot banks belongs to Russian money launderers.

2) Few German politicians of any persuasion would have voted for a Cyprus rescue that simultaneously rescued these launderers.

3) So the only way to get the bailout through the Bundestag is for the launderers to be taxed to the tune of almost 10% of their allegedly ill-gotten cash. And if innocent savers are hurt too, that is the way this particular "Keks" will crumble.

On that analysis, private sector lenders either to Spanish banks or to the Italian government - as two topical and relevant examples - need not fear that it is their turn next to take a write-off.

That may be seen as comforting by investors, up to a point.

Except that if we are to see the Cypriot rescue as a very public statement that "hot money", which might be deemed to be laundered, has no place in the eurozone, then this money may well be withdrawn from wherever it sits in the currency union.

And although that might be a great thing from the point of view of the ethical standing of the banking system, it is never nice or easy for any bank to see a vast amount of cash walking out the door - especially since, as I mentioned earlier, that can increase its dependence on emergency replacement finance from the European Central Bank.

Cash does not know where it comes from. But it is a toss-up for any bank whether it is preferable to be kept alive by laundered cash or cash lent by the state via a central bank. Being dependent on either source is not a sign of health.

 
Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this
    +3

    Comment number 793.

    The answer is quite simple:

    Banks need our cash to make them appear solvent (although most are technically bankrupt hence QE £375, 000, 000, 000)

    Take your money out and switch to more ethical banking arrangements (building societies etc) and then they really haven't got a savers leg to stand on. They rely on YOU to keep them afloat.

    PPI, LIBOR - get shut of them.

  • rate this
    0

    Comment number 792.

    Heads banks win, tails we lose.

  • Comment number 791.

    All this user's posts have been removed.Why?

  • rate this
    +3

    Comment number 790.

    The more I see the more obvious it becomes that there are certain players in this great game that make money no matter what.

    At the expense of pensioners, savers, the prudent, the vulnerable.

    It's so sad that capitalism has been taken over by a bunch of self entitled greed monkeys.

    No way should Cypriot residents pay for the banks. Get a class action and get your money back, every penny.

  • Comment number 789.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • Comment number 788.

    All this user's posts have been removed.Why?

  • rate this
    +2

    Comment number 787.

    171.inacasino

    Rest assured the USA wanted to do to HSBC what they are doing to BP. However so interlinked are the big banks that it would have brought down the financial system including the american banks so guess what? They stopped with a fine, had proceeding against HSBC not affected the USA or better still given them an advantage over other countries companies they would have done HSBC in.

  • rate this
    +1

    Comment number 786.

    Like in the uk the responsible savers get screwed over to cover for the irresponsible peole who are in debt and live on credit.
    Why bother doing the right thing if you are just going to get shafted?

  • rate this
    0

    Comment number 785.

    So what was the EU to do with our money? Give it away and say to Cyprus "Here you are. Do what you like with this. Carry on just as you are. We won't pay any attention to your affairs, they're none of our business."?

  • rate this
    +1

    Comment number 784.

    @ 781 Joking aside, I agree on one thing - balanced budgets should be mandatory. Govt should run a structural surplus with any extra tax revenues being either invested in growth producing infrastructure, a sovereign wealth fund or re-funded/ re-distributed directly back to the tax payer.

  • Comment number 783.

    All this user's posts have been removed.Why?

  • rate this
    -1

    Comment number 782.

    781. Mr Right "They might actually be on to something here."

    >> Whaaat??!!! A levy on my assets to pay for the bail out & bonuses of our own over profligate banksters? Please lets just stick to austerity measures and get the poor & those with no assets to cough up through reduced living standards.

  • rate this
    -1

    Comment number 781.

    They might actually be on to something here.
    Imagine if the UK paid off its entire national debt by a one off levy on all private assets, but simultaneously revoked the ability of the government to issue gilts i.e. cut up HMG's credit card.
    Get the pain out of the way in one go rather than decades of torture we seem set for.
    No borrowing would also force the state to live within its means.

  • rate this
    +2

    Comment number 780.

    Shocked. Worst decision ever by those we still seem to trust. Surely it will be illegal - but too late. And escalate without a U-turn.

    Why do we tolerate weak politicians, financiers and economists who have no clue?

    It's not hard.

    Ditch Draconian, reward those actually doing the earning and spending however lowly. Scrap austerity, build confidence. Within a framework that stops past excesses.

  • rate this
    +1

    Comment number 779.

    @777.WolfiePeters
    "The system is not difficult for anyone who makes the effort."

    Have you seen the underlying equations of some of the more complex derivatives? Seriously - wow. Somebody sat down and made them up (I mean derived them from first principles, but quite possibly literally made them up). Compare them with quantum chromodynamics - in comparison physicists have a simple job.

    It's BS.

  • rate this
    +2

    Comment number 778.

    So "Regulators and politicians are convinced that a vast amount of cash in Cypriot banks belongs to Russian money launderers."

    And the best way to deal with this corruption is to steal money from honest working class people and create a run on the banks.

    Expect "Black Monday" and a major enquiry! "bankers"

  • rate this
    +3

    Comment number 777.

    The whole of banking & finance is filled up with jargon so that people who probably cannot add or subtract can make their dirty activities opaque to most of the public (& politicos) & pay themselves M$ in the process.

    The system is not difficult for anyone who makes the effort. But, even we do and learn how we are slaves to it, do we have the courage to change it?

  • rate this
    +1

    Comment number 776.

    What a stupid method to attack the money laundering assets of alleged Russian criminals, scew everyone, the familiy savers, the small business, the genuine retired residents etc.

    Why dosn't Frau Merkel send in the German security agencies and send the bill to the EC?

  • rate this
    +1

    Comment number 775.

    @763.purple
    "There is little understood about the realities of Central Banking, a pity."

    Now why is that? It's not as if it's a case of trying to fully understand astrodynamics (see VY Canis Majoris, R136a1). It's a human invention and really ought to be very well understood, even from a subjective viewpoint. Central Banking is a complex psychological condition? It seems schizophrenic.

  • Comment number 774.

    All this user's posts have been removed.Why?

 

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