Damage limitation in Cyprus

Protesters in Cyprus

Nearly everyone involved in the deal for Cyprus hammered out on Saturday now agrees it was a mistake. What we don't know, yet, is how big.

Goodness knows, the European authorities have made mistakes before in their handling of the eurozone crisis.

Some, like the initial reluctance to bail out Greece in 2010, seemed very damaging at the time but were ultimately fixable.

Others, like the Franco-German announcement, in the autumn of 2010, that private sector creditors would face haircuts in all future rescue programmes, were a slow burn.

There was initially a muted reaction to this from the markets. But once investors had fully digested the consequences, the fears of bondholders effectively forced the Irish into a bailout.

The G20 summit in Seoul at the end of that year was devoted to picking up the pieces. And the German effort to "bail in" the private sector was set back years.

Needless to say, the authorities will be hoping that the Cyprus mistake is in the first category, not the last.

They are hoping that in a week's time people outside Cyprus, at least, will consider this just another messy bump in the road, in a tiny eurozone country, to which global investors have never previously given a second's thought.

Trust in banks

How likely is that? Well, depositor confidence is a precious and deeply unpredictable thing. But so far in the eurozone crisis, it has proved remarkably robust in countries such as Spain and Greece.

We have seen deposits flee these countries - but not the flood that many have darkly predicted.

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Depositors and investors noticed very quickly that this deal broke all the rules”

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You could say that the lesson of the past few years is that even angry voters really, really want to trust their banks. Just like we all really want to trust our doctors.

But, as Alistair Darling pointed out on the BBC's Today programme this morning, once you do finally lose that trust, it can be very difficult indeed to get it back.

He found that out the hard way. The herd mentality takes over - indeed, joining the herd becomes the rational thing to do.

As I say, we don't know yet whether the damage done in the past few days will turn out to be fixable. But we can say everyone seriously miscalculated.

The ECB wasn't happy with the deal from the start. Even the Germans weren't exactly happy about it - they would rather have not been bailing out Cypriot banks at all.

But they and the IMF all hoped that Cyprus would be considered a special enough case that people would not look too closely at the precedents that were being set.

Blame on Brussels

In fact, as Robert Peston pointed out yesterday, depositors and investors noticed very quickly that this deal broke all the rules. Of course they did.

The negotiators on the Cyprus side also got it wrong. Awful though the levy was, the Cypriot president thought he would be able to blame all of it on Brussels and Frankfurt. Unfortunately for him, Brussels and Frankfurt felt differently.

Officials had been surprised, in the negotiations in Brussels, that the Cyprus side were willing to impose such a high levy on the poorest savers, in order to limit the "sticker shock" for Russian high rollers with holdings of more than 100,000 euros.

On Sunday, they were quick to share that surprise with well-placed journalists, just as the Cyprus government was trying to dump everything on Berlin.

It is still quite possible that this will turn out to be containable, that the only lasting damage to depositor confidence will be in Cyprus itself. For that to happen, it would help if the European authorities could explain more clearly why this will not set a precedent for the future.

It would be especially reassuring if the Germans explained, convincingly, why this does not reflect any toughening in the country's approach to bailouts.

But for either of those explanations to be convincing, they probably need to be true. I think Germany, at least, will want to tough it out.

Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 351.

    Yet again the Euro zone has proved to be a disaster....Cyprus is a minor implosion compared to a major economy (Spain/Italy) falling over. Its interesting that there has been little commentary with regard to the motivation behind the no votes and abstentions of the Cyprus Parliament.Its not National pride. Those of us that know the truth....are equally unable to comment openly!

  • rate this

    Comment number 350.

    Everyone seems to blame the Germans for the Euro crisis and the bailout conditions, but all they are doing is offering to lend money to the EU states that have run out of money through their own mismanagement.

    Anyone lending money is bound to set conditions. If the states concerned don't like the conditions, they don't have to accept the offer, but they shouldn't blame those offering to help.

  • rate this

    Comment number 349.

    banking is a bussiness and many bussinesses go out of bussines. so if a bank miss manage there money bye bye. go out of bussiness they are not to big to fail they are a bussiness . thats why we have free enterprise u can start a bussiness and uyou can go out of bussiness so long banks maybe next time you will be better at taking care of bussiness.

  • rate this

    Comment number 348.


    Gas. In the memorandum of understanding that was signed in November, the IMF and the EU want to be paid back in profits from the gas which should start to be processed in (estimated) 2016. Russia also wouldn't mind bailing Cyprus out if it could get hold of the gas.

    GAS GAS GAS. It's the new oil.

  • Comment number 347.

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


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