Monday, March 25, 2013

Another Sunday night save

Early this morning, Eurozone finance ministers agreed on a revised bailout plan for Cyprus. The Eurogroup re-offered a €10bn package. Small savers will be saved and the burden of the bailout out will now be carried by a smaller number of bigger depositors and shareholders and senior bondholders of the two largest Cypriot banks.

After another extremely long meeting, preceded by other high-level meetings and endless rumors, Eurozone finance ministers agreed on the fifth bailout since the start of the crisis. After Greece, Ireland, Portugal and Spain, Cyprus will be the next official member of the bailout group. 

One week after the first bailout attempt, Eurozone finance ministers and Cyprus agreed on a new bailout. The size of the bailout remains at €10bn euro. The earlier Cypriot contribution of €5.8bn euro was replaced by a complex upfront restructuring of the Cypriot financial sector. The second attempt leaves deposits of less than 100 000 euro unharmed. Instead, the burden of the bailout will now be carried by a smaller number of bigger depositors and senior bondholders of the two biggest banks of the country. In detail, the Eurogroup and Cyprus agreed on the following:

·       The second-biggest bank of Cyprus, Laiki Bank, will be unwound, with full contribution of equity shareholders and bond holders. Viable assets and insured deposits will be put into a “good bank”; €4.2 billion worth of uninsured deposits would be placed into a “bad bank”, with no certainty that big depositors will get any money back.
·       The remainders of Laiki Bank, the good bank, will be merged with the largest bank of the country, the Bank of Cyprus (BoC). BoC will be recapitalised through a deposit/equity conversion of uninsured deposits with full contribution of equity shareholders and bond holders. How much uninsured depositors will eventually lose due to the restructuring remains unclear. According to wire reports, it could be around 30%.
·       All insured depositors in all banks will be fully protected in accordance with the relevant EU legislation.

A happy ending after all? At least a final agreement has come closer and a disorderly default of Cyprus has, at least for now, been avoided. According to the Eurogroup statement, the ECB would continue allowing ELA for Bank of Cyprus. However, a couple of short-term hurdles still remain: i) Will the Cypriot parliament agree on the deal? Probably it will as big parts of the bank restructurings had already been brought forward at the end of last week. ii) Will national parliaments of other Eurozone countries agree? Currently, the Eurogroup expects a formal green light for the bailout only in the third week of April. Still a long way to go. iii) As for the first time during the crisis, temporary restrictions on the movement of capital have been imposed, the question is when Cypriot banks be able to re-open and what will happen then. As more often during the crisis, a Sunday night save brings instant relief but is no guarantee for calmer waters.

More broadly speaking, the crisis in Cyprus, while (at least temporarily) neutralized after this weekend’s decisions clearly shows that the Eurozone still has not found a uniform model to guarantee financial stability in the future. The idea of a banking union to break the link between indebted sovereigns and weak banking systems is not accepted by the stronger countries when it involves burden sharing (which it sooner or later inevitably will have to do). At least not if the banking sector is suspected to be a money laundering place and/or the result of too much risk. The message is clear: the German-led bloc in the Eurozone pushes ahead with conditional solidarity and conditional integration but not with financial charity. As such, failing banks remain the problem of their home country, even if that cripples government finances for many years. Secondly, deposit guarantee schemes cannot be taken for granted. German finance minister Schäuble pointed out that these schemes are only reliable if a country’s public finances can afford them, again emphasizing the direct link between the sovereign’s and the banks’ solvency. On top of that, the challenge for the coming weeks will be how to get the genie - that a cash strapped sovereign may consider a levy on all deposits - back into the bottle. The exemption of small savers could help. However, as so often, it is much harder to restore confidence than destroying it. A recent survey in Spain indeed revealed that nearly 90% of Spaniards are worried that they might face a Cyprus like levy on deposits, while 62% claimed deposits were not safe in Spain. Finally, the decision to impose capital controls, even though loopholes in the Treaty would allow it, shows that the single financial market is far from being assured. The fragmentation of financial markets might be reinforced by the decisions of the last few days, further complicating the ECB’s job. More unconventional measures might be required to cure this.

The Cyprus bailout has been an unprecedented power struggle in the euro crisis. While Cyprus tried to call the Eurozone’s bluff, the Eurozone, led by Germany, wanted to make an example that the rescuers do not like to be blackmailed. Particularly the German government played hardball, based on the assumption that the consequences of a Cypriot “no” would be much graver for Cyprus than for the rest of the Eurozone. Germany won the bet as Cyprus eventually bended. However, this strategy is not risk-free and will hardly work with bigger countries with a broader economic business model than Cyprus. 

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