Monday, March 18, 2013

Bailout with bail-in for Cyprus

With the principle agreement on a bailout, Eurozone finance ministers gave the green light to make Cyprus the fifth country receiving financial aid.

The real party only started after the end of last week’s EU summit. Earlier than expected, Eurozone finance ministers agreed on the conditions for a bailout for Cyprus. The bailout programme for Cyprus will be a fully-fledged one, aimed at stabilizing the financial sector, fiscal adjustments and structural reforms to “support competitiveness as well as sustainable and balanced growth, allowing for the unwinding of macroeconomic imbalances”. As announced earlier, there will be an independent evaluation of an anti-money laundering framework. Cyprus has agreed to do a lot to restructure its economy and to increase tax revenues. Probably the most important decision is the one-off levy on bank deposits in Cyprus. This deposit will be 6.75% on deposits with up to 100 000 euro and 9.9% on deposits with more than 100 000 euro. This tax should raise 5.8bn euro. However, measures like “the increase of the withholding tax on capital income, a restructuring and recapitalisation of banks, an increase of the statutory corporate income tax rate and a bail-in of junior bondholders” indicate that the country will get almost a complete overhaul. The size of the bailout package would, in principle, be 10bn euro. Now, the Cypriot parliament will have to agree on the terms of the bailout and other national parliaments will have to give the final green light.

This new bailout package is the result of balancing two – sometimes opposing – rationales: an economic and a political one. Politically, it would have been hard to sell a bailout for Cyprus in core Eurozone countries without some kind of bail-in. Economically, however, the bail-in of bank depositors has the potential to create new turmoil and possible bank runs in other peripheral countries if people start to fear similar treatment in the future. During the weekend, political doubts rose in Cyprus and the parliamentarian vote on the bailout was postponed to today. First smaller changes or fine-tunings to the depositor levy have already been announced. To avoid a bank run, depositors who keep their bank accounts for two years will receive securities linked to future revenues from the country’s gas reserves. Moreover, other options currently under discussions are the exemption of smaller deposits from the levy and other sweetener to encourage depositors keeping their money at the banks.

The consequences of last Friday’s decisions are still hard to predict. Today, there will be a bank holiday but tomorrow could start with long queues in front of Cypriot banks. Will depositors in other peripheral countries believe that Cyprus is a special case or will they also run to their banks? Everything seems possible. Fact is that the financial rescue of an island with less than 800 000 inhabitants marks a next step in the euro crisis: after the haircuts on Greek sovereign bonds, there now is the depositor bail-in. A clear message that rescue actions exclusively funded by tax payers money are a thing of the past.

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