The troika of international lenders (the European Union, European Central Bank and International Monetary Fund ) has blundered in its handling of the proposed €17 billion bailout programme for Cyprus. The trade off in the rescue plan envisages a €5.8 billion levy on Cypriot bank deposits and other money raising measures, in return for €10 billion in loan support. The proposed bank levy, a 6.75 per cent tax on deposits under €100,000 and 9.9 per cent on sums over that amount, shocked not just Cypriot account holders, but in particular small savers who had assumed their deposits were protected. The bailout agreement, rejected yesterday by the Cypriot parliament, has undermined the trust and confidence of Cypriots in their government, which agreed the terms of a deal that they have since sought to change.
This debacle has also weakened the credibility of euro zone leaders, who have in effect now rewritten the rules on the security of bank deposits throughout the euro area. Up to now, savers in the euro zone were reassured by the promise made by all governments that bank deposits up to €100,000 were fully protected. Cyprus has altered that perception and set a worrying precedent. A long-standing taboo on seizing the savings of small depositors has been broken by the move to impose losses on them.
Why the Cypriot government and the troika agreed to accept these terms as the basis for the financial rescue are, as yet, unclear. Cyprus has a huge and unsustainable level of public debt, which it hopes could be reduced to 100 per cent of GDP by 2020, if the bailout programme is implemented. The agreement to impose losses on all depositors remains the most controversial aspect of that programme. For the Cypriot government, its desire to develop an offshore financial centre and its dependence on Russian money – which accounts for one-third of all deposits in Cypriot banks – to do so, helps to explain why all deposit holders, and not just those with large deposits, were hit by the bank levy. However, that does not explain the troika’s agreement to such a proposal, given its obvious implications for other euro zone countries. Euro zone leaders have sought to suggest that Cyprus is a unique case, and that the bank levy sets no policy precedent for other countries.
Depositors in other peripheral states (Italy, Spain, Portugal and indeed Ireland) may not feel quite so reassured, given the ease with which the guarantee to small depositors was abandoned. That makes it harder to attract deposits and retain them, at a time when, as in Ireland’s case, confidence in the banking system has begun to be restored. But it will also make countries in difficulty think twice about entering a euro zone bailout programme, where the price of future protection may involve a bank levy on savers.