Ten days after a rescue package was first proposed for Cyprus, the group of lenders involving the Eu ropean Union and the International Monetary Fund (IMF) finally reached agreement with Cyprus on a bailout deal in the early hours of yesterday.
The proposal, though reportedly close to the IMF's and Germany 's original plans for the package, differs substantially from the first proposal put forward last week.
While that agreement proposed deposits should be levied to raise the €5.8 billion demanded by the lenders, the new proposal replaced that with a restructuring and shrinking of the Cypriot banking sector.
Under the new agreement, Cyprus's second-largest bank, Laiki, will be split into good and bad banks. The good bank, with individual deposits of less than €100,000, will be protected and folded into Bank of Cyprus, the country's largest bank. The bad bank, which will house senior bondholders and depositors of more than €100,000, will be run down over time.
Haircut
It is not yet clear what "haircuts" deposits of more than €100,000 will face – this will be decided in the coming weeks as the bank resolution process is worked out – but some estimates suggest depositors could face losses of up to 40 per cent. Many but not all of these are Russian.
The EU-IMF troika has in effect introduced a deposit levy though the back door. While bank deposits will still be taxed, the fact that this is taking place in the context of a wind-down of a bank means it does not need the approval of the Cypriot parliament, which passed emergency bank resolution legislation last week.
The decision to wind down the bank allows the troika to enforce the EU-wide guarantee. As euro zone authorities reiterated last week, the EU-wide guarantee applies only in the case of a bank wind-down.
For Cyprus the impact of the closure of one of the country’s biggest banks is enormous. The immediate fallout of the bank restructuring, particularly the closure of Laiki, involves the loss of thousands of jobs but the longer-term impact may be on Cyprus’s financial sector.
Given the centrality of finance to Cyprus’s economy, the restructuring could spell disaster for the economy. Some analysts have suggested gross domestic product could fall by 20 per cent over the next few years as a result of the banking plan. Those fears were echoed by residents of the island as they reacted in shock to the terms of the bailout.
Impact of restructuring
Yesterday, Europe an Commission president José Manuel Barroso said Cyprus could "count on the European Union to support it", and spoke of the country's need to stimulate economic growth in other ways. While he declined to comment on the potential impact the bailout would have on GDP, officials conceded privately it is a real concern.
“We are under no illusion that restructuring the banking sector is going to have a significant impact on GDP,“ said one EU official. “That is why we explored other options first.”
Cypriots may feel let down by Europe, which has enforced a radical contraction of their financial industry.
Officials in Brussels yesterday suggested intransigence by the former Cypriot government in implementing much-needed changes such as privatisation plans, as well as legitimate concerns about money laundering, meant the deal was delayed by nine months. At eight times’ GDP, Cyprus’s teetering banking system was, they argue, too big to be supported by the state, though, ironically, it was a forced write-down in Greek sovereign debt that contributed to Cypriot banks’ problems.
Market uncertainty
While Europe has managed to prevent a euro zone exit, comments from Dutch finance minister Jeroen Dijsselbloem yesterday that the unprecedented terms of the Cypriot bailout could be replicated in other euro zone countries has sparked uncertainty in markets.
The prospect that a bail-in of deposits of more than €100,000 in other troubled regions could reignite depositor and investor fear, particularly in Spain and Italy. Having taken a hard line with Cyprus, European authorities will now be hoping it was worth it as they try to limit the fallout on the rest of the euro zone.
