Word has just come in from Europe that there will in fact be a deal between the EU and Cyprus about keeping the banks in Cyprus alive. The basics of the deal are now that one of the two major banks (Laiki) will go bankrupt with losses to junior and senior bond holders.
It is the wrangling about the bigger bank, the Bank of Cyprus, that is the really interesting one. As I commented on just last week, the politics of Cyprus were such that its parliament could not openly approve a haircut on major deposit holders, partially because it would mean they would openly and personally be taking action against the interest of people more wealthy and dangerous than themselves (ie Russian tax evaders).
Yet, as soon as there were any rumours of a bank levy, a major capital flight out of Cyprus was a certainty the moment that banks would resume normal proceedings. Hence, despite the fact that the Cypriot parliament could not, for political reasons, go against the interest of the wealthy and the dangerous, by the same toke allowing business-as-usual was no longer an option either: a bank-run would have been immediate the minute the banks opened its doors.
So how did they solve this catch-22? Quite ingeniously, really. The Cypriot parliament basically allowed itself to no longer decide on bank deposits by voting in a new law on bank restructuring last Friday! Hence, instead of openly and democratically deciding on a tax, parliament voluntarily gave up that power so that a ‘bank restructuring’ could occur that would allow exactly the same thing to happen but without their open approval and without their further involvement. Truly ingenious. And forgive me for suspecting it was exactly due to the reason I talked about last Friday, which was fear of the wrath of particular deposit holders.
What will thus happen? Well, one bank will go bankrupt and the other bank is going to inherit the small deposits (under 100,000 euro) from it, together with the loans Laiki had to the EU. Within that remaining bank, the large deposit holders will easily be taxed some 30% of their total deposits in order to ensure that the bank meets ECB standards. Importantly, the bank restructuring is entirely left to Cypriot officials. One can imagine that even the ECB did not really want to have to decide on which deposit holder was going to lose out how much!
The long-run ramifications of this saga look like being enormous. Within Cyprus, the ability to do political deals and quickly make a lot of money has just been transferred from parliament to whomever is going to actually decide on the financial restructuring of their remaining bank. You should expect frantic lobbying on that point as there will be all kinds of details yet to be decided upon that will create huge losses and gains, meaning that there will be lots of money available to ‘ensure particular wins’. For instance, if the tax would be only on deposits above 100,000 then of course there is a huge discontinuity around 100,000 in terms of taxes paid. Small innocuous looking decisions can then make all the difference, such as whether or not a ‘large deposit’ is calculated on the basis of several types of bank accounts that fall under the same name, or whether interest due of the last year should be added before a decision is made on whether someone is large, or whether to count minor withdrawals that banks are going to have to allow in the near future to ensure the continuity of the economy.
Similarly, if it is decided that levies will apply only till the ‘resulting deposit’ hits a 100,000 euro (and hence the discontinuity does not apply), then of course the unit of accounting will be crucial: will it be on the basis of individual accounts or will several accounts of the same company be combined? Will deposits with multiple holders (such as a married couple) be considered as a single deposit or a combined one? Is the levy going to be higher for even bigger accounts? Etc. Etc. On small decisions made in back offices, large sums of money will depend, opening the doors to lots of shady dealings. Now is the time to be a financial expert in Cyprus with good connections!
The ramifications for the banking system in Europe will also be large. Cyprus is essentially a kind of ‘minor Greece’ in terms of banking so bank-runs throughout southern Europe are now looking a whole lot likelier. This is of course great for Northern Europe, where I am from, because it means capital flight to them will continue. Yet, it is not good for Southern Europe, meaning that euro-exit is looking a whole lot likelier. Indeed, make-or-break decisions will probably be sped up in the rest of Southern Europe as they will have to choose more clearly between muddling on as usual or quickly enacting large financial restructuring packages.
Another ramification is that the principle of raiding the deposits of overseas tax-evaders has now been established. If ever there was a group of very mobile and forward-looking people, it is tax evaders, so their behaviour will change incredibly quickly. I can imagine Russian tax-evaders as well as the tax evaders from other countries pulling money out of any banks in Europe where they deem a similar risk to exist. Indeed, they have probably already done so the last week. Any remaining such money in banks in Greece and Spain will probably be in the firing line. Golden days hence for tax advisers.
It is clear that the whole saga was going to be disastrous for Cyprus the moment that the possibility of a raid on Russian bank deposits became a serious possibility. I am heartened to see that the ECB and the EU have finally caught on to the principle that they should leave the actual restructuring to countries in trouble and that bailing out banks is a bad idea. Still, a lot of detail on the deal is yet to emerge and the only way in which the Cypriots would have agreed to the final deal is if there is, yet again, another European loan for them on offer. It will make the politicians in Cyprus even more inclined to blame overseas agencies for any of their domestic troubles and increases long-run dependency. In that sense, the basic mistake of the ECB and the EU to get involved in huge loans in the absence of a fiscal union continues.