A taxi driver in Cyprus describes it as “a lightening bolt out of nowhere.” This weekend, the Mediterranean island nation announced that individual bank account deposits are in the crosshairs of an EU bailout plan. According to a deal negotiated with EU members, Cyprus must raise $7.5 billion in exchange for $13 billion in German bailout funds. And as of yesterday, Cyprus’ leaders agreed to do so by tapping individual bank accounts.
Wolfgang Munchau of the Financial Times writes the proposed bank account grab isn’t technically a haircut but a “wealth tax” of 6.75% on (insured) deposits up to €100,000 and 9.9% above that threshold (i.e. uninsured deposits.) Practically speaking, it is the confiscation of property. Shaving money off of savings accounts is not only a “depositer haircut” but a trigger for a bank run.
Cyprus got to this point by allowing its banking system to bloat into a “too-big-to-fail entity” in a nation that is too-broke-to-bail-it-out. The country’s biggest banks are running out of money as the nation’s debt load climbs to 100% of GDP.
Matthew O’Brien at The Atlantic sums up the problem with the banking sector in Cyprus:
Cyprus’s banking sector has been kept afloat with infusions of “emergency liquidity assistance (ELA)” from Cyprus’ central bank. ELA is a creation of the European Central Bank (ECB) meant to assist entities that are “short on cash, collateral and confidence,” when they don’t qualify for an ECB loan. For a high rate of interest a commercial bank can get a loan from its central bank under some pretty strict terms.
That leads to the cash flow problem. Cypriot banks are funded by two main sources: bank deposits and ELA funding. The government needs to find €7 billion in order to get the German bailout package to keep the economy and government operating. But as of this afternoon, Cyprus’ Parliament struck down the first EU approved proposal: the depositor tax plan.
Matt Persson at Open Europe sees four possible scenarios.
1) Cyprus tweaks the depositor tax and levies it anyway.
2) The ECB extends Cyprus some flexibility, wanting to head off a Cyprus eurzone exit.
3) Cyprus comes up with another plan involving funds from Russia.
4) Cyprus’ banks run out of money. Then Cyprus’ government runs out of money and can’t guarantee deposits. They exit the eurozone, print their own money, leading to hyperinflation and economic collapse.
Perrson thinks the worst case scenario will be avoided. A combination of interventions — a smaller tax on deposits, more flexible terms from the ECB, and maybe some Russian funds — will pull Cyprus back from the cliff.
Image courtesy Harm Bengen.
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