Europe botches another rescue - Cyprus suffers pain of haircuts without gain of restructuring
March 17, 2013
Just as the eurozone had begun to set the right course in its struggle with an ever-mutating debt crisis, it relapsed into its old vice. Faced with a drowning member state, instead of throwing Cyprus a lifebuoy, leaders put a millstone around its neck.
Appearances notwithstanding, the Cyprus deal does not “bail-in” creditors in an orderly resolution of bankrupt banks. Instead it imposes a tax on all depositors down to the smallest ones. However legal it may be, this rank violation of the spirit of deposit insurance – small savers in the EU are guaranteed that deposits up to €100,000 are safe regardless how moribund their bank – unforgivably betrays those with the most to lose and the least to answer for.
It is also contrary to a future European banking system in which taxpayers are shielded from the losses of banks; investors pay for the risks they take in a predictable order of priority; and savers can trust that deposits up to the insurance limit are protected.
The hope of righting the eurozone’s listing ship relies on divorcing the debt problems of a sovereign from those of the country’s banks. Last June, the eurozone’s leaders finally acknowledged the nature of the problem. Cyprus seemed a possible salutary test for the more enlightened approach.
With unsustainable public finances and a banking sector about seven times the island’s annual economic output, the stark choice was between sovereign restructuring and forcing losses on bank creditors. Choosing the latter course was correct. But instead of restructuring broken banks at the unfortunately necessary price of creditor losses, this package pays the price without the benefit.
It will not take the banks into immediate restructuring. It will apparently not bail in unsecured senior bondholders. While Cypriot banks have very little bonded debt outstanding – a mere €1.7bn, as against some €70bn of deposits – this is still significant compared to the €5.8bn the deposit tax will raise. It also circumvents the legal status of claims on bankrupt debtors in a way that hurts ordinary depositors to benefit sophisticated investors. This is destabilising as well as morally unconscionable.
The structure of Cypriot banks’ balance sheet meant some deposits had to be hit. But President Nicos Anastasiades’ claim that there is no alternative to the current plan is an insult to the small Cypriot saver or business owner. Insured deposits could be protected in full by imposing larger haircuts – Mr Anastasiades himself suggested 60 per cent – on accounts above the €100,000 threshold. Cyprus has had two years in which to prepare legislation that could have ringfenced small deposits (or even all EU residents’ deposits) with a matching amount of assets in an emergency. Even now, a variant of Britain’s special resolution law could be adopted. This is a conscious choice to make poorer people pay to help richer ones.
The suspicion must be that Cypriot leaders are determined to salvage the pieces of their offshore banking model, even against eurozone pressure to shrink the sector. Like other European island states before them, the people of Cyprus are discovering who pays to keep a metastasised banking sector alive.
The risks for Europe are as significant. However haltingly, the eurozone has been moving towards banking union. The European Commission has also made plans for cross-border deposit insurance and resolution schemes including bail-in rules. The Cyprus “rescue” throws all this into doubt. If a deposit tax is the preferred solution, bank resilience is once again a function of sovereign strength.
The biggest risk is political. The prescription of universal austerity combined with kid-gloves treatment of big investors in banks is increasingly toxic to European voters. Leaders have just added fuel to the fire.
Copyright The Financial Times Limited 2013