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The Cyprus bail-out

2013-03-28 12:14:57

This septic isle

Being tough on bank creditors could prove costly for northern European

taxpayers

Mar 30th 2013 |From the print edition

THE second deal to bail out Cyprus was much better than the first. For one

thing, there was actually a deal: with the 10 billion ($13 billion) loan the

prospect of the euro zone s first exit has receded. An agreement among

euro-zone finance ministers to wind up Laiki Bank, Cyprus s second-biggest

bank, and restructure Bank of Cyprus, the largest lender on the island, undid

the worst elements of the initial botched agreement. Savers with accounts below

the 100,000 deposit-guarantee threshold will be spared. Losses will hit

creditors of weak banks in line with the normal hierarchy: shareholders and

junior bondholders first, followed by senior bondholders and uninsured

depositors (see article).

About time, many especially the German voters who, it seems, figured large in

the minds of the plan s architects will say. For far too long during this

crisis banks on Europe s periphery have got into trouble and been bailed out by

northern European taxpayers. Jeroen Dijsselbloem, the Dutchman who heads the

Eurogroup of finance ministers, made it clear on March 25th that the Cypriot

deal represented a template: if banks fail, creditors can expect to pay the

whole bill. The principle of moral hazard has supposedly been re-established.

The Nicosia neinfield

But at what cost? The fact that, within hours, Mr Dijsselbloem was back to

calling Cyprus a one-off is a clue. His earlier comments had prompted a slide

in the markets, as investors deduced that the deal had weakened the euro zone

as a whole in three ways that German voters may come to rue.

First, Cyprus itself looks crushed (see article). The collapse of its

oversized, Russian-flavoured banking sector will cause a catastrophic economic

slide one which may need more cash.

Second, the deal allows Cyprus to use capital controls to stop deposits fleeing

the banks when they reopen (on March 28th, with luck). The single currency is

now not so single: a euro in a Cypriot account is not worth the same as a euro

in Greece or Belgium. The euro zone says these controls are temporary, but

Iceland s are still in place over four years after they were imposed. A

precedent for restricting the movement of euros is one that investors and

depositors will not soon forget.

Third, the decision to punish large depositors will also weaken the euro zone.

Whatever the justice of saving Russian money-launderers, the best way to

protect European taxpayers from the cost of cleaning up banks is to give all

short-term creditors reason to stay put. Hitting them will discourage them from

putting money into weak banks in peripheral economies, and make it even harder

to keep sick banks alive in crises. When a run starts it is rational for

others, even insured depositors, to join. The euro area has 8 trillion of

deposits and only 4.5 trillion of annual government revenues: governments

could not guarantee all the deposits even if they wanted to.

Greater instability, coupled with rising resentment of creditor countries in a

stagnant periphery (see Charlemagne), is a bad outcome for northern European

taxpayers. It would have been better to put up a bit more money and push on

with building a better banking system. That means extra capital: large European

banks are building up buffers but are still 112 billion short of the new Basel

3 requirements. It also means putting less flighty creditors in the line of

fire, by adopting an EU-wide resolution regime requiring banks to issue bonds

that absorb losses before big depositors do. And only a full euro-zone banking

union, including a fiscal backstop and a joint deposit-guarantee scheme, will

break the link between weak banks and weak sovereigns. Europe, sadly, is behind

in all these things.

From the print edition: Leaders