Lessons from Cyprus will consolidate pan-European financing

As the dust settles on Cypriot bailout talks, the break in the link between the sovereign and the banks marks the beginning of a brave new and more stringent world for the eurozone, writes Europe correspondent Ann Cahill

THE deal over Cyprus means the eurozone has finally succeeded in breaking the link between the sovereign and the banks.

It has arrived at a set of rules almost despite itself. But it is a pity that, in the wake of this brave new world, is the wreckage of the Cypriot economy: Savers, including businesses, with more than €100,000 in the popular Laiki bank are losing everything and those in the second, Bank of Cyprus, are losing up to a reported 40%.

In future, as in the US, when a bank is broke its investors will lose their money, whether they are senior or junior investors, and anyone with money on deposit will also forfeit it, in what is known as a bail-in rather than a bailout.

Deposits below €100,000 are safe, at least in the Cypriot case, thanks to an EU-instigated guarantee. But when pushed last week, eurozone ministers showed they would have been willing to welch on this as well.

The prolonged battle over bailing out Cyprus — a battle which has run for almost a year — also consolidates the idea that the EU’s rescue fund, the ESM, whose €700bn is made up of European taxpayers’ money, will not be used to cushion the fall of failing banks.

This was underlined by Dutch finance minister Jeroen Dijsselbloem, who now heads the Eurogroup ministers, when he said the Cypriot deal was the new template for fixing eurozone banking problems, and that other countries may have to restructure their banking sectors as well.

Many Irish people would wish this had been the case when the Irish banks hit the rocks and senior bondholders were immune, perhaps because they were mainly German, French, or British, but also because the government of the time was guaranteeing everything in sight.

Mr Dijsselbloem, who is close to Berlin, also dealt a blow to Irish hopes that the €32bn put into the Irish banks from pension and other funds could be recouped from the ESM.

“We should aim at a situation where we will never need to even consider direct recapitalisation,” he said.

This will now almost certainly happen, in line with the announcement last year from the German, Dutch, and Finnish finance ministers, who insisted the EU fund would only bail out banks it was responsible for getting into a sorry state. And that will not be for years, as the ECB only becomes responsible for supervising them next year.

The terms of the Cypriot bailout reveal more elements of this brave new EU banking world. The statement issued in the early hours of yesterday stated: “The programme will contain a decisive approach to addressing financial sector imbalances. There will be an appropriate downsizing of the financial sector, with the domestic banking sector reaching the EU average by 2018.”

So any country with large financial sectors will be subject to close scrutiny to ensure it does not threaten the national economy and this will doubtless include Ireland and its larger banking colleague, Luxembourg.

The new banking morality extends to suspicions of money-laundering. In this case, Cyprus will undergo a second audit to see how well its money-laundering legislation is working. People close to the EU institutions said this is now on the watchlist of Germany and its fellow austerity hawks. They and say they have proof that much of the estimated €20bn of Russian money was from the proceeds of crime or at least escaping taxation in Russia.

OTHER countries can expect to be put on the watchlist too, especially if they need any kind of financial aid from the ECB to buy bonds to funds from the ESM rescue fund to tide countries over a sticky patch raising money on the markets.

The issue of wealth taxes was also raised by the Cypriot bailout. When, in a not too subtle effort to get around the deposit guarantee, euro ministers agreed to tax rather than haircut small depositors, they explained that wealth taxes in Cyprus were almost non-existent.

Some countries, such as the Netherlands, do not only tax the interest paid on money lodged in banks, they also tax the capital.

“Well, it’s wealth, isn’t it?” said a Dutch national, slightly put out that other countries did not view it the same way.

The agreement to raise corporation tax from 10% — the lowest in the EU along with Bulgaria’s — to 12.5% in line with Ireland’s rate is another indication of what we can expect in the future. As the EU exercises much tighter control over national finances and how economies are faring, the issue of taxes being a sovereign matter is bound to soften as targets are set and meeting them is crucial. There will be more sticks — as in the Cypriot example — and more carrots when the eurozone institutes a joint debt programme for countries.

This new eurozone world will need new structures, including an EU finance minister that will be part of the new treaty Germany is pushing for in 2015. The issue will be who will qualify to be part of it. Having failed to ensure that the standards set for joining the currency union were honestly met, they are unlikely to make the same mistake.

Perhaps the fire of bank and sovereign restructuring, if it does not kill economies, will make them fit to join the new euro.

In the meantime, there will be other issues to deal with, such as whether the current changes will restructure EU banks to such an extent that EU business and governments will no longer rely on them for up to 75% of their funds, but switch to the US model where the stock market plays this role.


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