Precedent may trigger bank runs

If bank deposits can be seized in Cyprus to fund its bailout, then they can be seized in other EU countries as well, argues Felix Salmon

I STUCK my neck out in January, saying that Cyprus was “certain” to default. After all, the Europeans weren’t willing to come up with the €17bn needed to bail the country out, and EU economics commissioner Olli Rehn told the Wall Street Journal’s Stephen Fidler that Cyprus would have to restructure its debt.

But now the bailout has arrived, and there’s no default. Instead, €5.8bn of the bailout is going to come from depositors in Cyprus’s banks, in the form of what the EU is calling an “upfront one-off stability levy”.

Don’t for a minute believe that this decision is part of some deeply- considered long-term strategy which was worked out in constructive consultations between the EU, the IMF, and the new Cypriot government. Instead, it’s a last-resort, and there’s still a real chance that the Cypriot parliament could scupper the whole deal. But, for the time being, everybody’s going on the assumption that the deal will go through, that Cyprus will get its €10bn bailout, and that everybody with a Cypriot bank account will see their accounts taxed.

In January, I said this wouldn’t happen. The last thing that Cyprus, or any other country, needs is a bank run. What’s more, in many ways the precedent of forcing depositors to take a haircut would be even more damaging than the precedent of imposing a haircut on Greek bondholders: At that point, there would be no reason at all to have deposits in any Mediterranean country. It might seem a little bit like shutting the stable door after the horse has bolted, but the lines in front of broken ATMs certainly suggest that there will indeed be a substantial bank run out of Cypriot banks when they reopen tomorrow morning.

Cyprus has been relying up until now on its status as an offshore financial centre, especially for Russians. That has bloated its banks with deposits, and if the deposit bubble bursts, the government has no money at all to bail out the banks.

Cyprus’s president, Nicos Anastasiades, said he was forced to choose this path because the only alternative was the collapse of Cyprus’s two major banks, with “catastrophic” consequences. What he didn’t say is that those banks aren’t remotely safe yet — not with the prospect of a massive bank run hanging over their heads.

And of course it is not only Cyprus where a bank run is a very real fear. If bank deposits can be seized in Cyprus, they can be seized in other EU countries as well. Given that this policy was not merely rubber-stamped but engineered by eurozone finance ministers and the IMF, it sends a disquieting message to anyone with deposits in a eurozone bank.

Although the ministers were quick to insist that this is a one-off and is “exceptional”, anyone even vaguely acquainted with the initial Greek bailouts will remember precisely how long such exceptions last.

The consequences of this choice are permanent: Countries such as Ireland and Portugal might not be at risk of a deposit tax right now, but they’re still getting bailed out on a continuous basis, and the more fraught the bailout negotiations become, the more likely it is that the EU will insist on bailing in depositors.

It’s an option on the table now and, as a result, a deposit run is surely more likely to happen whenever a eurozone country finds itself in need of a bailout. Which, of course, is always the worst time for a bank run. From a technocratic perspective, this move can be seen as simply being part of a standard austerity programme: The EU wants tax hikes and spending cuts, and this is a kind of tax: “A one-off wealth tax,” as Matt Yglesias puts it.

Other taxes would raise less money or, if they didn’t, they would be more harmful to the Cypriot population, since much of this one is going to be paid by Russians. Cypriots are going to have to pay somehow, and although this is an unpleasant way of forcing them to do that, it’s also effective. But what we’re seeing here is the Cypriot government being forced to break one of its most important promises — the promise that if you put your money in the bank, and your deposits total less than €100,000, then they will be safe.

What’s more, there’s no good reason for insured deposits to be hit in this manner: The same amount of money could be raised just by taxing the uninsured deposits at a slightly higher rate. The insured depositors are being hit, it seems, just so that the uninsured depositors can be taxed at single-digit rather than at a double-digit rate.

Meanwhile, people who deserve to lose money won’t. If you lent to Cyprus’s banks by buying their debt rather than by depositing money, you will suffer no losses. And if you lent money to the Cypriot government, you will be paid off at 100c on the euro. This is more by accident than by design. As Joseph Cotterill of the Financial Times says, Europe dragged its feet on Cyprus for so long it missed the deadline for doing a bond restructuring. It takes time to put such deal together, and there isn’t enough time between now and Cyprus’s next big coupon payment to do that.

As a result, the EU found itself with a massively reduced menu of options: Either fund the bailout itself, in full — an option which the Germans were adamant would never happen — or force a haircut on Cyprus’s depositors. Given the balance of power in the eurozone, it comes as no surprise that Germany won and Cyprus lost.

The big winner here is the ECB, which has extended a lot of credit to dubiously solvent Cypriot banks and which is taking no losses at all.

This decision is important not only because of the precedent it sets with regard to bank depositors, but also because of the way in which it points up just how powerless all the Mediterranean countries have become.