Cyprus: The E.U. ‘Rescue’ That Risks Backfiring

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With its $13 billion agreement to bail out Cyprus, the E.U. this weekend thought that it had successfully doused the latest threat to its single currency, the euro. Cyprus has run into trouble because its banks are heavily exposed to Greek debt. Instead, the nature of the bailout – which features a levy on the bank deposits of ordinary Cypriots — has sparked a bank run on the island that threatens to spill over to other European countries.

The sudden eruption of panic could still be contained; European officials on Sunday night were looking to revise the terms of the agreement ahead of a vote on the rescue package in the Cypriot parliament, in order to shield smaller depositors. E.U. officials insist that Cyprus was always a special case. But by forcing ordinary citizens to fund the bank rescues up front, through a tax on deposits, the E.U. is setting a precedent that is chilling to people in other countries, like Spain, which has looked at a bailout for its own beleaguered banking system.

(MORE: Saving the Euro Zone, One Bank at a Time)

In an impassioned address on Cyprus TV on Sunday night, President Nicos Anastasiades said, “Cyprus is in a tragic situation,” but he argued that this rescue package was the best one for the island nation. “I chose the least painful option, and I bear the political cost for this, in order to limit as much as possible the consequences for the economy and for our fellow Cypriots,” he said.

The $13 billion bailout package may seem like chump change, but in fact it represents about 50% of Cyprus’ total economy. The Cypriot central-bank governor, Panicos Demetriades, has pointed out that, as a proportion of GDP, it is one of the largest bank bailouts ever, second only to the 1997 bank bailout in Indonesia.

The government first requested a bailout in June 2012 after the two biggest banks, Laiki Bank and Bank of Cyprus, racked up huge losses on their exposure to Greek debt and themselves needed to be rescued. The sticking point for E.U. officials, and especially for the German government, has long been Cyprus’ status as a haven for Russian money, at least some of which is widely assumed to be of dubious origin. The German national intelligence agency in November reportedly found that Russians had deposited as much as $26 billion in the island’s banks, prompting government fears that E.U. bailout funds would simply disappear into a bottomless pit of corruption.

(MORE: Why the Euro Crisis Is Nowhere Near Being Over)

At the insistence of both the E.U. and the IMF, Cyprus would only receive a bailout if as much as $6 billion of the money could be recouped from bank depositors. That solution was aimed primarily at the Russians and other wealthy depositors, with more than $130,000 in their accounts. But under the terms of the agreement finalized on Friday night, all depositors will take a hit. A one-time levy of 9.9% will be charged on deposits over $130,000, and accounts with less will be charged 6.75%.

Monday happens to be a bank holiday in Cyprus, so the agreement was supposed to take effect on Tuesday, following a vote by the Cyprus parliament. Electronic bank transfers were suspended and ATM withdrawals were limited — but even so the cash machines quickly ran dry as ordinary Cypriots rushed to withdraw as much money as they could.

The parliamentary vote, slated for Sunday, was postponed, and now looks like being a critical moment for the island’s politics: President Anastasiades’ party has only 20 of the 56 seats in parliament. In his TV address on Sunday, he insisted that he was seeking to strike a revised and more favorable deal for small depositors. But opposition leaders are rejecting the deal. All in all, it’s a volatile mix that looks sure to rattle markets around the world until the situation is resolved.

MORE: Europe’s Good News: Economic Decline Is Bad, but Could Be Worse

11 comments
bojimbo26
bojimbo26

The government will pocket 90% of the money .

Bullsgt
Bullsgt

I agree with AngelaWalker. This is a test and we should voice opposition to it. If the Cyprus government needs to tax assets they should start with the banking/financial industry leaders and the watchdogs who are supposed to prevent these poor banking practices.

JohnDavidDeatherage
JohnDavidDeatherage

Talk about the law of unintended consequences... How did they expect deposit holders to react?  A run on banks is a reasonable reaction to taxing deposits.


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Victori41697771

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mikerana
mikerana

So as a foreigner, I lose faith in Cyprus, which once I thought was heaven .. and I wrote about it. Why do the manipulators eat away money of the innocent investors ? It happened to provident funds in Russia. It is happening in Cyprus .. May be Cyprus has become a tax hell instead of its being a tax haven.

efrustrated
efrustrated

Difficult to predict what the consequences of this will eventually be, but hey, I'm just a "man in the street", the EU Economics geniuses couldn't even predict what the immediate reaction would be. 

They and their rapacious banking buddies will not be regarded well when this series of charades is finally recorded as history.

AngelaWalker
AngelaWalker

A test-run to see how the population responds to the direct appropriation of their funds.