The pressure on Cypriot leaders finally worked. Cyprus’ parliament had thrown out the plan to levy the bank deposits of ordinary Cypriot citizens – a plan drummed up by Cyprus right-wing president Nicos Anastasiades and the EU leaders. The Cypriot leaders then appealed to its Russian ‘benefactors’ (the main foreign bank deposit holders) to give them a new loan to bail them out. But Anastasiades’ Russian pals refused to help – they did not want to make a new loan as it would eventually have to be written off. Good money after bad.
So Cyprus has been forced to return to the idea of a hit to deposits to find enough money to trigger the EU-IMF bailout funds of €10bn. The final deal is a ‘restructuring’ of the second biggest bank, Laiki, with deposits over €100,000 (so-called uninsured) being frozen for use in restructuring and the largest Bank of Cyprus may also be hit with a levy on uninsured deposits and will take on the debt that Laiki has with the ECB. All other bank deposits will be untouched. This measure means big losses for Russian depositors and the end of banking as we know it in Cyprus. Apparently, the plan to restructure Laiki angered Anastasiades so much that he threatened to resign rather than see his beloved ‘casino banking’ centre wiped out- yet another example of his great leadership of the Cypriot people.
Along with a package of further austerity measures and significant sales of public assets, this will raise enough funding to meet the demand of the Troika for about €6-7bn to add to the €10bn Troika bailout. Cyprus faced a Monday deadline to clinch a bailout deal with the EU or the European Central Bank says it would cut off emergency cash to the island’s banks, spelling certain collapse.
The aim of making Cyprus pay part of the bailout is two-fold. First, the German and other Euro leaders did not want to bail out in full all those Russian oligarchs and ‘mafia’ who used Cypriot banks as tax havens and money launderers. It would look bad in German parliament just months before a general election to have to explain why Russian crooks should get German money because Cyprus banks acted like money prostitutes for Russians and then went on a speculative spending spree across Europe. Second, the IMF was concerned that if the bailout came completely from EU-IMF loans it would take Cyprus public sector debt to above 150% of GDP and there would little prospect of getting that debt down over the foreseeable future (as the graph below shows). So Cyprus’ public sector could end up defaulting or being bailed out again. So a ‘bail-in’ of bank assets was necessary.
The levy on deposits is unprecedented in the Eurozone, as is the proposal to introduce capital controls so that Cypriots, Russians and other foreigners cannot take all their money out of Cyprus when the banks open on Tuesday. For the first time in the Eurozone, a member state is taking people’s savings and blocking the movement of euros within the Single Currency area in order to pay its bills. This is breaching EU Treaty rules. It is a big sign that the Eurozone area is in deep crisis. The impact on deposits in banks in other EMU states like Greece, Spain or Portugal could be damaging. Depositors will look to get outside the risk of capital controls being applied again within the Eurozone.
Small depositors have been spared a ‘haircut’ in their savings, but remember there are still ordinary citizens with over €100,000, as for many this constitutes their life savings in their old age. It is not all Russian oligarchs or tax-hiding wealthy foreigners – many of these had already got their money out or move it to Swiss bank accounts. And then there is the hit to bank workers. It is not their fault that their boards and the politicians built up a ludicrous financial albatross round the necks of Cyprus and then tried to defend this huge ‘rentier’ financial centre at the expense of depositors and bank staff. Cyprus has a skilled workforce; with possibilities to to develop manufacturing and services industries; and it has gas reserves soon to come on line. It did not need such a distorted economy. Bank workers and public sector workers (photo below) are now to lose their jobs and pensions as Laiki is ‘restructured’ and the whole banking system is shrunk by half over the next few years.
As Paul Krugman put it in his blog: “The Cyprus mess shows just how unreformed the world banking system remains, almost five years after the global financial crisis began.A few Cypriot banks bet big on Greek bonds, very big, and their losses are about one-third of Cypriot G.D.P. Why would anyone want bank executives and traders to be in a position to do this much damage to a country? But step back for a minute and consider the incredible fact that tax havens like Cyprus, the Cayman Islands, and many more are still operating pretty much the same way that they did before the global financial crisis. Everyone has seen the damage that runaway bankers can inflict, yet much of the world’s financial business is still routed through jurisdictions that let bankers sidestep even the mild regulations we’ve put in place. Everyone is crying about budget deficits, yet corporations and the wealthy are still freely using tax havens to avoid paying taxes like the little people.”
Cypriot politicians and bankers were so swept up in the short term benefits of the Mediterranean island’s adoption of the euro that they ignored warnings over the resulting lending boom. Banks’ loan books expanded almost 32 percent in 2008 as its newly gained euro zone status made Cyprus a more attractive destination for banking and business generally, but Cypriot banks maintained the unusual position of funding almost all their lending from deposits. That supposedly protected them from the credit crunch and global financial collapse in 2008-9, where banks that relied on inter-bank borrowing like Northern Rock, Dexia etc, went down. But then the Cypriot banks stimulated a property bubble in the island and funded it by ‘hot money’ from abroad, namely Russia. And the bank boards, like those in Iceland and Ireland, got hubris. They could do no wrong and the politicians were happy to agree for a slice of the action.
The rapid expansion of bank assets left Cyprus with a banking system eight times the size of its national output, as its accommodative regime of not taxing foreigners’ dividends and capital gains lured investors from countries like Russia. A depositor would have earned 31,000 euros on a 100,000 euros deposit held for the last five years in Cyprus, compared to the 15,000 to 18,000 euros the same deposit would have made in Italy and Spain, and the 8,000 euros interest it would have earned in Germany, according to figures from UniCredit.
Bulging deposit books not only fuelled lending expansion at home, it also drove Cypriot banks overseas. Greece, where many Cypriots claim heritage, was the destination of choice for the island’s two biggest lenders, Cyprus Popular (Laiki) Bank and Bank of Cyprus. About 30 percent (11 billion euros) of Bank of Cyprus’ total loan book was wrapped up in Greece by December 2010, as was 43 percent (or 19 billion euros) of Popular. More striking was the bank’s exposure to Greek debt. The Bank of Cyprus’s 2.4 billion euros of Greek debt was enough to wipe out 75 percent of the bank’s total capital, while Laiki’s 3.4 billion euros exposure outstripped its 3.2 billion euros of total capital. Bank staff, who mostly got small bonuses and annual pay rises of around three or four percent, were unhappy about the mounting exposure to Greece but powerless to stop it. The banks could survive a maximum 25 percent loss on their Greek bonds. The “haircut” on Greek debt imposed on private creditors ultimately agreed by the EU leaders, including Cyprus’ then president Demetris Christofias, was more than 70 percent, heaping losses of 4.5 billion euros on the banks. The ricochet of the crisis across the Eurozone finally brought Cypriot banks to their knees.
So is this deal the only way out? No, no, no. Cyprus could pay for the recapitalisation of its bust banks itself without having to take a Troika bailout. There are at least €30bn in deposits held by tax-dodging foreign-based individuals and companies. A bank bailout would cost €10bn maximum but if the four largest banks were restructured into one state-owned bank with any worthless assets siphoned off and sold, that would reduce the ultimate cost. Bank staff could be guaranteed a job in the state-owned banking system or retraining on full pay for a new job. Also there is €2.5bn in bank bond debt held by foreign banks (including Greek) that could be written off.
A 50% levy on foreign-based deposits plus the writing off of bank debt and the restructuring of the banks would raise €20bn, more than enough to sort out the banks and provide support for bank workers and others that may have a case of need. Then a properly run banking system can be established owned by the Cypriot people, garnering deposits from citizens and lending it back to residents and small businesses on the island. Instead, this deal protects senior bank bond holders (other banks), threatens thousands of bank jobs, imposes severe fiscal austerity and a permanent depression in the Cypriot economy for the rest of this decade, at least.
The leader of the Church of Cyprus, the island’s largest property owner, said after the Sunday mass in Nicosia that on Thursday he is going to host a dinner with the chiefs of Russian companies that are active in Cyprus to convince them against taking their money away from the island so that the situation does not deteriorate further. He blamed the previous Communist-led government for the mess and said that “Cypriot people must learn to live on tighter budgets”. The church leader is worried that his Russian friends will flee. Maybe if church property was sold off, it could help bank staff keep their jobs and pensions.
And my alternative would enrage not only the Russian oligarchs and their government, it would also be against the interests of the financial and church elite in Cyprus who are in league with rich Russians and other Eurozone banks. And it would mean losses for the ECB which has lent credit (€9bn to Laiki). Banks holding Cypriot bank debt would go to international courts to get their money back. And a Cypriot government that did not impose austerity and privatisations would be breaking the fiscal compact targets of the Eurozone. But breaking Euro law is already being envisaged with the measure of capital controls in this ‘emergency’.
This is an emergency too for the Cypriot people. A fearless Cypriot government could ‘bank’ on its people (and those in other Eurozone countries like Greece) to support them in arguing its case with the Euro leaders. The Euro leaders could provide solidarity support with funding, but they won’t. The terms of EU-IMF funding deal means selling Cypriot jobs, savings and resources to pay for it.