Posted: 18/03/2013
Derry Pickford, Macro Analyst at Ashburton comments:
“Rescue packages have an impossible trade-off. Any form of bail-out today creates moral hazard tomorrow.
“It was this fear in mind that probably led the Troika (IMF-EUR-ECB) to demand that €5.8bn is raised from a "one-off" levy on Cypriot deposits in return from €10bn of support. The decision was likely influenced by the fact that Cyprus's banking system is large relative to the size of the economy so a government-financed bailout would have burdened the sovereign with excessive and unsustainable debt. Moreover, there was little outstanding bank debt so imposing losses on bond holders would not have raised much money. Over 30% of deposits are non-EU, and are believed to be predominantly Russian. Together with alleged lax money laundering standards, the reluctance by the Finns and Germans for a full bail-out is therefore, understandable.
“However, punish depositors too hard, particularly when you renege on earlier promises, and you make banking systems incredibly fragile. Depositors don't need to think a bank is insolvent to withdraw their money: they just have to fear that other people might. Banks provide liquidity transformation; this makes even solvent banks vulnerable to bank runs. Deposit insurance, together with a central bank acting as a lender of last resort are the two main mechanisms by which this vulnerability is reduced. Policymakers who meddle with these need to be aware of unforeseen consequences. EU governments were supposed to promise to protect all deposits below €100,000. Under the current plans deposits below this level face a 6.75% levy. Yet, there are no plans so far for senior bank debt holders or sovereign bond holders to take a haircut. So despite inflicting a large amount of pain on ordinary savers, the package will still not put Cyprus on a sustainable trajectory. Debt to GDP is likely to break 100% by 2015 and a second bail-out will be needed. Long before that crunch point is hit, savers will legitimately ask whether they will be hit again?
“Will this attack on depositors create contagion in other periphery banking systems? Our view is that this policy won't be sufficient on its own. Despite significant fears that Greece could leave the Eurozone last year and a steady flow out of the Greek banking system, Emergency Liquidity Assistance (ELA), the mechanism by which individual national central banks can lend to their banking systems against assets which would not be eligible for standard Euro-system repos, prevented a complete collapse. A 6.75% or 10% loss is painful but still a lot less than Greek depositors would have lost in a Euro exit. If depositors in other banks believe the claim that Cyprus is a "special case" they might not bother to flee. It seems likely that at least some of the pain inflicted on smaller depositors will have to be back-tracked on, and therefore the damage will be reduced.
“However, this move doesn't inspire confidence either. It is reminiscent of the misguided policies of 2010/11. It suggests lessons from the crisis have not been learnt and that German commitment to a full European Banking Union is weak. Italian Target2 deficits had already started to rise on the Italian election. When German Target2 surplus reached €750bn back in August last year there were mutterings from the Bundesbank about suspending (ELA). Such a move when confidence in deposit protection has been undermined could throw the Eurozone back into chaos.”