Cyprus’s rescue sets precedents for the euro zone that may stick in the memory of depositors and bondholders alike as investors debate who will next fall victim to the debt crisis.
Economists and academics from Nicosia to New York said the message that stakeholders of all stripes could be coerced into helping a cash-strapped nation might make investors more skittish about being targeted by the next country to need help. The risk was that bank runs and bond market sell-offs became more likely the moment a country applied for a new rescue, they said.
“We now have a new type of rule, and everyone within the euro zone has to sit down and see what that implies for their own finances,” said Nobel economics laureate Christopher Pissarides, who is an adviser to the Cypriot government.
Euro region officials had, until now, left bank depositors and senior bondholders untouched. The Irish banking system collapsed partly because its government refused to renege on a guarantee to deposit holders made after Lehman Brothers collapsed.
In Spain, senior bank bondholders have been safeguarded, unlike investors in the subordinated debt and preferred shares of Bankia Group. And in Greece, a restructuring of government debt was set up in a way that avoided default.
With Cyprus, that tradition has been broken. The original pact, announced on March 16, shocked Cypriots by imposing a levy on all deposit holders, before opposition led to it being watered down.
It is also the first time that senior bondholders in a euro zone bank have taken losses. At Cyprus Popular Bank, those bondholders will be wiped out.
Europe’s crisis fighters are spreading the net wider as taxpayers across northern Europe balk at the cost of rescuing their cash-strapped southern neighbours. That showed there might be few taboos left, said Charles Goodhart, emeritus professor at the London School of Economics.
“They will swear black and blue that Cyprus is a unique case but so was Greece,” Goodhart said. “You can talk about the inviolability of insured deposits but the problem now is: would anyone believe you?”
The first use of capital controls by a euro zone member might also pose a challenge to countries such as Malta, Luxembourg and Estonia, whose banks also boasted large foreign deposits, said Nomura International economists Jacques Cailloux and Dimitris Drakopoulos.
“Fearing a similar fate as those with deposits in Cyprus, there is a serious risk that these depositors decide to reduce their exposure, putting other countries under stress,” they said in a report to clients.
But some spotted silver linings. At Berenberg Bank in London, chief economist Holger Schmieding said the lesson was that “countries will take a lot of pain to stay in the euro zone. The glue that holds the euro zone together remains strong.”
Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington, said that the Cypriot deal marked a “step forward” for Europe by better detailing the order of who lost out in a rescue.
“It provides a lot of clarity for investors and depositors,” he said, drawing a parallel with the Federal Deposit Insurance Corporation, which protects deposits in the US. – Bloomberg
