The Cyprus precedent

Drinks all round -- mine's a Keo beer.  A deal reached after difficult negotiations over the weekend has averted the possibility of Cyprus going bankrupt and getting forced out of the Eurozone.  The deal will see the closure of the most egregiously dodgy of the country's bloated banks (Laiki, the second largest), though a "good" bank, for depositors with less than the insured limit of 100,000 euros, will be spun out from it first.

The key element of the plan is the revival of the haircut for depositors that was the core of the previous deal, the one that Cyprus's Parliament turned down last week.  Smaller depositors (those with less than the insured limit) will now be spared, but those with larger sums face a much more severe scalping, possibly as high as 30%.  For reasons that are not entirely clear, this new deal doesn't have to go before Parliament.  Maybe that has something to do with the fact that most of the losses will be borne by foreigners with deposits in Cypriot banks.  Most of these depositors are Russians, and the EU, egged on by the European media, seems happy to assume that they are all crooks, and thus deserve everything they get.

That assumption is not exactly contradicted by the reaction of the Russian government to this latest deal.  Prime Minister Medvedev has said something to the effect that "what has previously been stolen is being stolen again".  President Putin, who spoke out strongly against the earlier deal, appears to have agreed that Russia will renegotiate the terms of its existing loans to Cyprus in order to help the country out.

All good news then.....or is it?  Stock markets initially reacted positively, but later sold off after the Dutch Finance Minister indicated that what was imposed on Cyprus might be a template for other countries.  He later attempted to soften the impact of that statement by noting that there were features of the situation in Cyprus that were unique to that country.  Most notably, the Cypriot banks have very little in the way of marketable debt, so there was no scope for inviting institutional creditors to step up and take the hit  And, of course, as we've already noted, a lot of the bigger depositors are, conveniently enough, citizens of a non-EU country.

Even so, if the message that Mijnheer Dijsselbloem is trying to get across is that in future, governments will look to all creditors of a bank to bail it out, then the consequences within the EU and even beyond are unpredictable.   Depositors are, of course, creditors of their banks, but that's not how they see themselves, and it's not how they've been treated in previous Eurozone bank bailouts.  Indeed, in every bailout prior to this one, avoiding losses for bank depositors has been a cardinal rule.  The principle that large depositors need to pay attention to the solvency of the institutions they stick their money into is a good one, but it's grossly unfair to impose it suddenly like this, when you've run out of other ideas.

Whatever happens next, Cyprus's days as a money laundering  offshore financial centre are surely over, which the EU and ECB will feel is no bad thing. Who else is at risk?  Well, banks in any of the countries that have already been bailed out or may be facing future bailouts will certainly be on the lookout for any signs of depositor flight.  And then there are countries that, like Cyprus, have bloated banking systems that are out of all proportion to their economies.  Such as, oh, I don't know....the UK?