Cyprus’s parliament couldn’t have been much clearer in its rejection of the plan, negotiated between eurozone members, to bail out the country’s failing banks. As a result, Cyprus is now turning from Brussels to Moscow for a lifeboat, and it looks like a deal might be done. Russia is demonstrating once again that is never backward in coming forward to build (or buy) new strategic alliances.
Yet outside the markets pages of the Financial Times, the merits of the original plan seem to have been little-discussed, with the assumption being that the plan was a universally bad one. But actually the idea seems to have been a sound one, and it was the cack-handed implementation at which the EU excels which led to its failure.
The basic plan was to fund part of the bailout of Cyprus’s banks by imposing a levy on desposits held in Cypriot bank accounts, with depositors losing a portion of their cash deposits and gaining in return the equivalent amount of equity in the respective bank.
How one views such an idea depends on how one views the nature of bank deposits. Are they simply a way for ordinary people to store their savings and earn a bit of interest, or are they a way to invest large amounts of money to make a return?
Actually, they are both. The vast majority of despositors fall into the first category, but in a banking system like Cyprus’s, a large proportion of deposits (in value terms) falls into the latter.
Most of those who put a few thousand euros in their local bank are clearly not primarily doing so as a conscious alternative to, say, speculating on the stock market or buying bonds. They are doing so because it is a convenient way to store one’s cash.
But the wealthy Russians who hold hundreds of millions of euros in Cypriot banks are doing so because it earns them a good return. Here, courtesy of the FT, is why those wealthy Russians have their money in Cypriot and not German banks:
And those foreign investors who put their vast quantities of cash into Cypriot rather than German banks knew exactly why they were being paid a higher interest rate: because it was a riskier investment. Cypriot banks were overleveraged compared to other European counterparts, so borrowing money therefore became more expensive.
And that is the key thing to remember: depositors are lenders. Borrowing people’s cash is one of the ways in which banks raise the funds which they then invest to make a return. And just as the other ways in which they can raise funds- selling shares, issuing bonds and borrowing from the financial markets – carry risks for those investing, so too does being a depositer.
For small depositors, it is understandable that they don’t think of their deposits in that way for the reasons set out above. And that is why it is right, and necessary, for governments to guarantee small deposits.
But the idea that all deposits should be protected is nonsensical. Those investing large sums of money as bank deposits are making a choice to invest in this way. They are receiving a return on that investment which corresponds to the risk of losing the principal sum. And when that risk turns to reality, they should not be cushioned from losses either by ordinary taxpayers or by governments from countries who have maintained responsible banking systems.
But this demonstrates the woeful implementation. Before this proposed bailout all bank deposits under £100,000 had been guaranteed; the levy would have reversed that guarantee, destroying both confidence in the banking system and trust in the EU.
Properly implemented, this plan would have made large depositors realise that they are not investing risk-free, and as the FT’s Izabella Kaminska points out could have started the journey from a banking system overreliant on debt to a sustainable one with a higher reliance on equity. In simply being proposed it might just do that, but it will now have been at the cost of yet more people losing faith in the compentence of the EU.
* Nick Thornsby is a day editor at Lib Dem Voice.
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23 Comments
The reaction to the proposal has been interesting. It appears that opposition to it was been stoked up mostly by:
a) Russian oligarchs, who dont want to have to pay any tax on their dodgy money to anyone, ever
b) Eurosceptics, who jump at any chance to try to help sink the Euro
c) Cypriot politicians, who dont seem to understand that their banking system is going bankrupt, and presumably want to be able to blame someone else ready for when the voters ask whose fault it was.
Nick,
I would endorse the analysis in your article and in particular the crucial difference between money as a store of value in a savings account and funds invested for higher returns.
Had the deposit guarantee of 100,000 Euros been respected and a levy on the non-guaranteed element of deposits in excess of this level proposed, then the European Commission plan may well have been more politically palatable for the Cypriot Parliament.
During the Savings and Loans Crisis in the US during the late eighties; regional State banks and S&L’s were competing with each other to offer ever higher rates of interest on Certificates of Deposit that were in turn invested by banks and S&L’s in so called ‘Junk Bonds’,;distributed principally by the boutique investment banking firm Drexel Burnham Lambert. That ended in tears also with the bankruptcy of Drexel Burnham, the jailing of its investment guru, Michael Milken and the wholesale collapse of long established savings and loans institutions and community banks across the country. The Cypriot banks have repeated this folly with investment in Greek debt.
I do have some sympathy for the Russians. The 1998 Rouble Criis saw millions of people lose their life savings due to banks closing. It is somewhat ironic that 15 years later, the Russian state is being called upon to help depositors that have managed to get their funds out of a notoriously unstable banking sysyem in their home country.
The Russian funny money could, and should, have been dealt with by other means. But this fiasco, certainly shows that the 100k savings guarantee/legislation, is worthless. But more importantly, banking is about confidence, and this (averted theft?), of savers money, tells Cypriots, and potentially the rest of Europe, that the financial situation in the Eurozone is so dire, that anything and everything will be considered, to plunder money from the average European, for the sake of the project. Strangely, when (or if ?), the Cypriot banks open again, Cypriot savers, will have a bizarre extra choice of investment, whereby a mattress, offers to pay up to 9.9% premium over a Cypriot bank. You couldn’t make it up.
As a final note, maybe, when all that Russian funny money is let loose again, perhaps it will begin to enjoy the company of all the worlds other, funny money, that has been inflating London property over the last 5 years?
Unfortunately, woeful implementation started when a number of countries were admitted to the eurozone without meeting clear requirements.
Consumers look at banks as a safe place to hold cash – the alternative is under the bed. They expect to get out what they put in and, until recently, to earn a level of interest which compensated somewhat for the erosion of the value of their principal through inflation. Ordinary consumers certainly view investment (in the sense of placing funds somewhere to keep it safe) differently from high net worth individuals (who are prepared to risk more principal for the chance of a greater return).
Nick’s analysis is interesting – but misses a key point. It’s that Cypriots didn’t appear to have much choice where to place their cash – they couldn’t choose “Safe and Steady and Highly Regulated Bank” to store their cash – they could only choose between the mattress and any one of a number of banks covered by (a now apparently worthless) guarantee.
The key point is to protect consumers, greater distinctions between banks are necessary. Slow and steady banks offering limited returns with significant restrictions on how they lend. More aggressive banks with fewer restrictions on lending. Give guarantees to consumers (up to EUR 100,000) depositing with slow and steady; don’t offer guarantees when investing elsewhere.
It’s another way of saying separate retail banks from investment banks.
I suppose we can all rest assured that the Cypriot ‘bank deposit skimming’ couldn’t possibly happen here in the UK ?
Errr… until you read section 34 of a document put together in December 2012 by the Bank of England, jointly with the Federal Deposit Insurance Corporation.
http://www.bankofengland.co.uk/publications/Documents/news/2012/nr156.pdf
34. The U.K. has also given consideration to the recapitalization process in a scenario in which a G-SIFI’s liabilities do not include much debt issuance at the holding company or parent bank level… [ but instead comprise insured retail deposits held in the operating subsidiaries ]. ……… [ Under such a scenario, deposit guarantee schemes may be required to contribute to the recapitalization of the firm, ]….. as they may do under the Banking Act in the use of other resolution tools. The proposed RRD also permits such an approach because it allows deposit guarantee scheme funds to be used to support the use of resolution tools, including bail-in, provided that the amount contributed does not exceed what the deposit guarantee scheme would have as a claimant in liquidation if it had made a payout to the insured depositors.
Unless I am reading it incorrectly, the content that I have enclosed in brackets [ ], tells me that the BoE, are indeed looking at, (in exceptional circumstances ) imposing a similar ‘deposit skimming’ operation, and that perhaps we can write off the savings deposit guarantee scheme as meaningless?
What no one seems to be considering is with a possible Russian injection of capital into Cyprus to help stabilise not just the situation in cyprus but to also help restore the Euro, is whether Russia should join the Eurozone…
The incompetence displayed by the Eurogroup during this whole fiasco is breathtaking. The arbitrary removal of the depositor insurance guarantee is a landmark event.
I read the story The Telegraph website on Saturday morning (because the BBC had decided it was a non-event and didn’t bother covering it before lunchtime) and my instant – almost disbelieving – reaction was “do these guys know what the word ‘contagion’ means?”.
Even the reversal of that decision would do no good now. The cat is out of the bag. “It can’t happen anywhere else. Cyprus is a special case” simply won’t wash.
This is without doubt a watershed event in the history of the Eurozone. What happens over the next few days is of critical importance. If Cyprus is pushed out of the Euro then there will be a period of crisis, the re-introduction of a devalued Cyprus pound and Cyprus will dive into recession.
But a Cyprus that is cheaper for trade and tourism may well emerge quickly from recession. And if that happens then what will be the reaction of the citizens of the periphery looking out from the endless vista of self-defeating austerity to which they have been perpetually condemned?
The Eurogroup shot themselves in the foot on Saturday. I suspect that foot may have been in their mouths at the time.
“Even the reversal of that decision would do no good now. The cat is out of the bag. “It can’t happen anywhere else. Cyprus is a special case” simply won’t wash.”
Quite right. It is not risk in a fractional reservebankingis wrong, no, it’s the fact that expediency justified tearing up the rules. Stupidity.
Nick seriously?
The whole contagen issue is because there is not an appropriate wind down mechanism for banks this just circumvents insolvency law as it exists.
The steps should have been:
1) Wipe out the share holders
2) convert the bond holders to share holders (bail in)
3) if still losses wipe out the new share holders
4) start to set the deposits over 100k agains losses until they are covered, issuing equity to the depositoers affected.
This is simple but would have caused losses to INVESTORS who expected to be earlier to take losses than depositors but the EU has now changed the game by circumventing the normal process. If they had carried out this according to the above simple steps they would be getting praise for having (finally) managed to carry out a bank insolvency correctly (having failed so many times in the past).
As it is this is another farse like in other EU bank crisies, e.g. Ireland.
@ Psi
You have accurately outlined the process that should have been undertaken. The question I would like the answer to is, Why was it not done that way? How dire is the situation, that the correct and proper process you outlined, could not be undertaken.? From the outside looking in, this grand union of European countries, is looking more and more like a loveless marriage, heading towards a bitter divorce.
As I understand it, those with under 100k Euros would have paid 6 – 7 % . To put this is perspective, if I buy something abroad on a UK credit card, most banks would charge me 4 – 5%; there might be other concealed charges in the exchange rates used. As the American and Irish examples above show, money in a bank is only as safe as the stability of the bank, so paying 6% might be cheap compared with the alternative.
About 20 years ago, I was among many depositors who were suddenly showered with money in demutualisations (which incidentally I’d voted against). Didn’t hear many complaints then that this was different from what we’d signed up to – a safe place for our money and reasonable return on it.
I think the handling of this whole issue has been dire, and I hope that a sustainable solution is quickly arrived at for the sake of small depositors and economy of Cyprus. But the lesson is something we should have known already – that we are dependant on each other in Europe, whether or not we are in the EU or the euro. The British government flying 1M Euro in cash to its employees in Cyprus, together with its earlier aid to the Irish Republic (where, of course, it has a stake in a major retail bank) should emphasize that.
Ian, I can’t believe you’re comparing a surcharge on a single purchase with having 7% of your life savings wiped out — all to validate the worldview of some arrogant yuppies in Frankfurt. This is stealing from the poor to give to the rich on an immense scale.
@Nick – a good article BUT your comment “Before this proposed bailout all bank deposits under £100,000 had been guaranteed; the levy would have reversed that guarantee…” is just wrong.
The €100K (not £100K) deposit guarantee applies when a bank FAILS. There is no such guarantee when a bank continues to operate. As such, governments are free to levy charges/taxes on bank accounts should they so choose.
Unfortunately, the Cypriot government managed to both scare depositors witless AND fail to collect the proposed levy.
@Paul R — Perhaps you’re trying to make a point about legality and what governments can do — but the real point that comes through is that this plan was so disastrous that it was far worse for people with bank deposits than letting the banks fail, which is, I think, what Nick was getting at. I don’t see anybody saying that the government of Cyprus could not have enacted such a levy; the problem is that if they do, they wreck public confidence in them and in the banking system. The result would necessarily be economic ruin, a return to a basically mediæval monetary régime, and a turn toward political extremism.
The name of the country appears to be mis-spelt in the title and in several places in the article itself.
Richard,
Thank you for pointing that out, and I have corrected the spelling accordingly.
@David
Unfortunately, the Cypriot government – with their botched levy – have already destroyed public confidence in their bank system. Once you announce such an unlimited measure that is inevitable. Botching it gives the impression you are erratic as well which neither inspires confidence or helps to restore it.
@ John Dunn
The answer is simple, and sadly sounds a little conspiratorial, though it is true.
The reason the process was not followed is due to stage 2, “Convert the Bond holder to equity share holders” the bond holders in the countries in badly affected countries were the banks, insurance companies and pension funds of the much richer large countries.
You will hear Irish people complaint that their government was forced to step in to guarantee the bondholders of their banks was a result of the biggest bond holders were German Banks, other large countries had exposures of different over exposed nations.
If the correct process were followed then the losses would be taken in the troubled economies then the pain would be spread (to a lesser extent) to the wealthier big economies who would have to bail out the affected industries at home, to a smaller extent (and who are able to afford it better).
However the large economies would have to acknowledge that they were also dangerously complacent about managing risk in their economies too. It would weaken their hand when handing down (the admittedly to a certain extent required) economic policies to the smaller countries.
And the main driver is that the failings would make the rich countries politicians unpopular at home (bailouts, and failing to see it coming).
@ Paul R
The Banks are insolvent and have therefore failed; just because the government has suspended normal activity (extending bank holidays providing guarantees etc) does not change that reality. That they have moved the legal goal posts of the legal definition of insolvency in the short term is not a reason to punish depositors to save the investors.
Because it meets a legal technicality does not make it right. Liberals are supposed tobeliev3e the in the rule of law, not governments moving goal posts to suit themselves.
David
I don’t see anybody saying that the government of Cyprus could not have enacted such a levy; the problem is that if they do, they wreck public confidence in them and in the banking system.
If they were not in the Euro, and resolved their problems in the time-honoured way, by letting their currency devalue, the effects would have been the same, but the grumbling much less.This is in effect what those who are saying there should not be a single currency advocating. Isn’t what was proposed for Cyprus just a more honest way of doing it?
What Paul In Twickenham said.
There is an immense amount of black propaganda swirling around this story. Until quite recently Cyprus had a healthy government balance sheet with less debt than the EU average. Also it had healthy banks until they got shafted in the Greek bailout – Laiki Bank in particular was fatally exposed. Yet somehow just a few months ago all the Cypriot banks passed an EU stress test. Is anyone in trouble for fixing the results of that test? Also again the Russian connection is not obviously as bad as is normally painted and only accounts for 28% of deposits – a part of which is perfectly ordinary and legal tax avoidance. A former chairman of our own FSA was pontificating on Radio 4’s Today this morning about how it was quite wrong for Cyprus to have a large financial sector. Actually, it’s a very sensible way for them to leverage their English law tradition and professional services firms to make a living. For instance BP’s investments in Russia are apparently held through BP Cyprus and I’m sure that’s all perfectly legal. I’m not a fan of offshore tax havens but it’s sanctimonious in the extreme for senior players in one of the very biggest (The City) to lecture smaller ones about their foolishness. Pot meet kettle.
The sums may look reasonable (that is, if they’re someone else’s life savings and not your own) but one thing the experience of the last few years should tell us is that bank bailouts never stop at the first round. They come back for more and more again and then yet more.
One theory doing the rounds and which looks increasingly credible is that this is a test run for a wider pan European (including the UK) roll out of the same plan (see John Dunn above). Stand by for ‘interesting times’ as the old Chinese curse has it.
@ Liberal Eye (& John Dunn having not commented on his BoE paper reference earlier).
My interpretation on the BoE proposal is that the intention is that the insured deposits would be protected, the reference to using the FSCS reigeme to bail out the bank is rather dodgy as it talksa as if the reigeme is a prefunded mechanism (which the UK is not) and to suggest that at the point of a bail in you know that it will cost less than liquidation, somethign that would be very hard to do.
Still it des refer to treating un insured depositors inline with “other similarly ranked liabilities in the resolution process” which does not make clear whether the uninsured would rank higher or lower than bond holders. I (as explained above) believe there would be much more confidence in a system where Bonds holder (as those are investors rather than depositors) where they were bailed in first then wiped out before uninsired depositors. But with the uninsired next.
But with the rules being flexed to suit what the politicians want rather than a stable set of rules that give Investors and depositors a clear idea of where they stand in advance of the colapse. Otherwise you have politicians “picking winners and losers” which does nothing for confidence for future inverstors who need to be able to price the risk they are taking when making decisions and adds higher risk premiums across the board.
@Matthew Huntbach
Surely it must be agreed that inventing the Euro has made things much worse than would otherwise have been the case?
@ Psi
There appears to be no, one ‘generic’, way of skimming savers bank deposits. Osborne’s current way is to let inflation do the heavy lifting over a number of years. But the troubling interpretation of the BoE proposal, is that it is not deposit skimming as such, but moreover, to relegate a savers account, to a lower level in the hierarchy or ‘food chain’. If we strip back the BoE proposal to its basics, my understanding is thus :-
We assume, that the first £85,000 of an individual’s savings account is guaranteed, or more accurately, ‘insured’. This BoE document, seems to say that the pot of money ( insurance fund ), that was intended to insure and ‘save’ your savings, might instead be used to ‘save’ the bank. Clearly, the deposit insurance fund cannot do both, so the ‘saving’, of your deposit account, would come second, to ‘saving’ the bank. ? Indeed, how would we know, or find out, if that deposit insurance funding is ALREADY, subsumed into a UK’s bank ‘scaffolding’?
Adding to the troubling thoughts, is that the policies of ‘deposit skimming’, appear to be expanding beyond the European frame.
http://www.scoop.co.nz/stories/PA1303/S00306/national-planning-cyprus-style-solution-for-new-zealand.htm