Raiding Cypriot Bank Accounts Will not Save the Banking System

By Walter Kurtz, Sober Look

Cyprus is zeroing in on a solution to avoid getting ejected from the EMU. It’s simple. Since taxing everyone’s account by a few percent didn’t work, it’s time to raid all the larger accounts.

NY Times: – With Cyprus facing a Monday deadline to avoid a banking collapse, the government and its international negotiators devised a plan late Saturday to seize a portion of savers’ deposits above 100,000 euros at all banks in the country, in a bid to raise money for an urgently needed bailout.

one-time levy of 20 percent would be placed on uninsured deposits at one of the nation’s biggest banks, the Bank of Cyprus, to help raise 5.8 billion euros demanded by the lenders to secure a 10 billion euro, or $12.9 billion, lifeline. A separate tax of 4 percent would be assessed on uninsured deposits at all other banks, including the 26 foreign banks that operate in Cyprus.

This action will really upset the Russian mafia, but is not going to save the the nation’s banks. Once the financial system opens for business, the run on banks will ensue – no matter what sort of controls the authorities will try to impose. No sane depositor who is able to open an account in Germany, France, or even Italy would leave cash in Cyprus. As far as the depositors are concerned, if the Cypriot authorities have done it once, they can do it again. Some of those deposits will quickly move back to where they came from – Russian banks.

Given the size of deposits at Cypriot banks, there isn’t enough in eligible collateral for MRO financing (short term secured borrowing from ECB) to replace these lost deposits. The flight of capital will increase the funding needs far beyond the €10bn Cyprus is trying to raise. And it’s unclear if the ECB should continue to provide further emergency loans (ELA). After all, the Eurosystem’s exposure to Cyprus is simply insignificant on a relative basis. The ECB’s balance sheet is still massive. It can generate more than enough interest income in a few months to cover the losses of Cypriot banks’ defaulting on their ECB loans. So why throw good money after bad?

Borrowing from the ECB by country

Of course there are geopolitical implications of walking away from Cyprus. Letting banks fail will likely result in Cyprus exiting the EMU and some fear that will trigger a contagion effect. However if the ECB sticks with its OMT program (commitment to buy unlimited amounts of periphery bonds) for the rest of the periphery, the effect of “Cyprexit” could be contained. But when it comes to the Eurozone, there is rarely a decisive action, and this mess will likely persist for some time.

Sober Look

Sober Look

Sober Look was founded by Walter Kurtz, a New York based hedge fund manager and credit markets specialist.

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  • http://morelivers.blogspot.com MoreLiver

    All the articles I’ve seen on the crisis of Cyprus:
    http://morelivers.blogspot.com/2013/03/16th-mar-special-bailout-of-cyprus.html

  • Andrew P

    How is an ordinary Cypriot going to open a bank in Germany, France or even Italy? Proof of state residency is now required to open bank accounts anywhere within the EU, and is strictly enforced in Germany. The big boys will of course be able to leave, and the little guys will be left holding the bag as the banks implode.

  • Very Serious Sam

    “This action will really upset the Russian mafia, but is not going to save the the nation’s banks”

    Nothing will save these banks. They have no business model, not anymore. Thus, they also don’t need to exist anymore. But they will, since the nowadays ruling, perverted anglo-saxon version of capitalism is primarily designed to save banks, may it cost the populace what it wants.

  • David Lazarus

    I suspect that this move will actually be very destructive to the financial system, all across Europe. What this will do is turn the rest of the periphery into a cash based society with minimal funds in the banks. It was what made the Depression so bad in the US. It was this that lead to the creation of the FDIC to backstop depositors. So the ECB has failed to learn from the last depression.

    There will be even greater withdrawals from banks in fear of them being hit the same way. Spain is in a similar situation to Cyprus as its banks are insolvent. So the contagion has happened, just that it is not a stampede yet. There has been a silent run on Spain and Italy for the last year or so I suspect that smaller savers will now start to empty accounts and stuff the cash into mattresses.

  • Stephen

    Actually a lot of this money is going nowhere at all for at least a couple of years. It’s going to be TD’s ,or similar. Similar means you might have a tradeable certificate.Hence,if you wanted out quickly you could sell it and take the inevitable haircut,but then the certificaste remains in Cyprus. This will be a cnetral part of their capital controls.

  • ftm

    A deposit tax which starts out high and declines over time might work to keep deposits in Cyprus. Say 75% tax if you withdraw now, scaling down by 10% a year if you leave your money in. This would convert demand deposits to time deposits with severe early withdrawl penalties.
    If the banks managed to recover they could then reduce the penalty rates.

  • jaymaster

    Hmm. I just got read this at Barry Ritholtz’s blog, and it struck me as even more appropriate here.

    John Kenneth Galbraith:
    “There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.”

  • William Bedloe

    The thought of powers that be reaching into one’s bank account and seizing monies held by individuals erodes trust in banking institutions. Then again, is an institution willing to hold ill gotten mafia millions trustworthy to begin with?

  • Explorer

    Once the “rescue” is formally agreed, won’t the ECB buy or at least accept the pledge of the loan assets of the Cyprus banks at or near current written down market value, assisting them in downsizing their balance sheets and paying out depositors in an orderly fashion over time at the written down value of the deposit?

    After all, where countries have sought assistance and agreed a plan, won’t the ECB “do what it takes”?

    Remember the ECB can create Euros, even though the sovereign states within the EMZ cannot.