European Council on Foreign Relations

The clock is ticking on Cyprus

 

An island on the edge of Europe with an outsize banking sector, lots of offshore investors flocking in, and an external economic shock leading to a financial crash of dramatic proportions: it’s not like we have never been there. But this time around it’s Cyprus, not Ireland or Iceland. This is yet more proof that no country is an island spared amidst the pan-European storm which is unlikely to go away. The restructuring of Greek debt and the ‘haircut” imposed on institutional investors has taken toll on the banks in next-door Cyprus (the Bank of Cyprus alone took losses worth €1.3 billion a year ago). The situation is pretty dire: the two largest banks – the Bank of Cyprus and Laiki (Popular) Bank are practically bankrupt. And Cyprus, with bank assets eight times its GDP and deposits four times, outdoes both Ireland in 2010 and Iceland in 2008. But nonetheless the déjà vu continues: talking heads in Europe and beyond compute the likelihood of pan-European havoc wrought by a run on Cypriot banks: talk that by now is painfully familiar to everyone in the EU. For decades a Cyprus split into Greek and Turkish parts was a symbol of division. If anything it now stands for connectedness and interdependence, albeit of the negative kind.

Interdependence is all fine and dandy in fair weather but when times get tough who it is to pay the bill? Obviously, the European Stability Mechanism (ESM) was set up to that end. But it is ultimately an intergovernmental tool, dependent on the will of member states. Which in turn means that leaders such as Angela Merkel have to convince their sceptical voters why their taxes should be spent to revive reckless banks and Russian depositors (believed to hold up to €20 billion in deposits) in a land far away which is, on top of everything, a known offshore haven. Why not opt for an Iceland scenario and leave banks go bust, while guaranteeing deposits? In all fairness, the (in)famous troika composed of the European Central Bank (ECB), the IMF and the European Commission has taken a more nuanced position – the €10 billion bailout package from the ESM has to be matched by €5.8 billion raised by Cyprus itself, perhaps by a “bail-in” of banks themselves. Only that two days ago mass protests forced the parliament in Nicosia to strike down the plan, which foresaw a one-off levy charge of up to 9.9% on depositors.

The clock is now ticking until Plan B is adopted. Banks are closed, due to reopen on Tuesday. The closures mean transactions have been frozen, the first time that the euro crisis has hit the EU’s Single Market and the free movement of capital. At the local level, even when the banks reopen (hopefully!) they might have not enough cash to meet the claims by businesses and households. The other casualty might well turn out to be the banking union, including a mutualised deposit guarantee scheme, launched back in 2012 as one of the planks of a future EU architecture.

Clearly, Russia (which loaned Cyprus EUR €2.5 billion in 2011) is not coming to the rescue, but neither is ‘big brother’ Greece. Despite the fact that Cypriot President Nicos Anastasiades, elected recently on the promise to clear the mess, has called several times on fellow centre-rightist Andonis Samaras to give a helping hend. Prodded by its own central bank Greek banks are said to be acquiring the subsidiaries of Cypriot institutions, to prevent reverse contagion. PM Medvedev says Russia needs the EU to step in first before it commits, and the message from Athens is hardly any different. So the troika and its conditionality could be the only option left. And German Finance Minister Wolfgang Schaeuble comments that Cyprus wouldn’t be able to raise its share of the rescue package without a levy.

The story is still in the making and we won’t known until the 12th hour strikes. But there is one other precedent from Ireland that we ought to bear in mind: the need to repeat a vote until Europe is satisfied that the "right" decision has been arrived at. 

 

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