Tag Archives: bailout

The Cyprus Bailout and European Banking Stability

Cypriot protestors demonstrate against the EU's proposed savings tax.

Cypriot protestors demonstrate against the EU’s proposed savings tax.

The Cypriot parliament on Tuesday rejected a proposed bailout package from the European Union that would have imposed a surcharge on bank deposits. The tax was resoundly defeated, with 36 members of parliament opposing the measure and 19 abstaining; no one voted in support. Meanwhile, thousands of protestors had taken to the streets to voice their opposition to the measure.

German Finance Minister Wolfgang Schauble noted that he “regretted” the Cypriot parliament’s decision, asserting that “There is a danger they won’t be able to open the banks again at all.”

The measure would have imposed a 6.75 percent levy on all deposits of less than 100,000 euros, and a 9.9 percent surcharge on deposits of more than 100,000 euros. In a last-ditch effort to save the measure, the government of Cyprus announced ahead of the vote that accounts of less than 20,000 euros would be exempted from the tax.

Cyprus, which like Ireland and Iceland had attempted to position itself as an international banking center, had an exceptionally large number of foreign depositors. It was estimated that approximately 40 percent of all deposits on the small island were held by foreigners, mostly Russians. The European Union’s measure angered the Russian government, which announced that it would need to reconsider the terms of a 2.5 billion euro loan it had made to Cyprus in 2011. Cyprus’ Finance Minister, Michalis Sarris, was in Moscow on Tuesday, hoping to extend repayment terms and lower the interest rate on the original loan.

International observers widely condemned the European Union’s proposed bailout package, the terms of which were released on Saturday. Economist Paul Krugman argued that,

You can sort of see why they’re doing this: Cyprus is a money haven, especially for the assets of Russian beeznessmen; this means that it has a hugely oversized banking sector (think Iceland) and that a haircut-free bailout would be seen as a bailout, not just of Cyprus, but of Russians of, let’s say, uncertain probity and moral character…The big problem, however, is that it’s not just large foreign deposits that are taking a haircut; the haircut on small domestic deposits is a bit smaller, but still substantial. It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying “time to stage a run on your banks!”

The Cypriot case is particularly interesting. According to an IMF report, the country was doing well before the 2008 global economic crisis, experiencing “a long period of high growth, low unemployment, and sound public finances.” But the global financial crisis hit Cyprus particularly hard, as the country was exceptionally dependent on foreign depositors. By 2011, concerns were emerging. Cypriot banks had made loans to Greek barrowers totaling more than 160 percent of the Cypriot GDP, and those ties to the Greek economy were beginning to drag down Cyprus.

What’s interesting is the moral hazard that the imposition of the new levy poses for other banks in the European Union. As Krugman notes, Europeans watching from other troubled economies (think Spain, Portugal, and Italy) the bailout requirements in Cyprus may be an incentive for them to relocate their assets before their country is forced to undertake similar reforms.

What do you think? Are the conditions imposed by the European Union on Cyprus as a prerequisite for receiving a rescue package reasonable? Or do they threaten to undermine economic stability in other troubled European economies? Leave a comment below and let us know what you think.

Five Stories You Might Have Missed

John McCain decided to participate in Friday’s presidential debate, which was predictably dominated by questions on the economy.  The status of the U.S. economy continues to garner significant international attention, but other stories also developed this week.

1. In perhaps the most important development last week, Congress reached a deal on a $700 billion bailout package for the financial sector.   Progress towards an agreement had collapsed last week after House Republicans withdrew their support for President Bush’s initial proposal and Democrats refused to move forward without their support.  The impact of the financial collapse (and bailout) in the United States has yet to be felt, but already some—including Germany’s finance minister, Peer Steinbrück—are arguing that the crisis means the U.S. has lost its “financial superpower status.”

2. In the most recent development in souring Russian-American relations, Russia and Venezuela moved to cooperate more closely in areas of energy policy.  This follows on the announcement that Russian naval vessels and aircraft would participate in Venezuelan war games in the southern Caribbean.  Since 2005, Venezuela has used a portion of its oil wealth to purchase more than $4 billion worth of weapons systems, including fighter aircraft, helicopters, anti-aircraft systems, and armored personnel carriers, from Russia. 

3. The vast expanses of space are becoming a bit more crowded, as China and India expand their own space programs.  China launched the country’s third manned space mission on Friday.  The mission culminated with a successful space walk over the weekend.  Meanwhile, India is planning its own launch intended to map the surface of the moon.  According to some observers, the Chinese and Indian governments are engaged in a new space race, echoing the U.S.-Soviet rivalry of the 1960s.  

4. On Saturday, the Syrian capital Damascus was rocked by a car bomb which killed 17 and injured 44 people.   Although no group has yet claimed responsibility, suspicions have fallen on resurgent Sunni fundamentalist groups.

5. South Africa’s president Thabo Mbeki abruptly resigned last week.  Although the African National Congress’ leader Jacob Zuma is likely to be elected president in the upcoming election, Kgalema Motlanthe, former guerrilla and union leader, was selected as the interim president on Thursday.  Motlanthe says his agenda will focus on maintaining economic and political stability.