Cyprus illustrates depth of EU woes, and hints of worse to come
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The European debt crisis that peaked in severity last summer has not really gone away even though it had not been mentioned much in the news until the Cyprus banking crisis. The core problems - too much sovereign debt and uncompetitive economies - are sti
While Greece’s and Spain’s problems were more about the refinancing of government debt, Cyprus’ was more of a banking crisis. Two banks – Cyprus Popular (Laiki) Bank and Bank of Cyprus – were flush with deposits from Russian businesses. They decided to invest their excess liquidity in Greek sovereign debt. Last summer when Greece couldn’t repay its debt, bondholders were forced to take a haircut on their investment.
The two Cypriot banks were hit hard, but the government stepped in and injected liquidity, which it couldn’t afford, into these two banks to keep them afloat. Now Cyprus’ government is in a bind and can’t keep the liquidity game going any longer and has asked the European Union for assistance.
The EU and the International Monetary Fund, not wanting to give the Cypriot government a free lunch, demanded ?5.8 billion (Bt218 billion) in exchange for a ?10-billion loan. And as we know now, only deposit balances below ?100,000 are spared from having to pay the levy while deposits over ?100,000 could see losses of up to 40 per cent.
While Cyprus’ economy is not big – only 0.5 per cent of the EU’s gross domestic product – contagion risk far outweighs its nominal contribution to the bloc’s economy. After Lehman Brothers fell, it became apparent that banks do not fail in isolation. A single bank failure has the potential to start a domino effect that can take down the entire financial system.
The significance of the Cyprus situation is that it may have set a precedent for how future banking crises are resolved. A simple savings account may not be so simple any more. The Cyprus crisis introduces the idea of the risk of confiscation of deposits anywhere around the world.
As a light-hearted example, a night-time television talk-show host recently made fun of Cyprus and the ever-larger US sovereign debt.
“The island nation of Cyprus is now considering a 10-per-cent tax on every individual savings account in that country. They’ll take 10 per cent of your money right out of the bank. To which President [Barack] Obama said, ‘You can do that?’”
When the next banking or sovereign-debt crisis strikes, and it will come sooner than many expect, the problem will be more severe and harder to resolve, as depositors and investors will rush to exit at the first hint of trouble. A small crisis can be amplified and make it that much harder to contain if depositors are jittery about their savings and there is a bank run.
Current asset prices around the world are somewhat like a house of cards – they are being fuelled by a record level of government spending and money-printing. The Cyprus crisis has weakened that foundation and made it that much easier for the house of cards to fall.
No one can be sure how many banking crises the EU can withstand, but it will be harder to survive the next one.
Thiti Tantikulanan is head of capital markets at Kasikornbank.
