There was initial shock at the announcement that the plan to bailout Cypriot banks would include a levy on depositors.
Initially that levy was to be 9.9% on deposits over €100,000 and 6.9% on deposits below 6.9%. The €100,000 figure seems to arise from the limit under which deposits are protected by guarantee.
It seems unfair that depositors, particularly those at a low level, would be subject to such a levy to bail out the banks. And there is no shortage of outrage and protest at this move. What is absent however is an alternative plan. If the contribution of the Cypriots to the cost of bailing out Cypriot banks is not to be raised by means of a bank deposit levy, then how is it to be raised?
It is important to look at the scale of the problem relative to Cypriot GDP. Deposits in Cypriot banks account for almost 400% of Cypriot GDP. The Cypriot banking system The assets in Cypriot banks are seven times the size of the economy. The losses made in the banks from the Greek economic collapse have reduced capital in the Cypriot banks to the extent that a bail out is needed.
The cost of the bailout is €16 billion. The Cypriots will contribute just under €6 billion to that. That is equal to about a third of their national income. So where will that money come from.
The agreement indicates that junior bondholders will be "bailed-in" (paragraph 4 in this Eurogroup statement) , which is technical-speak for reductions in the returns they can expect. It is expected that junior bondholders will take a significant hit:
A key question for the finance ministers was expected to be whether any revised formula for the tax on deposits could still deliver the 5.8 billion euros agreed to in the bailout deal. The plan, a so-called bail-in, also would wipe out 1.4 billion euros held by junior bondholders in Cypriot banks. Only senior bondholders, who have paid a premium to be first in line for repayment of their investments, would be fully protected.
Even if the bond holders, senior and junior, are to be completely burned there is still a shortfall that needs to be made up by the Cypriots.
With Cyprus, the euro zone once again sidestepped the question. Officials involved in the rescue talks say that “bailing in” senior bondholders wouldn’t have made sense given that, by the end of September, Laiki and Bank of Cyprus had only some €184 million of senior bonds between them—peanuts next to the €10 billion the two banks need in new capital.
The only apparent solution is for the Cypriot government to raise the revenue through taxes. This is obviously not feasible as the funds are required now and the amounts in question are too large to raise given the size of the economy. (It may be interesting to note that Ireland funded its contribution to its bailout from the National Pension Reserve Fund).
The Cypriot government also has the small political cover of the large volume of non-domestic deposits in these banks. They can blame the Russians who use Cypriot banks to stash their cash and earn high interest rates relative to elsewhere in the euro area. The levy will the cost of the services provided by the Cypriot banking system.
There is still some way to go on finalising a deal that is fairer for depositors. It is now reported that deposits below €20,000 may be exempt. That makes sense, as does a staged levy that grows in line with deposit size.
Of course, this analysis is based on the premise that the banks in question should be saved. It would be interesting to see the figures for the value of deposits less than €100,000, because an alternative for the current levy may be to allow the banks to fail. If this could be a managed failure where deposits below €100,000 are protected the signal sent to other countries would be that banks may be allowed to fold if they are not viable.
The risk of that scenario is that it is difficult to control a bank failure and it seems the Eurogroup of Ministers have no appetite for such a risk.
I'm an economist so many of these posts will be about economic issues. But since everyone is allowed a view on economics I am inclined to go beyond my profession to throw my tuppence ha'penny into other issues.