Cyprus has negotiated a weekend €10 billion ($13 billion) bank rescue due. The deal will end up with a bail-in on junior bondholders and a one-time tax on depositors. Deposits below 100k will be taxed 6.75%, and those above 9.9%, for a total contribution of €5.8bn. Depositors will receive bank equity as compensation. In addition, the Eurogroup expects the Russian government to come to an agreement with Cyprus soon to make a contribution to the rescue.

The agreement has been reached this morning after over 10 hours of talks between the IMF, EU and ECB. The tax on depositors is more severe than the general consensus from the recent newsflow, which envisaged no losses to smaller, insured depositors. Cyprus’s parliament will debate the bill on Sunday.

Cyprus Different?

Is Cyprus a special case? Likely. Cypriot banks are very large, with assets of €125bn, over 7 times the size of the economy. They also have very few bonds outstanding – around €2bn in senior and sub, making bondholder bail-in not effective. EU Commissioner Olli Rehn also ruled out a repeat of a tax on deposits in future bank rescues.

The intervention reinforces the Eurozone’s philosophy to hurt stakeholders of failing institutions, rather than socialising losses across the system. After the expropriation of SNS sub debt in Holland as well as losses on residual IBRC senior in Ireland, European policymakers have broken the taboo of hurting depositors.

IMF Deficit Projection

The IMF’s 2013 current account projections for the Euro-zone show Cyprus in second to last place. The three biggest imbalances in terms of GDP aren’t deficits at all. They’re surpluses: 8.2% of GDP in the Netherlands; 7.1% in Luxembourg; and 4.7% in Germany. The three biggest deficits, meanwhile, are much smaller: 2.9% of GDP in Greece; 2.0% in Cyprus; and 1.7% in Portugal.


What is the contagion effect? analysts at RBS state that the tax rate on depositors is not a credit event – strictly speaking – and therefore it prevents triggering defaults across senior bonds. This shows policymakers are still wary of contagion risks and protective of senior debt. However, the Cypriot bail-in adds to the history of resolution events happening prior to the adoption of the common resolution framework mechanism.

Market Impact

RBS believes that it is positive for the sovereign debt, negative for small banks and bank sub debt in the rest of the periphery. The impact should be at a minimum a re-pricing of risk on subordinated debt of other peripheral banks who may need additional capital or sovereign support (Monte Paschi in Italy, for example). It is also possible that some of the smaller periphery banks may suffer deposit outflow to larger ones.

UPDATE 3/18/13 9:25AM EST: The previous version of this article incorrectly cited RBC as the source for comments on ‘contagion’ and ‘market impact’. The updated (and correct) version states the firm correctly as RBS (or Royal Bank of Scotland Group PLC)