Cyprus was supposed to receive 10 billion euros as part of a bailout plan. However, the details of the plan has lead to anger and fear both domestically and abroad. Futures have gone down across the globe and the Euro is trading down on the news. Few expected the deal to cause bank runs, bank holiday, fears of a Euro-break up etc. before the Cyprus bailout was proposed before the weekend. First, we get into the details of what exactly is happening then some interesting reports coming out from various firms.
What happened?
The deal to effectively haircut Cypriot deposits is considered by many an unprecedented move in the Euro crisis and highlights the limits of solidarity and the raw economics that somebody has to pay. It is also (in hindsight) the most dangerous gambit that EMU leaders have made to date.
What happened?
In the early hours of this weekend, the Troika decided to impose an effective haircut to both uninsured and even more interestingly insured (<€100k) Cypriot bank deposits. More precisely, the €10bn bank rescue in Cyprus 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 at 9.9%, for a total contribution of €5.8bn.
Depositors will receive bank equity as compensation and the Cypriot President has offered Gas-linked notes if deposits are kept in the country for two years. The situation is flux and those amounts have changed slightly. However, at the time of this writing the market is still frightened about any deal which taxes depositors (or even if the deal does not tax depositors the fact that it was considered).
In addition, the Eurogroup expects the Russian government to come to an agreement with Cyprus soon to make a contribution to the rescue.
The Eurogroup head, Dutchman Jeroen Dijsselbloem, has refused to rule out that Cyprus will be the last instance where deposit holders get hit. Olli Rehn however has ruled this out by saying Cyprus is unique. The difference is that Mr Dijsselbloem represents the views of national finance ministers and leaders.
Cyprus shocked
The Cypriot leadership were stunned by this move but were cornered by news the ECB would otherwise pull the plug on Cyprus’ Laiki bank, which rather fortuitously, apparently no longer qualified for ELA. This in turn would have meant the sovereign would be on the hook for all insured deposits, which according to the FT would be some €30bn or 175% of GDP, as well as ushering in social upheaval.
This explains the fact that Cyprus – which had planned to vote for deal on Sunday 17th March – has had to delay the vote to Monday 18th March. The reason is that Cypriot President Anastasiades did not have a mandate a move
to haircut deposits.
According to eKathimerini.com the Cypriot cabinet has declared Tuesday a bank holiday as well, which could be stretched to Wednesday. Note that electronic transfers over the weekend have been suspended but European treaties prevent capital controls on banks, which these delays appear to borderline.
Bank runs
The local Cypriot media report that bank ATM machines have run dry and that there is general anger about a freeze in electronic transfers
The move by the Eurogroup is unprecedented but the fear is rather obviously that a bank run may be in the offing. Morgan Stanley analysts believe that “the Cyprus central bank may have difficulties in controlling a possible temporary bank run.”
Game theory
Analysts at RBS think that the decision to hit depositors in Cyprus has two major influences.They have called the decision ‘the world’s largest poker game’.
Firstly, game theory the future where a country such as Italy is reaching the limits of debt sustainability. The analogue here is to get wealthy Italians to finally pay tax via perhaps a one-time solidarity tax on sovereign bond coupons/principal, given that domestic residents and the ECB own 71% of the market. Alternatively, getting the locals to make a sacrifice by extending the debt maturity is also feasible under the concept of ‘you broke it – you pay for it’.
The more domestic financial architecture, including ownership of government bonds, makes such local burden-sharing solutions more politically viable. One could even say that the ownership moves in markets aids some type of Paris Club and London Club workout.
Secondly, even if the Eurogroup wins on the idea that Cyprus wants the Euro so much that it takes the medicine, and Cyprus’ banks are unique enough to mean limited contagion effects, then that would only be phase one of the impact.
RBC thinks the very fact that deposit haircuts have been put on the table means the cost of future bailouts will be higher as banks (at a minimum the weak banks) will be destabilised.
Contagion
Contagion to other peripheral deposit bases and funding markets is, however, the issue. It appears that senior unsecured creditors, few though they are, will be untouched rendering the seniority spectrum ineffective and reigniting the debate of the exact terms on which one invests in bank securities. Insured deposits in the Euro
area are, apparently, not as risk free as banks’ clients had once expected.
Bill Passage Won’t end problems
Even if the bill passes it may not stop bank runs. The risk of holding deposits in Cyprus is now clearly higher. The EU/Eurogroup/IMF has history in underestimating the size of required bailout packages/bank recaps. With interest rates at historic lows there is little upside to holding a deposit in Cyprus if it is not in fact riskless. While the impact of haircutting savings on additional loan losses and economic growth has been considered, it is essentially uncharted waters which could lead to higher capital requirements. There is an unquantifiable social element – an average person may be unwilling to repay loans to banks after suddenly being taxed on their savings at the same banks.
Is it legal?
The legality of the package is unclear. While there are very few bondholders in Cypriot banks as they are nearly 100% depositor funded, the small proportion of senior unsecured bondholders appear unaffected. Choosing which creditors from the seniority spectrum are bailed-in is contentious. The fact that this is a tax may circumvent legal issues, and it would not be the first time the seniority spectrum has been manipulated, but it is uncertain grounds. The lack of a European resolution regime enables this manipulation and it is the reason why laws surrounding senior debt bail-in are currently in discussion. Random selection of creditors lends little security to investing in Euro area bank securities and at the very least makes it more expensive to issue as a peripheral bank.
Problems started in December?
RBC states that Cpyriot peripheral deposit bases have already seen some fragility in Dec/Jan and wholesale markets have stalled in the last 6 weeks. The best case in their view is mild outflows providing additional peripheral bank margin pressure and liabilities lead balance sheet shrinkage. The worst case, more severe outflows could cause liquidity issues.
Calendar
RBC notes key events for Cyprus, Spain and Italy coming up:
17-19th March- Parliamentary approval of the Cypriot bailout
19th March- Spanish EUR 3-4bn (RBC estimates) of bill issuance
19th March- Greek EUR 1bn of bill issuance
19th March- talks for Italian coalition formation scheduled to begin
21st March- Spanish EUR 3-4bn (RBC estimates) bond issuance
25th March- Italian EUR 2.5-4bn (RBC estimates) issuance
26th March- Italian EUR 7-8bn (RBC estimates) bill issuance
28th March- February Euro area banking balance sheet data including deposit flows
7th April- Italian March Target2 data and central bank lending
11thApril- Spanish March Target2 data and central bank lending figures
