Cyprus: Would stealth tax have been a better idea?

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Cyprus: Would stealth tax have been a better idea?

The idea that the deposits of the average person in Cyprus (in addition to corporations, and Russian organized crime) could be confiscated via a levy has caused a great deal of fear in the financial markets.    For instance, to people in the United States it almost seems unfathomable that you could wake up to have JP Morgan/Wells Fargo/Any Local Bank take 7-10% of your deposits.

Yesterday in the Financial Times, James Mackintosh showed a chart of the deposit rates for both Cypriot and German banks.  The difference was easy to see, as deposit rates (less than 1 year) in Cyprus have averaged over 4% for the last three years while German deposit rates have hovered around 1-1.5%.  As Mackintosh points out, over a three year horizon, a depositor in Cyprus would have earned roughly 13%, or ~10% over an equivalent German account.  This difference, as he points out, is ~10% or nearly the exact amount that was originally proposed as the levy on deposits over 100k euros.

Better Idea?

I’m clearly out of my element to discuss bank specifics in Europe (let alone Cyprus!) but I will carry on anyways.  US banks are all assessed fees (I’m simplifying the specifics) for FDIC insurance based on the amount of non-interest bearing deposits.  So banks in aggregate pay out fees to “fund” FDIC insurance.  Ultimately these costs are borne by the depositors as the bank incurs the cost of the insurance.

Instead of a publicly proposed/mandated tax/levy on deposits in Cypriot banks, could the EU/ECB not have accepted a “payment plan” from these banks?  The banks could lower the deposit rates (Let’s say from 4% to 1%) and pay the difference as “ECB tax”.  The cost of funds would remain the same for the Cypriot banks (all else equal), while the costs would still be borne by the depositors.  This would be more like a “stealth tax” as the depositors would not feel this as much, and theoretically confidence would remain in the system.

Now there are obviously valid arguments to this.  Would depositors keep their money in these banks at substantially lower interest rates?  Isn’t this the return that is needed to entice depositors?  How would you assign the tax rates among banks?  I agree that this is no slam dunk, but you wonder if the same end game could have been achieved through lower deposit rates and the banks paying the difference in lieu of the levy.  Thoughts?  Am I crazy?

By David Schawel, CFA of Economicmusings

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