A eurozone agreement to bail out Cyprus only if the government puts a levy on deposits in Cypriot banks is raising fears that savings in EU banks might be less safe than many people think.
Under the deal agreed in Brussels on March 16, the eurozone would provide Cyprus 10 billion euros ($13 billion) if Cyprus raises another 5.8 billion euros ($7.5 billion) through a levy -- or tax -- on its bank deposits. The Cypriot government has said it will seek parliamentary approval for a levy of 6.75 percent on balances below 100,000 euros and a levy of 9.9 percent on balances larger than that.
"Initially, I was quite shocked by the announcement, and in particular because Cyprus does have deposit insurance, so depositors who have up to 100,000 euros are in theory protected by the government," says Richard Wellings at the Institute of Economic Affairs in London. "But this shows that deposit insurance really isn't a guarantee and that there are other ways of making depositors share part of the pain of a bailout."
The targeting of bank deposits has led to much speculation over the eurozone ministers’ motives.
Bailing Out The 'Russian Mafia'?
Some analysts think that one reason for shifting the burden of pain directly to Cypriot banks is that the island’s financial crisis is largely due to bad bank decisions. Cypriot banks lost large amounts in bad loans to Greece, making many in Brussels feel they should directly bear much of the cost of recapitalizing themselves.
But Wellings says another reason for demanding funds from Cyprus’s banking sector is that it has long been seen as oversized and as a haven for foreign investors interested in money laundering.
"The Russian depositors have put away tens of billions of euros in Cyprus, and it is suspected that a lot of these are people within the Russian mafia who are using Cyprus as a haven to store their ill-gotten gains offshore," Wellings says. "And there was a sense in which the Germans, in particular, didn't want to use their bailout funds to bail out the Russian mafia."
Deposits from Russia alone totaled some $30 billion at the end of last year. Any taxing of depositors would make the banks in Cyprus a less attractive destination for illicit profits and help clear up the money-laundering problem.
For now, it is unclear whether the initiative to raise the money from insured deposits comes from the eurozone ministers or from the Cypriot government itself. But no matter the origin, the proposal is a risky one. Wellings warns it could backfire by driving future foreign depositors not just away from Cypriot banks but also from banks in other troubled or at-risk EU states.
"We'll probably see a flight to safety," he says. "Some of the traditional safe havens like Switzerland will seem more attractive now for international investors."
If so, that would be a setback for the EU’s efforts in recent years to reassure foreign investors its banking system is safe. In December, finance ministers from the 27 EU states agreed to give the European Central Bank authority to directly supervise the eurozone's biggest banks and intervene in smaller banks at the first sign of trouble.
Zsolt Darvas of the Brussels-based think tank Bruegel says those steps are intended to reassure investors that there will be no more banking crises.
“Europe is moving ahead with the so-called European banking project, whereby the first element, the single supervisory mechanism, is likely to be in operation early next year," Darvas says. "From that point [forward], the single European Central Bank will be the supervisor, which will mean most likely that the quality of bank supervision will improve and therefore the potential for banks failing will be quite limited."
But if the banking project aims to reassure, other steps by the EU’s various bodies leave room for confusion.
One is a new directive due to be proposed by the European Commission this summer that will establish the order in which bank shareholders and bondholders are to be held responsible for making up a failing bank’s losses. Davas says the directive will exclude depositors with balances under 100,000 euros from responsibility. However, it does not spell out the degree of responsibility for depositors with balances over that amount.
As the Cyprus crisis plays out, some of the eurozone’s thinking on such aspects may become clearer. And that, in turn, may give foreign depositors in EU banks less -- or more -- reason to worry about their accounts.
However, some analysts caution against trying to deduce too much about the eurozone’s future strategies from any single crisis.
Janis Emmanoulides, an EU expert at the Brussels-based European Policy Institute, says one reason the eurozone's strategy often seems unpredictable is that each crisis requires its own specific remedies.
“It seems rather likely that [the eurozone] will not go for a solution in other member states that will be similar to the one they have now identified for Cyprus," Emmanoulides says. "We already see that also with respect to Greece. They did not do the same thing now in Cyprus as they did in the Greek situation; they looked for a different way of handling the crisis.”
So far, the eurozone has bailed out four member states: Greece, Ireland, Portugal, and Spain.