Cyprus In Crisis: What Are The Implications?

Once again, a small and lethargic economy at the edge of Europe is threatening to upend progress made on resolving the eurozone crisis.

Burdened by an overleveraged and outsized banking system, on March 16 Cyprus took the unprecedented step of announcing a levy on bank deposits in order to secure a bailout from the troika (IMF, European Commission and European Central Bank).

The terms of the bailout have not yet been finalised, and the course of events is evolving quickly. In Business Monitor Online today, we outline our immediate response to this weekend’s developments and answer some of the key questions which have arisen. In particular, we discuss:

  • The specific bailout terms
  • Why Cyprus is ‘exceptional’
  • The role the ECB has played
  • The role Germany has played
  • The meaning of Cyprus’ crisis for the broader eurozone

The eurozone has ventured into uncharted territory. Although bank deposit levies are not completely without precedent – Italy introduced a tax on deposits in 1992 – the size of the charge and its potential to override the EU-wide deposit guarantee scheme are major developments with far-reaching implications. Even if the Cypriot government were able to shift more of the burden onto larger deposits, the mere announcement of the government’s intentions could trigger a mass withdrawal of funds in the coming weeks. A pledge by new President Nicos Anastasiades to compensate savers for any losses with bank shares and reward savers who kept money in their banks for two years with securities tied to national gas revenues may not be sufficiently persuasive.

Depositors across the eurozone will also be on tenterhooks. There remains enormous uncertainty surrounding Spain and Italy and the potential for further state bailouts. If Cyprus sets the precedent of taxing deposits, it risks setting off capital flight across southern Europe. This in turn could restart the polarisation of funding markets which threatened to pull apart the eurozone in 2012.

The Cypriot bailout could mark another inflection point for burden sharing, which has shifted from banks to governments, to future taxpayers, to bondholders, and now potentially to current taxpayers and pensioners. We stress that while Cyprus appears to be an exceptional case, once such a precedent has been set, it is entirely feasible that similar policies could be rolled out in future bailouts.