I had the opportunity to talk with Cosimo Maracsciulo, Pioneer’s Head of European Government Bonds and Foreign Exchange, on the latest issues with Cyprus’s banking crisis. A summary of his thoughts follows.
Why did Cyprus’s financial crisis spur the European Union into action?
There are a couple of reasons worth mentioning. The first is that these smaller countries have developed, at times, a banking industry whose assets under management outgrow GDP by several times: the ratio is above 7-to-1 for Cyprus. The second reason for watching Cyprus’s liquidity crisis closely is that it may provide the first severe test of the European Union’s (EU) ability to deal with the EMU debt crisis after the European Central Bank (ECB) pledged to save the euro from collapse.
What is the rationale behind the controversial levy on bank deposits?
Unlike previous cases, depositors in Cyprus’s banks are set to share the burden of this rescue. The earlier proposal, later rejected by Cyprus’s Parliament, called for deposits above the threshold of €100,000 to pay a hefty 9.9% one-time levy. This provision took aim at foreign depositors whose rescue would not have met the approval of EU and German taxpayers.
Even more incensed were local depositors holding money below the quoted threshold of €100,000. According to the plan, they would have received equity in the banks in exchange for a 6.5% bank levy and this burden looked excessive. Some argued that the Cypriot government wanted to spread the pain rather than hit only non-resident depositors and undermine its ambitions as an offshore tax haven for rich foreigners.
Is this the reason why Cyprus’s Parliament voted against the bailout?
I believe the Parliament rejected the first bailout package as unfair. Lawmakers could accept that Cypriot residents should not be exempt from burden-sharing, but opposed a plan that left senior bank bondholders untouched, while common people are being squeezed. They might have welcomed a “haircut” for investors who allegedly bought Cypriot government bonds at distressed prices and stand to gain handsomely when maturity comes (the first such tranche is scheduled for redemption in a few weeks’ time).
What is your assessment?
The main flaw in the plan is that it is barely consistent with the EU’s efforts to protect banks’ balance sheets from external shocks. Lenders drawing funds from retail depositors were said to be less at risk of a liquidity crunch compared to those raising money from wholesale inter-bank markets (which ground to a halt in the recession). It is hard for people to hold money in the bank if they feel their savings are less secure there than under the mattress.
So, is there any risk of a new contagion?
The euro crisis has been less frightening since last summer, amid the efforts of the European Central Bank to quell concerns about an EMU break-up. Political leaders have had plenty of time to follow up on the improved climate and solve the crisis on a structural basis, but that does not mean that any failed attempt to do so will spark a new crisis. The global economy is looking much healthier than at the height of the euro crisis and the amount of long-term emergency funds to the banking sector is declining. In this backdrop, the EU can afford to work on an alternative plan to sort out Cyprus’s specific problems.
What are the main features of the new deal?
The plan singled out the two main Cypriot banks, as if the banking sectors could be separated from the whole economy. This does not look feasible for a country whose bank assets are above seven times GDP. The second-largest (and least-solvent) will be stripped of its bad assets and eventually be folded into the biggest one, but not before being strengthened by a capital infusion funded by depositors above the €100,000 ceiling and, crucially, bondholders. The new plan addresses the solvency issues of specific banks and did not touch on deposits below the conventional €100,000 ceiling. As a result it should not need parliamentary approval.
Where does the European Central Bank stand in this latest crisis?
It has talked tough on this issue and we believe the threat to freeze emergency funds to hardly-solvent Cypriot banks helped bring forth a new package. Some questioned the ECB’s tough stance, as if its pledge to save the euro by any means necessary was not dependent on political leaders’ firm commitment to solve the main issues. The German Executive Board said that the ECB could provide emergency liquidity to solvent banks, suggesting that Cyprus’s stricken lenders were barely in this group.
This latest crisis may provide an early opportunity for the ECB to increase its clout. The case for a selective bail-out of creditors (notably depositors) on bank resolutions was made by ECB board members since last year and the new deal of Cyprus meets that principle.