The Cyprus Mess

Building a Smarter German-American Partnership

There is truly no shortage of reactions to the European Cyprus deal that emerged over the weekend. The plan to raid depositors on the Mediterranean island—no matter how small their bank account—has not only drawn the ire of citizens in Cyprus itself, it has even managed to shake confidence among Germans.

On Monday, the German administration felt forced to reassure its citizens that their savings are safe. For months, Germany had made it quite clear that some form of bail in, i.e. private participation of Cypriot depositors in raising the necessary funds, was necessary as part of a deal to rescue Cyprus. Merkel and other creditor countries needed to address their own bailout fatigue. The fact that Cyprus has the reputation of allowing Russian oligarchs to launder their money through Cypriot banks has made things much more complicated. Going after bond-holders did not make much sense. Corporate bonds of Cypriot banks are small in size, with the bonded debt amounting to a mere 1,7 billion euros against some 70 billion euros in deposits. Cyprus needed a country specific solution, one that included bank depositors. More importantly, the deal needed to be credibly sold as such.

But instead of doing just that, the euro zone and the International Monetary Fund (IMF) managed to jeopardize the fragile European stability of the past few months. By forcing Cyprus to raid small bank deposits (those worth 100,000 euros or less), they have triggered renewed turbulence in the financial markets. In fact, this deal has been sold so badly that, on Monday, even the U.S. Treasury felt it had to publicly urge Europeans to find a fair solution. Cyprus is now scrambling to tweak the deal and will first try (and probably fail) to extract better conditions from Europeans. In the meantime, banks in Cyprus remain closed.

There is much blame to go around. However, the main mistake was for Europeans to allow Cyprus to decide on its own how to raise the 5,8 billion euros needed from deposit holders. Contrary to initial reports, Germany and others did not insist on raiding small depositors. How to raise the money was largely left to Cyprus itself. According to many media reports, it was the government of Cyprus that resisted putting a much heavier levy on accounts exceeding 100,000 euros. It did not want to excessively squeeze big depositors (including Russians), for fear of losing them. Europeans made the mistake of not protecting small depositors.

Some have criticized Europe of being too hard with Cyprus, others of not going far enough. But there are also those who think that overall Europeans did the right thing. Everybody seems to agree on the fact, however, that asking small depositors to pay a high price for Cyprus’ rescue was a mistake. Just how bad is not clear yet.

For opposing views and further analysis on the developing situation in Cyprus:

The Cyprus bank Deal: What it Means, by Jakob Funk Kirkegaard. Originally published by the Peterson Institute for International Economics

Europe is Risking a Bank Run, by Wolfgang Münchau. Originally published by the Financial Times (paid content)