the Cyprus bank crisis solution

the bailout

Over the weekend the EU and IMF came to agreement with the government of Cyprus on the shape that the rescue of Cyprus’ failing banks will take (I wrote about the overall situation late lase week).  The banks themselves remain closed, as they have been for ten days.

The highlights, if that’s the right word to use:

–the smaller of the two main Cyprus banks, Bank Laiki, will closed down.  It will be separated into a “good” bank, which will contain all insured deposits (those of €100,000 or less), and a “bad” bank, which will contain everything else.  Deposits in the former are safe.  Deposit and bond holders in the latter will get whatever’s left after the bank’s dud loans are settled.  That could well be close to zero–and, in any event, large depositors will have lost access to their funds for a considerable period of time.

–the Bank of Cyprus, the bigger bank, will remain open.  This is a face-saving concession insisted upon by the Cyprus government.  Uninsured deposits will be used to cover the losses on the bank’s loan book, with uninsired depositors losing as much as 40% of their money.

it’s Cyprus’ best alternative

The country’s recent prosperity is due mostly to the access it allows to the rest of the EU, and its less than diligent attention it pays to the provenance of the bank deposits it accepts.

The rescue injects €10 billion of EU/IMF money into the Cyprus banking system.  Cyprus also gets to remain in the EU.  Otherwise, it would still have the same large bank loan losses, but be €10 billion poorer and out in the cold.

Some commentators are saying that the losses that uninsured deposits in Cyprus will suffer will undermine confidence in the banks in other EU countries, like Italy or Spain.  I don’t think so.  The Cyprus story–crazy bank lending, deposits of dubious origin, tax haven–is well-known throughout the EU.  If anything, the union was hamstrung in its efforts to bail Cyprus out by how well-known the story is–and, in consequence, how politically unacceptable an outcome where Cyprus escaped very significant hardship would be.

The main result of the Cyprus episode, I think, will be to give the EU a significant push toward unified EU bank regulation.