Blue Horizon: Cyprus – lessons learnt
Thomas Trauth, Blue Horizon Wealth Partner AG (Foto: Blue Horizon).
Zurich – Cyprus is a small island, which was able to develop itself into a financial center with low taxes and strong secrecy rules. Cyprus played a very prominent role as a turntable, especially for Russian money. Banks grew large and banking debt at the end of 2010 amounted to about nine times Cyprus’s GDP. At the same time the public debt to GDP ratio was relatively moderate at about 60%.
The sub-prime crisis in 2007 and 2008 pushed Cyprus into a recession as tourism and the shipping business were contracting. The second hit came in 2011 when the European Union decided on a haircut of 50% and more on Greek government bonds, in which Cypriot banks were heavily invested. The Cypriot financial system was not able to absorb these losses. In January 2012 an emergency loan of EUR 2.5 bn from Russia to cover Cyprus’s budget deficit and to re-finance its maturing debt only served to postpone the collapse. In June 2012 the Cypriot Government requested a bailout from the European Union, but could not agree with the EU on the terms. On 16 March 2013, the so-called troika (the European Commission, the ECB and the IMF) agreed on a EUR 10 bn deal with Cyprus, making it the fifth country—after Greece, Ireland, Portugal and Spain—to receive money from the EU-IMF. As part of the deal, a one-off bank deposit levy of 6.7% for deposits up to EUR 100,000 and 9.9% for higher deposits, was announced on all domestic bank accounts. The deal required the approval of the Cypriot parliament, which rejected it, however, on 19 March 2013. On 25 March a new deal was closed, keeping Cyprus in the eurozone and restoring the promise to protect bank deposits covered by the EU-mandated EUR 100,000 deposit guarantee.
Conclusions from the Cyprus crisis
We think there are a number of important conclusions to draw from the Cyprus crisis and the respective policy responses:
- You should be aware that your deposits in a bank are basically a loan to that bank. With a bank deposit you are exposed to counterparty risk vis-a-vis the bank. If the bank fails, your deposits can be used to fund other claims on the bank’s balance sheet. As a rule, claims are covered first by shareholders, second by bondholders and third by depositors with a special status for insured deposits below EUR 100,000.
- The bank offering the highest interest rate may not be the safest bank. Usually, deposit rates rise with higher funding costs in the inter-bank market, a phenomenon associated with higher counter-party risks, and the funding needs of the bank.
- Avoid weak banks, especially those in weak countries. In the wake of the Cyprus crisis, depositors will become more careful and selective and may start withdrawing deposits from weaker banks.
- The risk of capital controls is not to be underestimated. If a national banking system needs to be restructured, the country in question may decide to protect its banks and prevent capital flight. This happened in Iceland five years ago and is now happening in Cyprus.
- Diversify your banking relationships across institutes and across jurisdictions. It is not always possible to foresee a bank’s balance sheet issues. In addition, as mentioned above, countries can very quickly introduce capital controls. If, for example, accounts in one country are frozen you can fall back on on any accounts you have in other countries.
- During a crisis, policy-makers may decide on measures which contravene existing rules. In the first Cypriot deal proposal, for instance, the bank deposit guarantee was not honored and deposits below EUR 100,000 were subject to a haircut of almost 7%. In addition, deposits in Cyprus remain frozen so far, and tight capital controls have been put in place.
(BH/mc/hfu)
