Cyprus wants to “tax” every depositor in every Cyprus bank to pay for a banking bailout. The depositors would lose some part of their cash deposits in the bank, and get shares in the bank in exchange for that cash. I am not certain of all of the details, but this appears to be close to the final deal which will be forced on depositors.
The forced and unexpected tax on deposits has called into question the idea that all Euros are fungible. Euros held in banks tend to be the same, but this move shows Euros are worth different amounts depending on the exact bank which holds them and how they are held.
This lack of fungibility insures there will be bank runs whenever the risks to specific countries becomes high. Deposits in Spanish banks are less valuable than deposits in German banks, simply because the risk of Spain being forced to impose a tax to support their banking sector is greater than it is in Germany.
I think this move could be the one that ends the long drama for Greece. Depositors in Greek banks must be thinking they are next in line for this kind of tax. The removal of assets from the Greek banking system will probably cause that economy to further implode – and at that point, why is Greece even bothering? If depositors are going to lose their money, they might as well have some say in how it happens, and that involves leaving the Euro.
Frances Coppola has a great summary of the risks involved with this proposed plan.
“The problem for depositors is twofold, really:
- their liquid assets (cash deposits) will have been replaced with illiquid ones (shares in banks that currently have little market value)
- they are forced to take the risk that the future value of those banks will not compensate them for the money surrendered to the sovereign.
So depositors have an immediate liquidity problem, and the possibility of future real losses.
Large depositors will eschew Cyprus in favour of non-Eurozone countries such as Latvia. Small depositors will withdraw funds in cash and stuff their mattresses, or they might buy gold. In fact there has been a slow run on Cypriot banks for some time now, as international depositors withdrew funds due to bailout fears: I expect this run to increase to a flood once banks re-open after the bank holiday.
The effect of large and small depositors removing funds on that scale will be a brutal economic downturn as the money supply collapses. In particular, the dominant financial sector will suffer a severe contraction, putting thousands of jobs at risk and paralysing lending to Cypriot households and businesses. And that is IN ADDITION to the estimated 4.5% economic contraction that is already happening due to austerity measures imposed on Cyprus in 2012 to reduce its fiscal deficit, and the further measures required in this bailout. “Deep recession” is already forecast for Cyprus. A major bank run will be economically catastrophic. And the effect of that economic disaster will be to increase both the fiscal deficit and the public debt as a proportion of GDP. After all, even if the government doesn’t increase borrowing, a collapse in GDP immediately raises the debt burden to unsustainable proportions, spooking investors and causing unaffordable rises in yields on sovereign debt.
One thing we need to remember about bank runs is they are not always logical. Bank runs involve fear and real uncertainty, all tied up with some form of distrust in a lack of getting paid back. It only takes a little bit to start a bank run, because small movements in the amount of deposits have outsized impacts on a banks ability to pay all of the depositors their full deposit.
Remember, Greece has an economy about the size of Indiana. It’s a very small place economically. It would not take much to cause a bank run in Greece which far, far exceeds the willingness of the Eurozone to control. And why would anyone believe the promises made by the Eurozone at this point?
This is why I suspect this move by Cyprus could have impacts far larger than just a haircut on depositors in Cyprus. The move puts every deposit in every problem country bank at risk right now, today. It means a Euro in a Greek bank is worth less than a Euro in a German bank. Euros held in banks are worth less than cash Euros.
This how and why bank runs start. Once bank runs start in Greece, the pressure to leave the Euro will be tremendous. The next few weeks could be interesting for the Eurozone.