They're Reneging On Government Deposit Insurance

There’s a little detail in the just announced bailout of the Cypriot banks (and Cypriot economy as a whole) that could be setting an entirely disastrous precedent for the entire European banking system. Please note the “could be” here, it depends upon how people react next.

That Cyprus and its banks need bailing out is beyond doubt. The banking sector is absolutely vast as compared to the size of the economy (largely as a result of a couple of decades of use as a secure location for Russian deposits) and the banks are indeed bust. Largely because they were heavily invested in Greek Government bonds which then, as we all know, suffered two substantial haircuts.

So, something needed to be done. And something has been done. More money is being sent in to recapitalise the banks, Cypriot loans are being rescheduled, the government will sell off assets to help plug the gap and so on. However, there is this one further detail that could have seriously bad effects:

Euro-area finance ministers agreed to an unprecedented tax on Cypriot bank deposits as officials unveiled a 10 billion-euro ($13 billion) rescue plan for the country, the fifth since Europe’s debt crisis broke out in 2009.

Cyprus will impose a levy of 6.75 percent on deposits of less than 100,000 euros — the ceiling for European Union account insurance — and 9.9 percent above that.

There’s nothing particularly bad about making depositors carry some of the load of a bank failure. Indeed, it has something to recommend it: if it happens occasionally then people will take more care over where they put their money and what the banks do with it.

However, there’s a very great difference between allowing depositors without government insurance to take losses and actually reneging on the previously promised government insurance. And it’s that second that they’re actually doing here. Here’s the description of the Cypriot government deposit insurance scheme:

http://www.forbes.com/sites/timworstall/2013/03/16/the-cyprus-bank-...