Thursday

19th Jan 2017

Opinion

Cypriot deal is welcome change to EU approach

  • Cyprus ruins: 'The change makes it politically more feasible to deal with struggling economies which are too big to bail out, such as France' (Photo: jnocca93)

In the wake of the bailout/half bail-in that is the Cyprus rescue package, Eurogroup chairman Jeroen Dijsselbloem said last week the EU is now "going down the bail-in track."

He later clarified his remarks to say Cyprus is a "specific case."

Dear EUobserver reader

Subscribe now for unrestricted access to EUobserver.

Sign up for 30 days' free trial, no obligation. Full subscription only 15 € / month or 150 € / year.

  1. Unlimited access on desktop and mobile
  2. All premium articles, analysis, commentary and investigations
  3. EUobserver archives

EUobserver is the only independent news media covering EU affairs in Brussels and all 28 member states.

♡ We value your support.

If you already have an account click here to login.

But despite his caution, the developments signal a welcome change from the EU's handling of the euro-crisis so far, in which the Union turned itself into a piggy bank for insolvent banks and governments.

Dispelling the myth that Brussels should protect depositors and bondholders from any risk of losses is a first step toward sensible management of the situation.

For that reason, the 25 March Cyprus agreement is an improvement on the original one from 15 March, which protected senior bondholders from losses and imposed a levy on small depositors.

 

Repairing the balance sheets of Cypriot banks can only happen through liquidation of bad assets.

When it comes to bank insolvency, Cyprus is in a class of its own.

Its non-performing loans (NPLs) represent a whopping 264 percent of banks tier 1 capital, the main measure of their financial stability, according to the International Monetary Fund.

To put this into context, Italian banks, with an NPL-to-tier-1 ration of 153 percent, and Greek lenders (217 percent), have a much better capacity to absorb losses.

Japan learned its lesson on bad loans the hard way.

When a surge in NPLs helped prompt its current economic malaise during the early 1990s, Japanese authorities merged weak banks with strong ones in an attempt to sweep the country's insolvency problem under the rug.

It did not work.

The newly merged entities earned the name "zombie banks" for a reason. Japan has since endured almost two decades of stagnation.

 

The EU is now trying to avoid making the same mistake with Cyprus.

The Bank of Cyprus - its largest - will be recapitalised via the liquidation of assets held by senior bondholders and a levy of up to 40 percent on unsecured deposits.

Cyprus' Laiki bank - its second largest and most insolvent lender - will close by liquidating its non-performing assets, a move facilitated by wiping out senior debt and an as yet undisclosed (but significant) portion of unsecured deposits.

Its other assets will be shifted to the Bank of Cyprus.

In return for bailing-in the banks, the Cypriot government will receive a €10 billion emergency loan, worth two thirds of its outstanding debt.

 

The deal is not without risk.

Foreign deposits comprise 37.5 percent of all Cypriot deposits (compared to a euro area average of 22 percent), and international investors are now likely to feel nervous about stashing their money in the island's banks.

Cyprus’s enormous sum of highly mobile foreign portfolio investment - totalling 122 percent of its GDP - is unlikely to endure.

Over time, foreign direct investment - currently at a large 89 percent of GDP - is also likely to decrease.

Add to this the "temporary" (weeks, months?) capital controls introduced by the fiat of eurocrats and Cypriot officials and the little Mediterranean island no longer looks like a financial paradise.

Iceland, which instituted "temporary" restrictions on currency convertibility in 2008 is unlikely to remove them completely until 2016.

If Cyprus' economy "tanks," as predicted by EU officials, a second or even a third bailout or bank restructuring may be on the horizon.

Precedents in Greece, Ireland and Portugal indicate this is not the last we have heard on Cyprus.

 

It is also unlikely to be the last we hear about the threat of capital controls, as investors fret over their positions in other weak eurozone countries.

If investors try to exit countries they see as potential candidates for the next bail-in, this could aggravate instead of soothing the crisis.

At a deeper level, creating a monetary firewall around Cyprus contradicts a basic tenet of the single market and one of the main reasons for having a single currency in the first place: free movement of capital across borders.

 

But despite the dangers, the Cyprus agreement marks a welcome sea change in the eurozone's approach to its problems.

The change of course makes it politically more feasible to deal with struggling economies which are too big to bail out, such as Italy and France, if they come under greater pressure.

 

The Cypriot precedent also marks a welcome step in another way - moral hazard.

Risk comes with reward but it also comes with potential loss.

Instead of being propped up by core eurozone countries' taxpayers, investors will have to face the consequences of their bad decisions.

 

The writer is the Warren T. Brookes Fellow at the Competitive Enterprise Institute, a Washington-based think tank

Opinion

The 89ers and the battle against populism

It falls to the Europeans who were born around 1989 and grew up in a peaceful Europe to build a fresh new vision for the EU that transcends the ideological, educational and national cleavages of the past.

Stakeholders' Highlights

  1. Caritas EuropaEU States to Join Pope Francis’s Appeal to Care for Migrant Children
  2. UNICEFNumber of Unaccompanied Children Arriving by sea to Italy Doubles in 2016
  3. Nordic Council of Ministers"Nordic Matters" Help Forge Closer Bonds Between the UK and the Nordic Region
  4. Computers, Privacy & Data ProtectionThe age of Intelligent Machines: join the Conference on 25-27 January 2017
  5. Martens CentreNo Better way to Lift Your Monday Blues Than to Gloss Over our Political Cartoons
  6. Dialogue PlatformThe Gulen Movement: An Islamic Response to Terror as a Global Challenge
  7. European Free AllianceMinority Rights and Autonomy are a European Normality
  8. Swedish EnterprisesHow to Create EU Competitiveness Post-Brexit? Seminar on January 24th
  9. European Jewish CongressSchulz to be Awarded the European Medal for Tolerance for his Stand Against Populism
  10. Nordic Council of Ministers"Adventures in Moominland" Kick Off Nordic Matters Festival in London
  11. PLATO15 Fully-Funded PhDs Across Europe on the Post-Crisis Legitimacy of the EU - Apply Now!
  12. Dialogue PlatformInterview: Fethullah Gulen Condemns Assassination of Russian Ambassador to Turkey

Latest News

  1. EU cannot copy Australia's offshore asylum model
  2. Brexit men launch anti-EU website
  3. Germany details its 'Marshall Plan' for Africa
  4. IMF predicts 'pain' for UK, as banks prepare London exit
  5. EP deal could help Tusk keep Council job
  6. UN struggles to monitor fate of readmitted Syrians in Turkey
  7. European space chief: Moon village is 'more or less a fact'
  8. May's speech was not a war declaration, Malta says