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In case anyone thought that the bank and sovereign debt crisis that has engulfed certain parts of the eurozone has produced all its dramatic twists, events this weekend came as a rude awakener.
Eurozone leaders agreed early on Saturday morning a deal to bailout and restructure the Cypriot banking sector.
The most controversial part of the deal sees a tax levied on depositors to raise about 5.8 billion euros, to add to the €10 billion committed by the Eurozone and (probably) IMF. A 9.9% levy will be imposed to deposits over 100.000, while deposits below 100.000 will face a levy of 6.75%.
So for the first time depositors, who were considered sacrosanct until now, are forced to share the cost of a bail-out.
A lot has been said about how this decision was reached. The blame shifts depending who one talks to, but the Financial Times give a good account. It seems that considerations about the future of Cyprus as an off-shore financial centre played a role when deciding how widely to spread the pain among depositors in Cypriot banks. It was feared that taxing only non-resident depositors would scare investors away.
So the main bone of contention (in an overall contentious decision) is that smaller depositors are put on the firing line, in a move that is seen as unfair and dangerous. Asking working people and pensioners to sacrifice their savings in the service of a failed banking sector is indeed cruel. But WSJ’s Simon Dixon makes a fair point, there is an element of fairness when asking locals to contribute to the bail out of their country’s banking sector, especially when that sector represents such a huge part of the country’s economy.
Many argue that it should not have come to this at all, that depositors should have been spared all together. But as Hugo Dixon of the Reuters argues the Eurozone and the Cypriot government had very little choice. Imposing a haircut on government debt, like it was done in Greece’s case, was not possible because most of the country’s sovereign debt is held under English law (making a Greek-style restructuring hard) and the remaining is held by Cypriot banks, making a hair-cut self-defeating.
Hence the decision to impose a tax on depositors, many of whom are non-resident, predominately Russian and in many cases suspect of money-laundering. It would have been a hard task politically to explain to taxpayers across the Eurozone why they should contribute more to a bail-out that would have, to some extent, helped Russian oligarchs.
The most important thing that one should consider is what would be the cost of an alternative. In the absence of a bail-out deal (one that the Cypriot government had delayed long enough) Cypriot banks (which are already under ECB life-support) would collapse, taking the Cypriot economy with them. Lest we forget that the banking sector in Cyprus is more than 5 times the Cypriot economy.
The one good thing that can come out of this is the de facto reduction of Cyprus’ banking sector to a size closer to the EU average, as the Eurogroup statement, that followed the bailout agreement, calls for. As we have seen in other European countries like Ireland and the UK, an oversized financial sector holds huge risks for the host country, especially for one whose economy is as small as that of Cyprus. To a large extent this is a banking crisis, rather than a “euro-crisis” and no matter what the structural inefficiencies of Eurozone’s governance (and European politicians inability so far to separate bank from sovereign debt) what Cyprus is faced with is the collapse of a banking sector that grew too big for its own good and made far too many bad decisions.
There is still a lot to play for, not least a parliamentary vote to approve the bail-out deal. Until then there is time and room to reconsider how the burden will be spread among depositors, and there are many proposals on the table on how to shield small depositors and reduce their contribution to the bail-out pot of money. Some reports talk about reducing to 3% the levy imposed to deposits up to €100.000.
One last thing. The situation in Cyprus shows that in an interconnected world we are not immune to what happens “over there”. Capital as well as people are mobile, the banking sector interconnected and as a result banks and people’s savings are affected, irrespectively whether we are part of the Eurozone or not. The fact that British citizens who live and hold deposits in Cyprus will have to be part of the bail-out levy shows how important it is for the British government to be as involved as possible in Eurozone governance and EU-wide efforts to address the systemic faults of Europe’s financial sector.
Petros Fassoulas, European Movement
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  1. The financial woes of Cyprus seems to indicate a continuing state of malaise for the Euro, following similar problems in Greece, Spain, Ireland and elsewhere in the Eurozone.
    It might seem a strange assertion to some, but these events show that the Euro project is doing exactly what it is supposed to do. The Eurozone as a whole is supporting member countries in financial difficulties, and will continue to do so until the situation improves. Of course, the situation is extreme – much more so than was envisaged when the Euro was set up, but in one way this is a good thing: because of the severe nature of the problems, rules and safeguards are being strengthened to ensure that similar crises are much less likely to happen.

    We need to remember that it is not membership of the Euro that has caused the financial problems in these countries – the world-wide financial crisis is indeed world-wide, and has affected nations everywhere, regardless of whether they are Eurozone members or not. The difference about the Eurozone is that there is mutual support. This does not mean that the solutions are easy – far from it – but at least there is a huge willingness to help. Remember ‘Black Wednesday’ in 1992? UK Prime Minister John Major, in anticipation of yet another Sterling crisis, thought he had obtained informal agreement from the German Chancellor that Germany would support the Pound if it came to the crunch. In the event, there was no support whatever. The Euro did not exist then, and the Exchange Rate Mechanism to which the UK belonged was not the same sort of arrangement at all.
    Part of the reason that some Eurozone member nations were so ill-equipped to withstand the world financial crisis is that they just did not obey the Eurozone rules. This is a lesson that has had to be learned the hard way; but the result in due course will be a stronger Euro and more stablity in the Eurozone. The UK will count the cost in the future of staying outside the Eurozone. The European Union is its biggest market, and what the UK simply does not have is the sort of stability that Eurozone members have in their mutual trade. It seems good when the Pound is strong and UK prices seem relatively cheaper on the Continent – but it doesn’t last; and the UK relies heavily on imports, so prices go up and up. Every trans-border financial transaction attracts fees, commissions and mark-ups, whether it is for businesses or for individuals travelling around or buying from Eurozone countries. This is a huge financial drain that the UK could do without. The UK does not have the stability in these matters that the Eurozone enjoys.

    One of the self-created problems of the UK is that it’s economic management is not forward-looking – it is just about the present and the immediate future. What about ten years time? Twenty years? Fifty years?

    It is easy to look at current events in the Eurozone and to write off the Euro as a disaster, as the media would have you believe; but that is typical short-term-ism. In fact, in ten. twenty and fifty years time people will look back at the second decade of this century and realise how much Europe owes to those who persevered with this noble, far-seeing and eminently sensible project. One can only hope that the UK will by then have realised that outside the Eurozone it will continue to decline, to the cost of its citizens, its businesses, its place in the World and its reputation.

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