Cyprus: a crisis made in Greece
by George Hatjoullis
The events of this week in Cyprus confirm the assertion of my previous post that the proposed levy on deposits in Cypriot banks is a tax event and not a default event. The initial ‘haircut’ proposed did not apply to deposits held in the UK branch of Laiki bank. However, the restructuring of Laiki bank, a default event, will affect deposits held in the UK branch. This is because it is a branch of the Cyprus based Laiki group and thus not covered by the FSCS, the deposit insurance agency of the UK. Deposits held in Bank of Cyprus UK are covered by the FSCS because it is a subsidiary and thus separately licensed as a UK bank. In contrast, any proposed levy on Bank of Cyprus deposits applied in Cyprus will not apply to deposits held in the UK subsidiary. These differences would logically not apply if the levy were a default event.
The emphatic rejection by the Cyprus parliament of the initial proposal to tax all deposits held in Cyprus banks has not achieved very much. Although the details of the new package are still being decided it does seem as if deposits below 100k may escape any tax (though a 1% tax may be applied). However, at what cost? Laiki bank is to be restructured, with inevitable job losses, and this will involve depositors holding above 100k in much larger losses (possibly up to 40%). Moreover, all deposits above 100k held in Cyprus banks may still be subject to a levy of 10% or more. Add to this the economic dislocation of having banks closed for a week, the uncertainty and adverse publicity for Cyprus and one gets some sense of the price paid for this display of defiance. Most important the negotiations are continuing and yet worse outcomes are possible.
The defiance of Cyprus is understandable, if ill-considered. This is a crisis made in Greece and it is not the first time that Cyprus has paid for events that originate in Greece. In July 1974 a Greece sponsored coup in Cyprus provided the pretext for an invasion by Turkey, with economic consequences commensurate with the present situation. There was in addition a huge loss of life in proportion to the population. Arguably most damaging however was the large number of unaccounted for people, the Cyprus missing persons, which condemned their families to years of anguish. Many cases are still not resolved.
The origin of the present banking crisis in Cyprus is the restructuring of Greek sovereign debt. At the time the leading Cyprus banks found themselves holding a disproportionate amount of Greek sovereign debt. One wonders how this could have come about. To avoid accusations of 20-20 hindsight let me note that from the summer of 2010 until the spring of 2012 I was employed to advise a prominent European bank on precisely these matters.
The crisis in the euro zone originated in Greece. The risk of holding Greek sovereign debt was evident from onset of the crisis. However, early on in the crisis Ms Lagarde, then finance minister for France, and Ms Merkel seemed to intimate that a haircut on sovereign debt was not to be considered as a crisis response. It was not until the first week of April 2011 that Mr. Schaeuble, finance minister for Germany, introduced the possibility that an exception in this respect might be made for Greece. Even at this juncture it was possible to reduce Greek sovereign debt holdings, albeit crystallizing a substantial loss and capital erosion. It is evident that no adequate action was taken and a fatal loss ultimately incurred.
It is not unusual for domestic banks in the eurozone to carry disproportionately large holdings of the domestic sovereign debt. However, Greek debt is not domestic for Cyprus banks. Why did the central bank not address the disproportionate holding of Greek sovereign debt by Cyprus banks? Here the offshore banking ‘success’ may have played a part. Large deposits need a home. Given the small size of the Cyprus sovereign bond issuance and the Cyprus economy, this home was inevitably going to be abroad. In the minds of the Greek speaking Cyprus hierarchy I can imagine Greek sovereign debt being seen as the closest instrument to a domestic sovereign bond. The rest is history that is still being made.