Cyprus bail-in deal may not be the last

by George Hatjoullis

Euro Currency

Euro Currency (Photo credit: Images_of_Money)

The answer to my previous blog is evidently that Bank of Cyprus is being restructured. No great surprise except perhaps to uninsured depositors and bondholders that were still in situ. The ‘rescue’ package for Cyprus is quite tidy in some ways. There is no need for further parliamentary approval because it can all be handled under emergency legislation already in place. Just as well i expect. The burden of the Cyprus contribution to the financing package is borne by the two banks that are at the heart of the problem.

Laiki bank will be closed and all insured deposits passed on to the restructured Bank of Cyprus. All other creditors of Laiki will find themselves owning part of a ‘bad’ bank.Not very much but they can always hope. Bank of Cyprus will be recapitalized by a conversion of debt to equity for creditors apart from insured depositors. In other words, a huge haircut for everyone else, the size as yet to be determined. Bank of Cyprus will accept liability for the 9 billion euros of emergency liquidity provided by the ECB to Laiki (a big bargaining chip for the Cypriot president). However, at least the bank of Cyprus is still in business, albeit in much reduced circumstances. Nevertheless, it may still be a while before it opens for business. A first for eurozone bail-outs(ins) is that senior creditors are not immune. The troika will now advance 10 billion to Cyprus and Cyprus is still in the eurozone (lucky Cyprus). Membership can still be classified as ‘irrevocable’.

The problem is that this is unlikely to be the end of drama. The damage to the Cyprus economy of the last week is incalculable and any estimate of economic growth built into the sustainable debt path calculated by the IMF is almost certainly over-optimistic. Cyprus is likely to need another bail-out. The structural impact of the destruction of the offshore banking model is large and there is no way it can be offset by any other sector in the foreseeable future. Consumer and business confidence has been shattered in Cyprus and the very real impact of redundancies and other austerity measures to come will depress it further. The Greek-Cypriot middle class is in severely reduced circumstances. After the shock and denial will come anger.

The gas reserves often come up in hopeful discussions. However, even on the most optimistic scenarios any benefit is some way off and the size of the benefit is indeterminate. Most important the development of these reserves runs into the insoluble Cyprus problem. Nice to know that there may be light at the end of the tunnel but the light is not yet visible. Meanwhile bills have to be paid and more debt may be the only way to pay.

The deal struck last night has kept Cyprus in the eurozone but has this done the people any favours?