Cyprus: special case or template for eurozone?
by George Hatjoullis
The president of the eurogroup, Jeroen Dijsselbloem, caused quite a stir in the markets yesterday when he appeared to suggest that the Cyprus ‘rescue’ package was a template for the eurozone. He promptly denied this and issued a statement to this effect:
25 March 2013
Statement by the Eurogroup President on Cyprus
Cyprus is a specific case with exceptional challenges which required the bail-in measures we have agreed upon yesterday.
Macro-economic adjustment programmes are tailor-made to the situation of the country
concerned and no models or templates are used.
The denial is most likely true, not because JD is inherently believable, but because there are good reasons to believe the callous indifference shown to the Cypriot people was indeed a special case. However, that is another blog for another day.
Although Cyprus is not a template it did introduce a new precedent and does give us an insight into the evolving shape of eurozone banking reform. Why emphasize eurozone and not refer to EU banking reform? Henceforth, the EU will evolve in the direction necessary to sustain the eurozone and with little regard to the needs or objections of non-eurozone EU members. The two-speed EU that was once a constant topic of conversation has arrived. Non-eurozone EU members that will not join the eurozone will be marginalised. However, once again this is another topic for another day.
Banking union needs to reconcile the systemic nature of eurozone banking crises and the lack of a federal fiscal eurozone authority. It comes down to what is guaranteed and who makes good the guarantee. As things stand national fiscal authorities make good the guarantees. However, this can be problematic if the national authorities cannot do so (see Ireland, Spain, Cyprus and, coming to a screen near you soon, Slovenia). The banking union problem is thus just a microcosm of the wider eurozone fiscal transfer problem. Who pays?
The Cyprus example raises the possibility that some of the bank creditors pay. However, this takes us back to systemic risk. Banks are inextricably linked and one failure impacts many others. If the creditors bear all of the shock then the economic consequences of the destruction of liquid wealth can be devastating. Some creditors must be able to protect themselves and someone must provide the protection.
Perhaps the solution lies in what is protected? The Cyprus example protected all insured depositors. This makes sense if banks are viewed as purely repositories of liquid wealth. However, this is not the only function of banks. Indeed arguably the main function of banks is to facilitate commercial transactions. Everyone that has bought and sold a house is aware that very large blobs of cash have to sit in bank accounts for short periods. There would have been some Cypriots holding cash for this reason in Laiki and Bank of Cyprus over the weekend of March 15, 2013. These are not necessarily rich people. Similarly, medium to large businesses must accumulate cash to pay salaries at particular points in the month. Many Cypriot businesses may have had such balances over this fateful weekend. Of course many businesses run a perpetual overdraft with banks which are run down as cash is paid in. Nevertheless, the point is every enterprise (charities!) may have reason to have large temporary balances in the banking system in the normal course of business. Those that were unfortunate enough to have such balances in Laiki and Bank of Cyprus are screwed. It is hard to think of a more apt description.
If banks cease to be trusted as vehicles for commercial transactions then economic activity is seriously inhibited (This has probably not been properly accounted for in IMF estimates of Cyprus potential growth from now). Any banking union must take into account the transactions needs of commerce. What is needed is not just insured deposits but insured accounts. These accounts would be zero interest and could even carry a regular charge. Indeed, they could carry a negative rate of interest in order to discourage large balances being held for long periods. These would be in addition to insured deposits and designed purely to be used for commercial transactions.
A banking world in which we begin with insured accounts, insured deposits up to some amount and default risk for all other creditors which is understood in advance, is likely to be more stable. Moreover, it should be cheaper to underwrite. It still leaves the distribution of the underwriting costs between member states and the eurozone collective open but this is a subset of the wider eurozone fiscal transfer problem and one cannot be resolved without the other. Banking union and monetary union are not separate problems.