Cyprus and the deposit ‘subsidy’: collateral damage

by George Hatjoullis

There is a report in the Daily Telegraph ( this morning to the effect that if Greece achieves its planned primary surplus on target it may get a further reduction in its debt. Exactly what this means it unclear but it may mean a further haircut for private bondholders. This raises an important difference between the treatment of Greece and Cyprus.Greece was treated to a haircut of private bond holdings. Many of the bonds were held by non-Greek entities and so constituted a subsidy to the Greek economy. A significant part of this subsidy was provided by Cyprus through the holding of Greek sovereign debt by Laiki Bank and the Bank of Cyprus. This should now be fully grasped by all.

The Cyprus rescue involves a restructuring and recapitalisation of the Cypriot banking system funded by a haircut not on Cypriot sovereign debt but on the uninsured depositors of Laiki and BoC. In the mind of the troika this also constitutes a subsidy from non-domestic depositors. Christine Lagarde referred to 95% of deposits being under 100k and hence protected. The eurogroup clearly believe the bulk of the deposits above 100k belong to non-domestic entities and thus provide a subsidy, equivalent to the Greek subsidy, from ‘foreign’ creditors.

There is clearly some truth in this. However, there are important differences. First, the collateral damage has been huge. Many Cypriots had deposits over 100k. Second, no one knows exactly the split between domestic and non-domestic depositors. This is also complicated by the fact that many apparently non-domestic depositors are Cyprus residents running businesses from Cyprus. The impact for these people and the economy is the same as from the impact of losses by Cypriot deposit holders. Third, the Greek haircut on bonds was a pure subsidy with little collateral damage within the Greek economy. The deposit haircut in Cyprus has destroyed the banking sector, the single largest source of income for the Island. It has dislocated economic activity within the economy through a unprecendented closure of the banking system and continues to disrupt through capital controls. These controls may be around for a while. It has destroyed the faith of the population in their own banking system and no one knows how long this will take to restore. This is all in addition to the wage cuts, employment cuts, pension and benefit cuts, tax increases and privatisations that will accompany the package.

What if the Cypriots meet their primary surplus targets? Will the troika reward them with another haircut on ‘non-domestic’ deposit holders?