US and Europe

Cyprus Bailout – The Right Decision?

Tuesday March 26, 2013 Hugh Dixon

 

On Monday 25th March (NZ time), the Cypriot Government along with the heads of the European Union (EU), the European Central Bank, and the International Monetary Fund, came to an agreement about how Cyprus would raise the €5.8 billion from its banking sector.  The funds were needed to obtain a €10 billion bailout from the EU, and came just hours before the imposed deadline from the European Central Bank, which had been providing emergency funding to Cyprus.

 

The agreement involves the Cypriot Government transferring deposits of under €100,000 from the Popular Bank of Cyprus to the Bank of Cyprus, in order to create a single ‘good bank’ out of the two ‘bad banks’.  By undertaking this action, it is thought that the Bank of Cyprus would become financial sound.

 

To raise the €5.8 billion from the banking sector, deposits at the Popular Bank of Cyprus over €100,000, which under EU law are not guaranteed, will be raided.  It is unlikely that depositors with over €100,000 in the Popular Bank of Cyprus will get any of their money back.  Also depositors with over €100,000 in the Bank of Cyprus will find that around 35 percent of their deposits will be taken.

 

This agreement represents the first time in the Eurozone financial crisis that depositors are being forced to pay for the mistakes of the banks they store their money in.

 

But is the agreement the right one?  In the short-term it has seen the Cypriot Government get the bailout it needed to avoid insolvency and refinance its troubled banks.  In the long-term, by punishing depositors, has this agreement damaged the trust the public throughout Europe have in their banks?