Haircuts imposed on Cypriot depositors – ramifications

The ramifications of the terms for the bailout of Cyprus agreed at the weekend will shake the European banking sector and lead to higher interest rates for bank deposits.

Early on Saturday, Cyprus reached an agreement with international lenders for bailout help. As part of the original agreement bank depositors with more than €100,000 in their accounts will attract a once off levy of 9%. Those with less in savings will see their accounts reduced by 6.75%. Cyprus has also agreed to increase its corporation tax rate to 12.5%. Since Saturday some amended levies have been proposed and will be considered by the Cypriot parliament including a flat rate of 15% on deposits exceeding €100,000.

This bailout plan differs from other recent EU/IMF plans in that it imposes losses on bank depositors. In a clear shift in EU policy, Cyprus is being treated as a ‘special case’. However a precedent has now been set that depositors can no longer assume that the EU will protect their deposit balances.

EU ministers also agreed to give Ireland and Portugal more time to repay their bailout loans but no further details have been provided. The move in Cyprus certainly represents a major shift in approach to national bailouts.

I would expect to see companies’ treasury and cash management policies reviewed in the days and weeks ahead. It is likely that corporate and financial institutions will take a different view on the credit risk of cash balances in the banks of certain other countries.

The finances of Greece, Portugal, Spain and Italy remain vulnerable. Ireland appears to have turned the corner and it should not require a further bailout. However, if uncertainty created as a result of the Cyprus deal leads to ‘panic withdrawals’ of deposits from banks, further capitalisation of the banks in these countries might be required. If another bailout or a restructuring of existing bailout terms is required, then depositors might be forced to take a hit.

The Cypriot deal sets a precedent in that depositors must now accept more risk when they leave cash in bank accounts. This will also have ramifications for banks in the financially weaker Eurozone countries. The greater risk factor now will inevitably mean bank depositors in those countries will seek higher interest rates putting a new squeeze on banks margins.