Cyprus's four op­tions to avoid bank­ing col­lapse

The Pak Banker - - OPINION - Me­gan Greene

THE only thing worse than Cyprus ac­cept­ing the rot­ten bailout pro­gram that Euro­pean pol­icy mak­ers agreed on late last week was Cyprus re­ject­ing it. Yes­ter­day, the par­lia­ment voted de­ci­sively against the terms of the bailout, with 36 mem­bers op­pos­ing it, the rul­ing party ab­stain­ing and not a sin­gle vote in fa­vor.

Pol­icy mak­ers will have to come up with a new plan, and they had bet­ter hope the Euro­pean Cen­tral Bank buys them enough time to do so be­fore Cyprus's fi­nan­cial sys­tem melts down.

A bank hol­i­day was de­clared at least un­til to­mor­row to pre­vent pan­icked savers from with­draw­ing their de­posits from banks when they learned over the week­end that a levy may be im­posed on de­posits as part of a bailout pro­gram.

If de­pos­i­tors were wor­ried about los­ing their sav­ings be­fore, they should be even more wor­ried now. Last week, the ECB threat­ened to cut off emer­gency liq­uid­ity as­sis­tance to Cyprus's two main banks in the ab­sence of a bailout pro­gram. This would re­sult in the im­me­di­ate col­lapse of both banks, and they would de­fault on their debt and most, if not all, of the 30 bil­lion eu­ros ($39 bil­lion) in de­posits they hold.

Faced with a bank run and the col­lapse of its largest fi­nan­cial in­sti­tu­tions, Cyprus would only be able to res­cue its banks and its econ­omy by print­ing money and leav­ing the euro. Luck­ily, this needn't hap­pen. A much more likely out­come is that the ECB will first im­pose cap­i­tal con­trols. The euro area is founded on the prin­ci­ple of free­dom of goods, la­bor and cap­i­tal, but Ar­ti­cle 65 of the Treaty on the Func­tion­ing of the Euro­pean Union stip­u­lates that cap­i­tal con­trols are al­lowed when "jus­ti­fied on grounds of pub­lic pol­icy or pub­lic se­cu­rity." We have al­ready seen cap­i­tal con­trols this week in Cyprus, with the bank hol­i­day and trans­fers frozen. Once banks re­open -- sched­uled for to­mor­row but prob­a­bly post­poned un­til next week -- we can ex­pect de­posit flight from Cypriot banks. A bank run is no prob­lem as long as the ECB con­tin­ues to fi­nance it by plug­ging the gap with con­tin­ued emer­gency liq­uid­ity as­sis­tance. Af­ter par­lia­ment's re­jec­tion of the bailout deal, the ECB an­nounced yes­ter­day that it would of­fer Cyprus liq­uid­ity within "ex­ist­ing rules," a strong in­di­ca­tion that it will back down from its ear­lier threat to take the punch bowl away and shut down emer­gency fund­ing to banks.

Cap­i­tal con­trols and the ECB's emer­gency fi­nanc­ing can buy time for Cyprus, but the tiny is­land will still need at least 17 bil­lion eu­ros in bailout fund­ing. So far, the 10 bil­lion eu­ros that the In­ter­na­tional Mon­e­tary Fund, the Euro­pean Union and the ECB of­fered in the orig­i­nal deal are still on the ta­ble, but Cyprus needs to find an ad­di­tional 7 bil­lion eu­ros. There are four po­ten­tial sources.

The best op­tion would be for the government to ac­cept that wealthy Rus­sian de­pos­i­tors have al­ready been well and truly scared off from Cypriot banks, given de­vel­op­ments over the past few days, and im­pose a big enough levy on unin­sured de­posits to avoid hav­ing to tax in­sured de­posits. The government re­mains stub­bornly pro­tec­tive of the coun­try's sta­tus as a tax haven, so this op­tion seems un­likely, though not im­pos­si­ble.

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