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Hell Breaks Loose in Europe as Banking Crisis Unfolds: Depositors' Money May Be Seized

In Cyprus, money deposited safely in banks will likely be seized and used to “bail in” the country.

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Editor's Note: The deposit grab will not offiically happen until parliament meets. A vote schedueled for Sunday has been delayed until Monday.

Saturday morning we learned that after hours of tense negotiation, Europe has hammered out a 10bn euro “bailout” of Cyprus. I put the term bailout in quotes because the key feature of this deal is the bail-in of Cypriot depositors to the tune of 5.8bn euros, about a third of Cyprus’ GDP. This means that depositors went to sleep on Friday night and woke up Saturday to find that their money, deposited safely in Cypriot banks, had been seized and used to “bail out” the country. While the bail-in became official EU bank rescue policy during the Spanish crisis last summer, bank depositors were never mentioned at that time. I see this as an extreme measure which, if the European banking crisis continues elsewhere, will have very negative implications for bank depositor confidence in other European periphery countries.

The mitigating factor in terms of preventing a loss of confidence in the European banking system is that the bail-in will happen principally via a one-time 9.9% levy on deposits over 100,000 euros. This is a bank holiday measure that means that Cypriot bank account holders with funds over 100,000 euros will have 9.9% of their account holdings deducted from their accounts when banks open on Tuesday. However, importantly, an additional 6.75% levy is going to hit deposits below that 100,000 euro level. As a bank depositor, given a one-day national holiday to decide what to do with your now shrunken savings, what would you do?

Cyprus’ finance minister Michalis Sarris said large deposit withdrawals would be banned. Jörg Asmussen, a German member of the ECB board and a key ally of Angela Merkel, added that the part of the deposit base equivalent to the actual bail-in levies would be frozen immediately so the funds could be used to pay for the “bailout”. The Financial Times has the best immediate write-up on this. The finance minister is quoted this way in that article:

“I am not happy with this outcome in the sense that I wish I was not the minister that had to do this,” Mr Sarris said. “But I feel that the responsible course of action of a minister that takes an oath to protect the general welfare of the people and the stability of the system did not leave us with any [other] options.”

Some of the bailout lenders like the IMF had actually been calling for Cyprus to seize all deposits larger than 100,000 euros. So this falls well short of those demands. Nonetheless, a rubicon has been crossed. Not only are senior bank debt lenders now on the hook before a single penny of European Union loans or guarantees flow to busted eurozone countries, but so are subordinated debt holders and so are even depositors. As an EU citizen, you must now believe that any lending exposure you have to a bank whether as a bond lender or deposit lender can be seized and confiscated by government, no matter how small the exposure. The FT notes that “[e]ven Ireland, whose banking sector was about as large relative to its economy as Cyprus’ when it was forced into a bailout in 2010, never considered such a measure.”

Bailout fatigue is the driving force behind the Cyprus bank deposit bail-in. The logic here is the same logic that was at work in the confiscation of subordinated debt holders’ money in the Dutch bank SNS Reaal’s bankruptcy. The principle is that the direct lenders of banks will now become the main parties to lose money in any future EU bailout deal. Significantly, sovereign balance sheets will not take a hit unless nationalized banks’ direct lenders do first.  No loans and no guarantees will flow before appropriate haircuts are given to the direct bank lenders. And we can see now that this includes depositors. This approach was first adopted as principle during the Spanish crisis last year. European policy makers see bail-ins as critical in breaking the sovereign-bank nexus which has been so destructive during the European crisis.