Cyprus’s parliament couldn’t have been much clearer in its rejection of the plan, negotiated between eurozone members, to bail out the country’s failing banks. As a result, Cyprus is now turning from Brussels to Moscow for a lifeboat, and it looks like a deal might be done. Russia is demonstrating once again that is never backward in coming forward to build (or buy) new strategic alliances.
Yet outside the markets pages of the Financial Times, the merits of the original plan seem to have been little-discussed, with the assumption being that the plan was a universally bad one. But actually the idea seems to have been a sound one, and it was the cack-handed implementation at which the EU excels which led to its failure.
The basic plan was to fund part of the bailout of Cyprus’s banks by imposing a levy on desposits held in Cypriot bank accounts, with depositors losing a portion of their cash deposits and gaining in return the equivalent amount of equity in the respective bank.
How one views such an idea depends on how one views the nature of bank deposits. Are they simply a way for ordinary people to store their savings and earn a bit of interest, or are they a way to invest large amounts of money to make a return?
Actually, they are both. The vast majority of despositors fall into the first category, but in a banking system like Cyprus’s, a large proportion of deposits (in value terms) falls into the latter.
Most of those who put a few thousand euros in their local bank are clearly not primarily doing so as a conscious alternative to, say, speculating on the stock market or buying bonds. They are doing so because it is a convenient way to store one’s cash.
But the wealthy Russians who hold hundreds of millions of euros in Cypriot banks are doing so because it earns them a good return. Here, courtesy of the FT, is why those wealthy Russians have their money in Cypriot and not German banks:
And those foreign investors who put their vast quantities of cash into Cypriot rather than German banks knew exactly why they were being paid a higher interest rate: because it was a riskier investment. Cypriot banks were overleveraged compared to other European counterparts, so borrowing money therefore became more expensive.
And that is the key thing to remember: depositors are lenders. Borrowing people’s cash is one of the ways in which banks raise the funds which they then invest to make a return. And just as the other ways in which they can raise funds- selling shares, issuing bonds and borrowing from the financial markets – carry risks for those investing, so too does being a depositer.
For small depositors, it is understandable that they don’t think of their deposits in that way for the reasons set out above. And that is why it is right, and necessary, for governments to guarantee small deposits.
But the idea that all deposits should be protected is nonsensical. Those investing large sums of money as bank deposits are making a choice to invest in this way. They are receiving a return on that investment which corresponds to the risk of losing the principal sum. And when that risk turns to reality, they should not be cushioned from losses either by ordinary taxpayers or by governments from countries who have maintained responsible banking systems.
But this demonstrates the woeful implementation. Before this proposed bailout all bank deposits under £100,000 had been guaranteed; the levy would have reversed that guarantee, destroying both confidence in the banking system and trust in the EU.
Properly implemented, this plan would have made large depositors realise that they are not investing risk-free, and as the FT’s Izabella Kaminska points out could have started the journey from a banking system overreliant on debt to a sustainable one with a higher reliance on equity. In simply being proposed it might just do that, but it will now have been at the cost of yet more people losing faith in the compentence of the EU.
* Nick Thornsby is a day editor at Lib Dem Voice.