Cyprus: the recipe for zero deposits

Contributed by Laveco Ltd.

March 16th 2013 will go down as a milestone in modern Cypriot history. The country, under the burden of financial difficulties, turns for help to the EU, who place draconian conditions on the bailout: all bank deposits will be affected, with 6.75% being taken from deposits under 100 000 euros and 9.9% from anything over that figure. The outcry is huge, the population takes to the streets straightaway to protest as nobody wants to lose any of their savings. In the end, Parliament votes against the recommendation and the Minister of Finance is sent to Moscow to enter an agreement with the Russians – probably involving the recapitalisation of the country and the exploitation of the gas fields situated under the seabed. After a few days the Minister returns home empty-handed. Subsequently a new proposal is put forward whereby the clients of LAIKI bank will lose everything over 100 000 euros and will be categorised as “good bank” and “bad bank” clients. Clients of the Bank of Cyprus fare a little better: they are guaranteed to lose “only” 37.5% of their deposits, with the majority of the remainder being frozen. And in the meantime all the banks in Cyprus remain closed for an unprecedented 2 weeks. I could go on and on, but here I only wanted to outline the essence of the matter as a starting point for further reflection.

None of Cyprus’s small depositors wanted to lower their genitals into the nettles. This is totally understandable: the majority of the population was blissfully unaware of the fact that the prosperity enjoyed by Cyprus for the last 40 years was due to the foreign money which had been pouring in. All they knew was that they could go to the bank for credit whenever they wanted to, and, apart from the last couple of years, they had no problems with liquidity. Thus, the Cypriots ended up siding with the greater of two evils, not even realising that they themselves were passing a long sentence on their own country. Or at least, they were in part contributing to its fate.

If we compare the original and final figures relating to the “haircut”, then the difference is startling. There is a huge gap between 6.75 – 9.9% and 37.5 – 100%. One of the conditions attached to the provision of a 10 billion euro bailout was that Cyprus had to find 6.6 million euros from its own resources. LAIKI Bank and the Bank of Cyprus between them account for some 50% of the banking market in Cyprus. If we calculate the amounts in equal proportions, then something, somewhere doesn’t add up. Even if we double the 9.9%, then we still only get 20%, and not 37.5%, which is the upper limit of the money to be lost by Bank of Cyprus clients. Not even to mention LAIKI’s 100%. True, here deposits under 100 000 euros escaped the haircut. However, nobody has ever published the final figures showing exactly how much was lost by depositors.

The amount deposited in Cypriot banks has been estimated at between 50 and 70 billion euros. For the sake of argument, let’s split the difference and call it 60 billion. It could be, though, that the proportion held by the 2 banks in question was more than 50% of the total, as they were the market leaders and had been attracting investors for decades. To this day, the real numbers have not been revealed. We could also speak about the causes here, with the heavy losses suffered by Cyprus as a result of the recession in Greece, where, apparently, the banks’ lost their money. Though even this is only partially true, as it turns out that LAIKI had been very actively financing its Greek “sister companies” as well, which had nothing to do with the devaluation of the Greek state bonds.

From the depositors’ point of view, however, this is neither here nor there. All they know is that when they try to perform a transaction on their Cypriot bank account, then two things will happen: if they had more than 100 000 euros, then they will have lost a large part of it, and they will be unable to use freely what is left because of the restrictions imposed by the Cyprus Central Bank. The Russians, presumably the biggest investors and therefore also the biggest losers in the process, put it slightly differently. In their opinion, with the collaboration of the EU, this is nothing less than authorised bank robbery. And if we’re totally honest, it really is a bit strange that instead of accepting the bankruptcy of the banks, they have chosen to nationalise a significant part of the deposits. And at this point the story suddenly goes way beyond the shores of Cyprus: the EU has used one of its smallest member states to test a method which in the future could be applied anywhere at any time. If some bank gets into trouble, then the depositors’ money can be used to save it. The recipe is simple: there is no bankruptcy as the bank simply appropriates part of the deposits and the problem is solved. Why can this happen? As one of my favourite British colleagues once said “Everyone has dirty shirts; the question is who has the most and whose are the dirtiest”. This is exactly the situation in banking the world over: they are crawling with bad debt, which, intentionally in my opinion, they have accumulated over recent decades. And if you think the above recipe through in depth, then you will realise that by applying this “elegant” solution, they can manage these difficult times rather effectively, without the slightest risk of being called to account. This way there is no need to string up bankers just because they handed out cheap loans to their cronies hand over fist, or overvalued real estate provided as collateral by 40%, or issued mortgages of several hundred thousand euros to people officially only earning the minimum wage. This can all be ignored, because, according to today’s strategy once the EU parliament gives them the nod, they are free to pilfer what they need from deposits over 100 000 euros.

And the game doesn’t end there. They don’t send the banks into ruin – although the LAIKI didn’t exactly come out too well – and the bankers aren’t made redundant. The whole infrastructure remains intact, and they don’t have to face new, possibly more efficient, competition offering better services, who may even make banking cheaper. Sooner or later the clients will come, unsuspectingly replenishing the bank deposits, part of which a couple of years down the line can be appropriated once again. It’s a perfect recipe, isn’t it? The problem is that we are the prisoners of this system. All of us. Individuals and companies alike. Today, without banks, we don’t even dare to have a good cough, as cough mixture costs money, and we can’t buy it if we don’t have a topped up bank card in our pocket because they’re trying to stamp out cash transactions.

The consequences of the Cypriot story are still unclear, as it is impossible to tell whether they wish to apply this new “technology” in all of the other EU states, or even in other regions. Who, then, would dare to place money in the banks, or leave it there for any extended period? The example of Cyprus clearly shows that the economy is starting to return to a type of primitive trading situation, where cash takes control wherever it can. Following March 16th, when the banks in Cyprus remained closed for some 2 weeks, the majority of shops and other service providers only accepted cash, or at least preferred bank cards issued by foreign banks. The lack of trust was such that even restaurants had to pay cash for their supplies. It’s true that the British, afraid that the Eurozone was going to collapse as far back as 2009, drew up a secret plan on how they would provide cash for the British citizens living in Cyprus through the Embassy in case of such a crisis. In 2013 they brought it into practice: they flew in 1 million euros in cash to cover the wages of the British armed forces based in Cyprus.

And in Cyprus there is no sign of an end to the story. In fact, it’s only just begun. Something has started, though nobody really knows exactly what it is or what it will lead to. As I have stated on numerous occasions in the past, the Cypriot economy is based on two sectors: tourism and financial services. The financial sector provides, or rather provided, the largest chunk of income. This now has been more or less totally eliminated, as international confidence in the country has been shaken and significant new amounts are not coming to the island, while existing deposits which can be moved are being transferred elsewhere for fear of further restrictions. The outward flow of money continues, and while the banks charge transaction fees left, right and centre, in the long run this will not even provide enough income to keep the system running. Although they insisted that the employees of the now closed LAIKI bank would be laid off, to this day there have been no large scale redundancies. In short, there are too many Eskimos and not enough seals; staff wages have to be paid from somewhere, offices have to be maintained and in the heat of the summer air-conditioning systems have to be operated.

As for what the future will bring, even with a crystal ball that would be difficult to say. I am certain of one thing: this will be a very long and painful process for Cyprus, which any country would have trouble getting over. Despite the fact that the banking infrastructure and culture which had developed in the island was the only one in the world capable of serving the offshore world. This is now visibly missing from the market, and such a vacuum has been created that some shrewd country with a bit of imagination could easily attract all that money which is leaving Cyprus. Some say that this is very unlikely, and it would be easier to re-start the Cypriot system, as clients with an interest in offshore banking have nowhere else to go, and then there are also the advantages offered by companies registered there. This is undoubtedly so: until now there were two countries capable of meeting offshore banking requirements in a professional manner, and these were Cyprus and Latvia. Latvia on its own can not fill the gap, and at the same time the world economy can not go on too long without offshore companies. It is all but impossible to create a country offering the right offshore banking background today, and this can not be achieved overnight.

In the case of Cyprus, something has been lost which it will be very difficult to get back. Confidence. Confidence and the long term stability which is the lifeblood of the financial world, without which the system can not operate smoothly anywhere in the world. Cyprus has lost its biggest ally, and at the same time its biggest business partner: the Russians, and they never forget when someone crosses them. Without them, however, Cyprus can not develop. The Russians are such a decisive factor in Cypriot financial life that they can not be left out when it comes to making important decisions. Presumably the leadership in Cyprus did not appreciate the significance of this when they chose the bailout package preferred by the EU. This was totally opposed to the best interests of the Russians. And the Russians play hardball, and aren’t going to give in easily. According to the official standpoint issued by the Russian media a couple of weeks after the outbreak of the crisis, the Cypriots had two choices: they either go forward with the EU and remain in the Eurozone, but at the cost of becoming one of the poorest countries in the EU, or they could make the interests of the Russians their priority, in return for which they could count on the economic might of Moscow. The latter would entail leaving the Eurozone – which of course is still an option with the other scenario – and returning to the Cypriot pound, which the Cypriots have been yearning for so long. It is also impossible to foresee what the consequences of this would be for Europe. Although Cyprus accounts for no more than 0.2% of the overall euro-basket, this would lead to a huge crack in the system which the euro might not be able to recover from, as the domino effect could set in.

The situation is extremely complicated, and the match between Russia and the EU has only just kicked off. The give and take is underway over a small country which is in pain and suffering badly, but this probably is of little interest to the big players pulling the strings. Today, as I close this article, the news has broken that the president of Cyprus has written to the EU. In his letter, he has asked the EU for a new debate on the bailout offered to Cyprus, claiming that the original plan was rushed and did not take the interests of Cyprus into account. Furthermore, the president stated that there is a huge question mark over whether or not the Bank of Cyprus can be saved, while also urging the abandonment of the fusion of the surviving part of the LAIKI bank with the Bank of Cyprus. For the time being, the EU seems to be intransigent, and shows no signs of giving in to the requests from Cyprus. So, then, is the EU capable of abandoning one of its members, leaving them in the lurch, while they spent hundreds of billions of euros on Greece?

Laszlo Varadi

LAVECO Ltd.

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