The Cyprus banks are due to open on Thursday (28th March). But the agreement includes the unprecedented (for the EU) provision for strict capital controls (restrictions on the movement of and free access to money) and as expected depositors will lose significant proportions of their deposits in the stricken banks. The new plan will plunge Cyprus into a deep depression, send unemployment soaring from the already high 15% level. Laiki Bank (sic “Popular” Bank) will be dismantled, with the loss of 2,500 jobs, and the country’s role as an offshore financial center is in tatters.
“We are looking at a very grim future for Cyprus,” said Michael Olympios, chairman of the Cyprus Investor Association. “Even firm believers in European project like myself see now that it was a bad idea and that we should have at least stayed out of the euro.”
As jobs disappear and the economy contracts, Mr. Olympios said, faith in Europe will wither. “I used to be a believer. Not anymore.”
The mechanics of the agreement are stark; deposits below €100,000 are now safeguarded “in accordance with EU principles”, a statement from the Eurogroup of single currency finance ministers said. Instead, the money Cyprus needs to raise towards it bailout, now more than the €5.8 billion it was first reportedly trying to raise, will in part come from winding up its second largest bank (Laiki). Losses will be taken by Laiki shareholders, junior and senior bond holders and uninsured deposits (i.e. over €100,000). The Bank of Cyprus will assume “good bank” parts of Laiki (if there are any) and critically the 9 billion liability from earlier loans from Europe’s bailout facility to Laiki Bank.
The agreement to “restructure” (collapse) the Cyprus banks will be devastating for the Cyprus economy. What money is left will soon go, and reports tell us that many Russians have cleverly avoided the lock-down upon bank funds by withdrawing them from London and other offices while capital controls were put in place. This will only place greater burdens upon the Cyprus based depositors who have not been protected.
Dutch Finance Minister and Eurogroup Chairman Jeroen Dijsselbloem called the plan: “a new template for resolving Eurozone banking problems” whereby depositors will be on the hook for future bank bailouts. Although under great pressure, he withdrew his comments later, making the argument that Cyprus is a special case (as Greece was), presumably worried that his comments might spark depositor flight in places like Spain or Italy. Yet, still the points he made are valid and cannot be ignored. The powers that be have thrown the local depositors “under the bus” and now its been done, this approach will always be on the table for future crises, regardless of whether his comments were retracted or not.
Dijsselbloem and the rest of Europe has a problem. If you look like you are taking a soft line with banks that get in trouble, you encourage excessive risk taking and banks get in trouble. But if you take a hard line, you risk promoting a panic and banks get into even greater trouble.
A local or global crisis
Cyprus has occurred against a global backdrop of stagnating economies, poor growth, negative interest rates, and accelerating money printing including quantitative easing to meet burgeoning government deficits and devalue currencies (currency wars). The US and Europe are leaders in this regard. As their economies have deteriorated, commercial banks have suffered – bad debts are accumulating and bank directors are taking ever greater risks to protect their bonuses and rebuild their balance sheets. Governments are keeping interest rates at record low levels to avoid the interest costs on their deficits from exploding, and to give banks the best chance to trade their way out of trouble. At the same time welfare costs are ballooning (with growing unemployment), medical commitment (aging hospitals and costly technological advancements) and pension costs (aging population profiles and greater longevity) are spiraling out of control in relation to flat economies. Austerity is exacerbating the problems and not generating growth, and the money printing will lead to high levels of inflation, if not hyperinflation.
In this context to declare that depositors can no longer feel safe in the banking system is a monumental error in a system that relies on confidence to survive. The imposition of capital controls, which is against European law, is also a hugely significant red flag announcing that investment in this system could mean that you cannot get your money back when you need it. The BBC termed the capital controls as “financial imprisonment”. The natural implication is to assume that your capital is not safe from confiscation, and to be used for future bank bailouts. The shadowy tax of inflation and austerity (which both hit the poorer most) is not enough to solve the crisis, so more draconian steps are now on the agenda with little Cyprus being the trial balloon. We will all remember the Cyprus precedents for a long time.
The root cause of the problems
The general public will be horrified to realise that their deposits with banks are not safe, that they are in effect giving loans to banks which can then gamble with those deposits with relative impunity, and generate large profits or swingeing losses for the bank. If losses, the bank bondholders, shareholders and depositors will bear the losses. Until now governments have bailed out banks and secured depositors (with taxpayer money), but the risks/losses are seemingly now too large. Bank Directors can hide behind limited liability, so enormous risks can be taken with impunity. The Directors will walk away when it goes wrong without financial responsibility for the risks they took.
This lax company structure (limited liability) encourages excessive risk taking, and with careers short, why wouldn’t Directors bet the farm to generate short term bonuses, when it is not their money. Until full liability for all transactions is undertaken by those responsible for entering them, and until this is within a company structure which ensures that there is a valid “responsible body” for these transactions (as demanded in Islamic contract law) then it will continue and worsen. That governments have entertained bailouts only worsens this moral hazard.
The notion of political union as espoused by the European union has also been badly damaged. Any political union in which the strong (Germany, Netherlands, Finland) can dictate to and effectively devour the weak (Cyprus, Greece, Portugal, Spain) is no real union. Many queried whether a currency union without unified taxation, welfare and social policies, could work. A union without real political unification is badly flawed. The European union is a club of northern states that benefit from the work and spending of their southern neighbours, and an artificially cheap currency. The southern club are learning the harsh realities from their northern neighbours who now impose bailouts at high interest rates and force depositors to pay for company Director failures. The absence of aid or provision of help without strings shows that there is no real unity between these countries, only dog eat dog at a state level.
Commentators may attempt to denigrate Muslim work to re-unify the Islamic world within the Caliphate political structure, yet the Khaleefah would never use union as an opportunity for the strong to devour the weak.