After the Cypriot bank deposit one-off tax

The Cypriot Parliament was to decide over the issue of the deposit levy, but sources stated that they postponed the issue until today [further delays rumoured]. I am not a Member of the Parliament (not a very pleasant occupation these days) yet if I were, I would be worried about several complications the 6.75-9.9% tax would cause.

1. What happens to the money? If the haircut goes through, then the two big banks (Cyprus Popular and Bank of Cyprus) will have an additional €5.8 billion in cash. From what I can assume, approximately €4-4.8 billion will be put to the former bank and €1.8-1 billion to the latter bank in order to raise their capital adequacy ratios (namely Core Tier 1 and Tier 1). Then, as shareholder equity will be increased to account for the increase in share number, cash amount will also be increased by those amounts. What will the banks do with that money? If we assume that assets are down (due to the levy), adequacy ratio will not be so hard to reach and even exceed. Thus, the banks remain with three options: use it to infuse liquidity in the market by way of lending, keep it as reserves or fund government debt.

Option 1 would be the best for the overall economy, since it will boost businesses and assist in both consumption and investment. The only drawback is that the Cypriot people may just be too scared to invest or consume now. Option 2 will do nothing more than safeguard the banks in the case of the economic environment worsening (which it will if Option 1 is not used). Option 3 will be very good for the state, yet the economy will not be able to enjoy this as the state cannot boost activity through payments or investment (given the austerity measures and its agreement to abide by it and reduce its budget deficit).

Ideally, a combination of all three would be the best choice. Keep some money as reserves, boost the economy by providing liquidity in the form of loans and fund some government debt in order for the state to continue functioning smoothly.

2. Why does Cyprus need so much money (about €10 billion) to sustain its government debt if its deficit will be less than 3% in 2013 and Russia will roll-over the €2.5 billion loan?

The question is pretty obvious: if the 2013 deficit is expected to be approximately 3%, which is considered a yardstick for debt stability, why does the island need  €10 billion? In 2013 the debt maturities are:

JPM Maturites on Cypriot debt

This means that all that is needed is to roll-over the debt, provided that no surprise expenses arise. Even if they do, then part of €5.8 billion obtained from the deposits levy can be used to fund those. Then, the question once again becomes why does Cyprus need an additional €10 billion?
3. What happens to loans attached to deposits?
This is what many banks do: they lend you €X while they freeze your €X cash amount in their accounts. Thus, they benefit from interest rate difference and you get a much lower rate. This kind of loan is considered to be 100% safe. Yet if you have a €110,000 loan guaranteed by a same amount term deposit then the levy would mean that your deposit is now worth €102250 (6.75 until €100,000 and approximately 10% after that). This is equal to a 7.05% decrease, which the bank would now have to assign an appropriate risk weight to. I cannot know the numbers, but how much will that additional risk weighting cost Cypriot banks? (and this time were are talking about all the banks, not just the two big ones)
4. Why sell out all bank branches in Greece?
Greek Finance Minister Giannis Stournaras has announced that Greek banks will almost surely take over the operations of the Cyprus banks subsidiaries in Greece. The problem with this situation is that Cypriot banks have assumed all the damage so far (i.e. 70% PSI, bad loan write-offs) which exacerbated their balance sheets. In addition, Greece is most likely out of the deep now and will start growing again in 2014-2015. Admittedly, the worst is done. If we already know this, how can Cypriot banks grow over the next decade if they are being denied all opportunities? They have taken all the damage there was to take, and now, just about when things are going to get better they cannot get the opportunity to profit from their operations. Now, that doesn’t sound like a good scenario does it?
5. How can the outflow of money be stopped? 
Nobody doubts that many foreigners will intend to remove their money from Cyprus. Some will, others will not (the rationale for the latter being they have already taken what they wanted). Yet, can Cypriot banks cope with such an outflow? Wouldn’t that severely damage their deposits’ base? How will regulators and banks react if on Tuesday €10 billion want to exit the system? Bank runs can be electronic nowadays, too…

About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.

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