The painful sequels of the Cyprus bailout

The against-the-clock deal to save Cyprus from a total bankrupt may lead exactly to the situation everyone wanted to avoid. The climate of distrust is preventing the country to go back to normal. Draconian controls to impede a bank run will force citizens to pay with cash, something that will definitely harm the banking sector and bring the economy to a halt.

Those with smaller deposits at Laiki Bank will see their accounts transferred to the Bank of Cyprus, a clear invitation for them to hide their cash under the mattress. Next step is a deep uncertainty, since the only thing we know is the financial system has been severely crippled. It was oversized, indeed, yet it was the island’s main activity.

The ECB can help with cash injections but this will not be enough shall the solvency problems worsen. This crisis will have dramatic consequences in Cyprus as well as in the rest of the euro zone. These new measures such as the forced closure of Laiki Bank, the tax on deposits or the control on the banking sector have increased the public’s distrust. European banking sector will probably have to pay a bigger price for those hard measures.

Cyprus government has played its cards with miscalculation, thinking that it would be able to save time to obtain Russia’s help. This has been Nicosia’s irresponsible attitude for the last years, a permanent escape forward, with an external debt (75pc from the banking sector) around five times its GDP.

Cyprus wanted to keep its financial capital’s status based on a lie, as we can clearly see in its Central Bank’s website: its banking system practically lived off deposits, which were highly remunerated and financed other domestic sectors. Its financial relevance had more to do with the money’s origins. And the most important thing is without any doubt the gigantic domestic credit bubble.

Nicosia didn’t want to know about this huge snowball that was putting the whole economy at a risk, as EBA stress tests showed, and this cannot be justified. Neither can the ECB attitude of total inhibition. A doubtful way to give the public confidence. The European Commission as well as the rest o the euro zone members did not worry at all either until the crisis started.Cyprus was not meeting its deficit targets but that was irrelevant compared to the huge problems of a whole financial system on the brink of collapse.

Europe has proved again that it does not know how to prevent risky situations nor handle them without pulling the trigger. The Euro group has manifested its myopia and total submission to Germany. The open gap between the IMF and the EC, as well as ECB carefree behavior are worrying, the symptoms of the euro zone disorientation.

About the Author

JP Marin Arrese
Juan Pedro Marín Arrese is a Madrid-based economic analyst and observer. He regularly publishes articles in the Spanish leading financial newspaper 'Expansión'.

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