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Saturday, March 23, 2013

Cyprus update – halfway to a deal, but the biggest obstacle remains

It’s looking as if there will be a deal in Cyprus, although there are some big obstacles to be crossed to get there and it is likely to go down to the wire.

Last night the Cypriot parliament voted to approve a few bills which will make a significant bank restructuring possible and allow the government to install capital controls if it sees necessary, here are the key points of what was approved (and what was not):
  • Plan to wind down Laiki bank – good assets and insured deposits below €100,000 will be shifted into a good bank which will be merged with the Bank of Cyprus. Bad assets along with uninsured depositors above €100,000 will be put into a bad bank – these depositors could lose as much as 40% of their money.
  • Ability to enforce capital controls – these are wide ranging from limiting non cash transfers to turning standard current account deposits into time fixed ones, and pretty much anything else the government deems as necessary for ‘public order and safety’.
  • The creation of a solidarity fund – this will not play a large role in the bailout deal, since it was already rejected by the EU/IMF/ECB Troika as an alternative to the deposit levy.
  • No deal on the bank deposit levy – Eurozone finance ministers will meet on Sunday in Brussels with the Cypriot parliament only likely to vote on a deal after it has been cleared at this meeting.
  • Bank of Cyprus has survived being ‘resolved’ for now.
  • The Greek bank Piraeus will take control of the Greek parts of Laiki and Bank of Cyprus.
These measures are expected to raise just over €2bn (maybe more, we’re waiting on firmed details on the solidarity fund). That still leaves €3.5bn+ to be raised to meet the €5.8bn target set by the Troika – although reports yesterday suggested this may have been raised by €0.9bn due to worsening forecasts for Cyprus. Below we outline our key takeaways from the deal.

The largest obstacle to a deal remains: Clearly, this will once again come down to the deposit levy. With a smaller amount needing to be raised, it is likely to fall only on €100,000+ deposits. As we noted yesterday a levy of between 12% - 15% looks likely, although given the bank bailout plan it could hit some big Laiki depositors especially hard. Kathimerini reports that the levy could be pushed higher and focused on a smaller group of depositors. Ultimately, though, with few alternatives left now a levy on largest depositors seems the least destructive option (but still far from ideal).

This will go down to the wire: The ECB has set a Monday deadline for a bailout deal or it will cut of liquidity to Cypriot banks. The banks are due to open on Tuesday but this could be extended if no deal is found. As long as the banks stay shut (and with use of the capital controls, see below) they may be able to buy a few days to reach a deal, allowing the ECB to reverse its decision. Still, it will be a messy few days with the Cypriot parliament unlikely to vote on the deal until the it is approved by the Eurozone and assured of passing. If the deposit levy is only on large deposits, it should gain support from DIKO (the junior coalition partner), while reports suggest some opposition members could abstain or be absent from the vote to allow it to pass.

Still, this has been left very late and the decision to approve the above measures first seems to be putting the cart before the horse. This is not too surprising though (since clearly these were easier options to push through) and reminds us of other parts of the crisis – such as the decision to approve the ESM before the EFSF was revised to be fit for purpose.

The capital controls are severe: The government has significant leeway to limit the flows of capital. People have rightly been asking questions of whether this, de facto, moves Cyprus out of the single currency. Ultimately, money is no longer fungible between Cyprus and the rest of the Eurozone and, at this point in time, it’s hard to argue that a euro in Cyprus is worth the same as a euro elsewhere. The real problem though may not be imposing the controls but removing them, as WSJ Heard on the Street points out. It is hard to see how the Cypriot economy will be able to function properly with these strict controls on and at some point questions will surely begin to be asked if it would not be better off with a devalued currency outside the euro.

Why is Bank of Cyprus not being ‘resolved’? Reports suggest the Cypriot government has fought hard to stop the bank having the same fate as Laiki. This may be because it is the largest bank and a large employer in Cyprus, but it is could also be because it remains very close to the government and is the home for some of the largest Russian depositors. In any case, avoiding the tough decision to fully restructure the banking sector is likely to make things more difficult in the future.

Greek banks are getting a very good deal: The branches of Cypriot banks in Greece have around €22bn in assets and account for 8% of all deposits in Greece and 10% of loans. Clearly they are sizeable and hiving them off helps reduce the size of the Cypriot banking sector relative to GDP and reduces the cost of the bailout. It also protects the rest of Greece from contagion. That said, Piraeus is picking up a very good deal, not least because Cypriot exposure to the Greek crisis was a key driver of the current problems Cyprus faces. The purchase was done at a symbolic €1 but the cost of recap is €1.5bn. Funding will come from the Hellenic Financial Stability Fund (the Greek bank recap fund) and the Cypriot bailout programme – €950m from the former and €550m from the latter. So these banks, investors and depositors avoid any losses despite many being entangled in the Greek crisis. The fact that Piraeus bank shares were rocketing yesterday is a clear enough sign of who did better out of this deal.

The deal has come full circle and has been very poorly managed: as we noted yesterday, we are basically back to a mix of the deal proposed by the IMF (bank restructuring) and the Eurozone (deposit levy) last Friday. The impact the events of this week will have on Cyprus should not be underestimated – there will be a huge outflow of capital (or will be whenever the controls are removed) and significant political upheaval. This has been poorly handled by both sides – the Eurozone failed to listen to the Cypriot government and was complacent about the impact of Cyprus on the wider Eurozone economy. The Cypriot government has fought to hang onto an impossible business model, focused on big finance funded by foreign deposits, and has looked to play a risky geopolitical game. Unfortunately, the ones that lose from all this are the 800,000 people who live in Cyprus.


Jesper said...

A lot depends on how they'll do the technical details.

If some of the deposits are forcibly converted in senior bank bonds then those bank bonds should be tradable. The bonds would then most likely trade at a discount. If that happened then the ones who wanted to move their money out of Cyprus can do so without restriction but it would come at a price - the discount they'd have to offer when selling those bonds.

Smaller depositors would have a difficult decision: There seems to have been some immense pressure to remove the guarantee and the guarantee survived. Does the deal prove that the guarantee is for real and strong (it withstood the pressure) or does the fact that it was being discussed prove that the guarantee is not to be trusted?

Rik said...

The original plan with some adjustments like no levy on <100K looked far superior to this thing (next to the bad publicity, which has killed Cyprus as a financial centre).
-15% or so is/was probably survivable for most >100Ks.
-now some could be hit with 50% or more. Which might be too high if you run a business. And depending which bank and a few other unknowns. Lotterylevy.
-Russia will not be pleased, why give a 2.5 Bn loan?
-my main problem with this is future bankruns will most likely be caused in other countries Lehman-way. Colleague banks and financial institutions taking the dough out. A lot under UK law as well, which makes it more difficult to stop.
This simply gives the impression that at the end of the day they will get presented the bill for a restructuring which is very likley to happen in Italy and Spain. Makes financing PIIGS banks not easier and likley see a quick move when something even remotely looking like manure comes even within a mile of a fan.

The guarantee stands as long Northern taxpayer not have to come up with large amounts. If such a situation would arise we have a whole new ball game again.
Also means that the big ones can be pretty sure they will pay the first part for the 100K guarantees. Aka their haircut is likley bigger.
Problem is some group will have to pay the bill and that group will be more careful. Small accountholders are more voters and more popular with voters elsewhere. But large accountholders and other large creditors can cause a lot more financial trouble.
As said a slightly revised original plan would probably have been a good balance. Now large creditors and Russians will be more cautious. In general a bad idea simple to hit almost at random parts of the large creditors for the sake of the middlegroup. That is Europe so it was a likley choice.