Have Cypriot deposits finally hit bottom?

Last year, we covered the Cypriot crisis extensively, and the steep decline in Cypriot deposits in particular. As we reported back then, the problem was likely to continue for some time, and did.

But now, just over twelve months on (data from end of April), Cypriot deposits may have hit bottom after increasing by €266m in April - the first increase since December 2012.

• As the graphs above show (click to enlarge), the increase was driven by money flowing in from monetary financial institutions (MFIs) from the Rest of the World (i.e. outside the eurozone), but mostly in euro currency.
• Given the well-established links between Russia and Cyprus, it is possible that some Russians could have begun moving small amounts of money back into Cyprus amid the threat of economic and financial sanctions on Russia. Of course, this is speculative, since the data is not detailed enough to see conclusively, while the continuing existence of capital controls would make moving large amounts almost impossible.
• Domestic deposits continued their slow creep downwards. As the economy continues to struggle, this is likely to continue as wages fall and people eat into their deposits.
• The headline figures remain bad. Total deposits are 34% below the level in December 2012. Given that much of this has fled the country and/or been written off, it is unlikely to return anywhere close to that level anytime soon.

Is Cyprus eyeing up an exit from its capital controls?

As expected the Cypriot government has finally reached a deal with the EU/IMF/ECB Troika over the final stage of the restructuring of the Bank of Cyprus (BoC).

As we noted in today’s press summary this was not an easy decision to reach, and has dragged on since Spring, for a couple of reasons:

• The Cypriot government was keen to limit the haircut and insisted that the BoC only had to reach a tier one capital ratio of 9% at the current point in time.
• The Troika however insisted that this 9% target applied to the end point of the bailout (2016) and therefore the bank needed a ratio of 12% currently since it will deteriorate overtime.
• As the Cyprus Mail notes the Memorandum of Understanding signed by both sides clearly fits the Troika view. Unsurprisingly it won out (as always) but the Cypriot government is still seemingly bitter about the whole affair (which doesn’t bode well for the many, many interactions between the two sides yet to come).

In the end the two sides settled on a 47.5% haircut for uninsured deposits over €100,000 – although these funds will not be completely lost but converted into shares of the bank. This is above the original target of 37.5% but below the potential limit of 60% (for the most part).

The most interesting part of this whole deal might be the following though:

“Following the recapitalisation, 12% of deposits that were previously blocked will be released (5% in total).

The balance will be split evenly into three separate time deposits of six, nine and twelve months, respectively. BoC will have the option to renew the time deposits once for the same time duration. These deposits will receive a rate of interest which will be higher than the corresponding market rates offered by the BoC.”

Of the remaining frozen deposits 12% will be released then, while the rest will first be converted to time deposits, meaning people may not have access to their money for between 6 and 24 months. There are likely a couple of motivating factors here:

1. Firstly, this eases the funding transition for the bank as it looks to return to normal operations since it locks in part of its deposit base.
2. Secondly, and more importantly, it locks in a large amount of deposits which would be liable to flee the country as soon as the capital controls are removed (not least because they tend to belong to rich and/or foreign depositors who would likely find it easier to shift their funds).

These funds are only likely to be worth around €6bn, so not a huge amount in a country with a deposit base still around €50bn and far from enough to settle the question of capital flight once the controls are removed.

But it suggests that both Cyprus and the Troika are planning for an exit from capital controls and looking for ways to stem the potential outflow. The quicker this can be done in a managed way the better for the Cypriot economy. As we have noted before, as long as the capital controls apply the hope of a recovery is slim to none in Cyprus and the euro continues to look incredibly fragmented.

(Note: the blog has been updated with new calculations. Previously it suggested the total coverted to term deposits would be €2bn, however, it is likely to be closer to €6bn). 

A turbulent Easter in Cyprus

Uncertainty continues to reign in Cyprus. Cypriot Finance Minister Michalis Sarris resigned this afternoon, seemingly confirming the earlier (denied) rumours that he had previously tried to resign and bringing to a close what must be one of the shortest stints as finance minister in recent history (35 days). To add fuel to the fire, initial reports suggest he resigned due to the on-going investigation into people moving funds out of Cyprus ahead of the bailout. Fortunately, unlike other aspects of the crisis, the Cypriot government has wasted no time in appointing a successor with Labour Minister Haris Georgiadis already lined up to fill the role.

Meanwhile, as we noted in today’s press summary (and have repeatedly suggested) the capital controls look set to last for much more than a week.We also highlighted some interesting comments by the President of the Cypriot Parliament Yiannakis Omirou who said:

“I would like to send a message to the Cyprus people that there is no other way, there is no alternative apart from freeing (the country) from the troika’s and the memorandum’s bonds…by leaving the troika and the EMS behind us, we will ensure our national independence, our national sovereignty, our moral integrity and our economic independence…If we remain bound by the Troika and the memorandum Cyprus’ destiny is already foretold and there will be no future.”

Clearly not one to mince his words.

Furthermore a draft version of the loan agreement between the EU/IMF/ECB Troika and Cyprus (the Memorandum of Understanding) was leaked yesterday. It drove home another point which we have flagged up before. Despite all the talk about depositors and banks, Cyprus is still getting a €10bn bailout, that will mean undergoing the fiscal consolidation and structural reforms (widely referred to as ‘austerity’) witnessed in the other bailout countries. The key points of the agreement confirm this:

• 7.25% of GDP in fiscal consolidation between 2012-2016.
• Freeze in public sector pensions and a two year increase in the retirement age.
• Implement a four-year plan as prepared by the Public Administration and Personnel Department aimed at the abolition of at least 1880 permanent posts over the period 2013-2016.
• Increase the statutory corporate income tax rate to 12.5%.
• Increase the tax rate on interest and dividend income to 30%.

These are but a few of the measures and the document remains incomplete. The impact on GDP is likely to be significant, while youth unemployment is already at 31.8% (total at 14%) – this is likely to rise substantially.

To add to all this, reports continue to abound about outflows of deposits before the bailout, while the banks were closed and people now trying to skirt the capital controls. Significant questions are being asked about the enforcement and implementation of all these rules. With a decision on whether to extend capital controls expected on Wednesday evening or Thursday morning the uncertainty is likely to continue.

The Great European Bank Run that never was?

Journalists were descending on banks across Cyprus this morning to monitor whether Cypriot depositors would rush to withdraw their cash as the country’s banks opened after being closed for 10 days. So far, however, there have been virtually no dramatic scenes of desperate people flocking to ATM machines and banks. There’s a feeling of calm. Those who expected Northern Rock style scenes have been left disappointed. However,  a couple of points:

• First, there’s no hard data available yet for deposit withdrawals in March, so everything is based on anecdotal evidence. There have been numerous press reports speculating about withdrawals in the run up to the bailout and even while the banks have been closed. Unfortunately, these are unlikely to be confirmed or disproved for at least a month (when data is expected).
• Remember, there are limits on what people can withdraw and/or transfer electronically. People may not be too bothered about waiting at banks if they are subject to strict limits.
• Obviously, in this day and age, much banking is done electronically so the number of people at the actual bank branches may not reveal the true level of transactions taking place behind the scenes. This is particularly true for Cyprus given the high level of foreign depositors who would have to bank electronically.

In the meantime the latest data on deposits in Cyprus in February was released this morning. Total deposits fell from €68.4bn to €67.5bn – a 1.3% fall, but not exactly as disastrous as some may have expected.

At the same time, as we predicted, depositors elsewhere in Europe – in particular Spain and Italy – have so far shown zero inclination to see themselves as next in line. There has been, however, a drop in banks shares in the wake of comments by Eurogroup Chief Jeroen Dijsselbloem.

So not the big collapse of everything that some expected, but, the capital controls are likely to play a role in mitigating this. As we have pointed out, the real challenge comes when the Cypriot government looks to remove capital controls and once the data on electronic transactions out of Cyprus becomes clearer.

When months turn into years...

About those "temporary" Cypriot capital controls:

From Iceland’s letter of intent to the IMF dated November 2008, highlighting the intention to remove capital controls “as soon as possible” (click to enlarge):

A statement by the Central Bank of Iceland dated July 2009:

“In order to remove the capital controls in a gradual, sequenced manner without inducing instability, it is necessary to reduce uncertainty about and create sufficient confidence in the economic programme. Many important steps have been taken in this direction in the recent term. These should make it possible to begin lifting the controls in the next few months.”

Yet four years on, capital controls are still going strong....

Cyprus closes the shutters as it announces capital controls

Some more details coming out about the much talked about capital controls in Cyprus (details via @MatinaStevis and RANsquawk):

• Will include limit on cashing cheques (but will be able to deposit cheques).
• Time fixed deposits will not be able to be redeemed during the period of capital controls
• Credit card transactions capped at €5k per month
• Limit to cash transfers outside Cyprus of €3k per person per trip.
• Applies to all bank accounts
• Valid for 7 days from Thursday, will then be re-evaluated.

We have already noted that these controls are pretty severe and have the potential to have a substantial impact on the economy. Below we list a few more thoughts:

• The fact that they are focused on limited external flows rather than internal transactions could be positive as it may help avoid a massive liquidity crunch in Cyprus.
• That said there could still be a very quick withdrawal of funds from banks, with people keen to hold cash instead. This could further destabilise the banks.
• Removal in 7 days seems optimistic, for two reasons. Firstly, the bank restructuring and recapitalisation may not be completed by then. But more importantly, the fears which would motivate massive outflows go further than just the banks. People will look to move money out of Cyprus because the financial sector has been massively shrunk and no longer looks an attractive investment. Furthermore, the economy looks consigned to a long period of economic contraction and its debt load may quickly become unsustainable. Lastly political unrest may grow. None of these motivating factors will be gone in a week.
• The lack of limit on cash withdrawals is a positive, although this could quickly change, especially with demand for cash likely to sky rocket.
• Many companies still use cheques in Cyprus, not least to pay employees, so limiting them could hamper the normal functioning of business. That said, since they can be deposited, this is mitigated a bit, although that only holds as long as people trust that they can access deposits - not clear they do at this stage.
• According to this via Zerohedge, any commercial transaction above €500 which sends money abroad will need to be proven to be in line with usual business practice. This will introduce a significant amount of time consuming paper work into the life of many everyday exports and importers. 

We’ll update the blog with more thoughts as more details become clear.

Let the guessing game continue: The Eurogroup's mixed messages on capital controls

As we have noted at length, the capital controls are a key part of the Cypriot deal and could have a huge bearing on how and when Cyprus recovers from this crisis. Unfortunately, as with almost all important eurozone decisions, this one lacks clarity.

The body of the Eurogroup statement said:

“The Eurogroup takes note of the authorities' decision to introduce administrative measures, appropriate in view of the present unique and exceptional situation of Cyprus' financial sector and to allow for a swift reopening of the banks. The Eurogroup stresses that these administrative measures will be temporary, proportionate and non-discriminatory, and subject to strict monitoring in terms of scope and duration in line with the Treaty.”

However, the Annex noted:

“Only uninsured deposits in BoC will remain frozen until recapitalisation has been effected, and may subsequently be subject to appropriate conditions.”

EU Internal Market Commissioner Michel Barnier added earlier today:

“Any measures to restrict or limit freedom of movement may only be enacted exceptionally and temporarily and that is what has been requested by the Cypriot authorities.”

Some pretty mixed messages. The first suggests that “administrative measures” (which is widely being taken as capital controls or related measures) will be generally applied. Bruegel suggests that this may not even need to take the form of full capital controls and could be limited to measures slowing down the movement of capital. This is contradicted by the second point which suggests they will only apply to the Bank of Cyprus uninsured depositors. Barnier’s point is closer to the first point but suggests actual controls will be needed.

FT Alphaville has an interesting run-down of the different type of capital controls and their implications. Paul Krugman makes the valid point that, if the trade-off of the single currency is reduced transaction costs in exchange for an overvalued currency, once capital controls are introduced, what is the motivation to stay inside? As he notes, wider points on the EU and access to ECB liquidity apply but it gets to the crux of the choice facing Cyprus.

As we have suggested, we find it hard to imagine that the banks could survive long without capital controls, while the economy would likely take an even bigger hit. As we have mentioned, it would fall on the ECB to continue to sanction ELA to keep banks afloat during deposit outflows, but this would amount to a large transfer of risk towards the Cypriot Central Bank (and therefore the Cypriot state, and therefore the eurozone). Meanwhile, access to the ELA is limited by the ECB’s view of bank solvency (one they have shown they may not stretch indefinitely) and assets which can be posted as collateral.

One thing that is for sure: this lack of clarity is certainly not helping an already messy situation.