As was to be expected, a deal has emerged over the weekend to deal with the demand by the European Central Bank that Cyprus needs to come up with 5.8 billion euros or risk going bankrupt.
Under the new plan, the bulk of the funds will be raised by forcing losses on wealthy savers in two of the country’s banks, with the remainder coming from tax increases and privatizations.
Laiki, the country’s second-largest bank, will be restructured, with all bond-holders and people with more than 100,000 euros in their accounts facing significant losses. The bank will be dissolved immediately into a bad bank containing its uninsured deposits and toxic assets, with the guaranteed deposits being transferred to the nation’s biggest lender, Bank of Cyprus.
Deposits at Bank of Cyprus above 100,000 euros will be frozen until it becomes clear whether or to what extent they will also be forced to take losses. Those funds will eventually be converted into bank shares. German Finance Minister Wolfgang Schaeuble said he expected a bit more than 50 percent of savings at Bank of Cyprus will be involved in the swap.
The good news is that the deal seems to have preserved, for now, the guarantees of those deposits under 100,000 euros, thus sparing small savers. But they will undoubtedly be hit in other ways as the austerity measures kick in.
Felix Salmon analyzes the new deal and says that the issue is not settled yet, but that there is one development in particular worth watching.
Meanwhile, the resolution of Laiki is going to give the world a very real example of what happens when a too-big-to-fail bank is allowed to fail. Laiki is small by global standards, but very large by comparison with Cyprus’s GDP. If Cyprus can survive Laiki’s collapse, then maybe — just maybe — the world could cope with the “resolution” of a big bank like Citigroup. But that’s a very big “if”.
It will be interesting to see what happens when the banks open tomorrow. It is expected that some restrictions will be imposed on capital flows.