The Eurozone Crisis Takes a New Twist

Just when it appeared that stability was returning, late on Friday, tiny Cyprus announced that its banks bailout will be paid for by depositors rather than the banks’ creditors or the pooled resources of the EU stability funds. Predictably, the announcement caused runs on the banks, which promptly shut down, as households attempted to remove cash before the government appropriates up to 10% of savings. The decision was made following talks with the EU and IMF and is subject to parliamentary approval on Monday.

The Cypriot bailout provides a new twist to the ongoing eurozone story. For the first time, depositors who may have had nothing to do with risky lending practices are asked to pay the bill to avoid default. Creditors including the ECB and German banks would be kept whole.

The bailout sets a dangerous precedent. Depositors in larger countries like Spain and Italy may see the situation in Cyprus as a catalyst for withdrawing savings before it’s too late. Until now, households in these markets have kept their savings in domestic banks though corporate depositors have not. If the decision to appropriate savings is approved, the thinking may change: since deposits can be appropriated in one EU country, why not in another?

A run on banks in a larger market would reverberate through the eurozone causing sharp economic contraction in that market and steep losses for creditor banks in neighboring northern European countries.

Implications for Your Strategic Planning:

  • Eurozone recovery pushed further into the horizon – Countries will be less likely to take immediate action to address insolvent banks because the new tradeoffs are so steep. As a result, bank lending will remain stalled and troubled economies will continue to contract.
  • Eurozone bank runs more likely – Even if depositors in weak eurozone markets do keep their cash in banks this week, the risk of bank runs will not dissipate. Because bailouts for markets like Greece and Portugal are ongoing, future negotiations may include demands to appropriate deposits from savers. There is no EU-wide deposit insurance and the deal with Cyprus superseded Cypriot deposit insurance law, wiping it out.
  • Creditor countries will make the rules – Harsh policy proposals coming from Germany and other creditor countries should be taken seriously as they are more likely to be enacted without support of countries in crisis. The precedent created around Cyprus protected Germany as the primarily German-funded ECB will not lose any money on its loans to Cyprus.
  • Increased probability of eurozone breakup – The new tradeoffs imposed by creditor countries makes staying in the eurozone less attractive. Governments will have to appropriate assets from savers, overturn national deposit insurance laws, and neuter domestic banks’ ability to recycle savings to restart economic growth. Popular support for anti-euro parties, like Beppe Grillo’s in Italy, will only increase.

Signposts to watch:

  • Cypriot parliamentary decision – Cyprus’ parliament will vote Monday to pass the bailout terms. A ‘no’ vote will make a eurozone exit more likely and a ‘yes’ vote will make bank runs more likely, both setting dangerous precedents.
  • Bond yields – While the value of bank deposits is a more important indicator, it is not published frequently. As a result, look at bond yields on Spanish and Italian banks. Rising yields indicate potential trouble, and flat yields indicate that contagion has not spread.
  • ECB response – Watch for an announcement about bank deposit insurance or cash injections into national banking systems. If there is a run on banks, these actions will be needed at the onset to stop them. Lack of an ECB response will confirm that the central bank does not “stand ready to act” as it publically stated.

Suggested Actions To Consider:

  • Remove any remaining corporate deposits from Portugal, Spain, Ireland, Greece and Italy.
  • Immediately communicate the significance of this seemingly minor event to corporate stakeholders who may believe the eurozone is entering a recovery.

Revisit and update your eurozone contingency plans or work with FSG to create them if they are not in place.

 

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