Cypriot bailout 2.0: Don’t underestimate the impact

Monday 25 March 2013 19.34

by Business Editor David Murphy

It is unclear what Cyprus will do to replace its financial services industry

The revised Cypriot bailout is startling.

Not only does it aim to sort out the banking mess, it also intends to extinguish part of the Cypriot economy and replace it with something else; but what? That part is unclear.

The decision to burn large depositors and shut its second biggest bank will permanently damage Cyprus’ financial services industry and result in thousands of job losses.

Brussels says this was an unviable industry which could not have continued.

That move has blown a gaping hole in the Cypriot economy which will have to be filled.

The European Commission president Jose Manuel Barrosso vaguely stated: “if there are some investments of European companies I believe Cyprus can restart.”

It is worth taking a step back.

Cyprus joined the euro in 2008. By that time the banking crisis was already underway in the EU following the first run on a bank in over 100 years with the collapse of British lender Northern Rock.

Brussels considers Cyprus to be a casino financial system with a dubious money laundering track record. But this predates the island’s entry to the euro.

So why was the island allowed to join the single currency while these issues were unresolved?

Europe has not answered that question. Instead it is trying to fix the mess left by its poor decisions in the past.

However, the latest Cypriot plan has set some important precedents for Ireland and other bailed out economies.

Firstly, burning senior bondholders is now acceptable, although the Troika insists Cyprus is a “unique situation.”

Much of the €35 billion cost of bailing out Anglo and Irish Nationwide went to repay senior bonds. One positive impact of the Cypriot crisis is that it lends weight to Ireland’s argument that it should receive more financial support for bearing the full cost of compensating bondholders.

Secondly, imposing losses on depositors has ramifications.

Many countries caught up in the eurozone crisis have not yet fathomed the full extent of their banking problems. That means future recapitalisations could impose losses on large depositors.

As pointed out in this blog last week, this could set the clock back for Irish banks hoping to regain the trust of big depositors.

While the Irish banking crisis may have stabilised that cannot be said of Spain, where property prices could fall another 15%.

So after the Cypriot bailout if you were running the treasury division of a large corporation would you leave spare cash in a eurozone country with financial difficulties?

 

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