Wednesday 27 March 2013 by FIIG Research Legacy

Cypriot bailout deal finally reached

The troika and the Cypriot government agreed on key elements of a bailout and Eurozone finance ministers subsequently approved it. Although German and Dutch parliaments will likely have to vote on the measures, the Cypriot parliament will not (as the concept of a levy on uninsured depositors has been abandoned entirely). Instead, legislation already rushed through parliament on Friday to deal with the wind-down of banks will do the heavy lifting. Deposits will still be adversely affected, but in different ways. Short term there will be positive implications however when banks reopen there will be significant deposit outflows.  Doubts over the safety of insured deposits will however remain and the possibility of another euro exit has again raised the "redenomination debate".

Key bailout elements

  • All deposits less than EUR100k will be exempt from financial loss (compared the original plan for a haircut of 6.5%). However these deposits will likely be partially immobilised via capital controls – described as “administrative measures” by the Eurogroup statement. Finance ministers implied Treaty violation was not an issue here and the measures are justified “in view of the present unique and exceptional situation…and to allow for a swift reopening of the banks”
  • Deposits greater than EUR100k will be impacted depending on in which of the two main banks they were held. Large deposits held in one bank will be frozen and the bank itself will be wound down. Owners of such large deposits may in theory have to wait months before learning of their fate. The aim is to raise EUR4.2bn from these deposits suggesting the financial loss to depositors will be severe
  • Laiki will be resolved immediately utilising the newly adopted Bank Resolution Framework.  There will be full contribution of equity shareholders, bond holders and uninsured depositors. Laiki will be split into a good bank and a bad bank. The bad bank will be run down over time. The good bank will be folded into Bank of Cyprus (BoC)
  • Deposits greater than EUR100k in the BoC will remain frozen until recapitalisation has been effected.  BoC will be recapitalised through a deposit/equity conversion of uninsured deposits with full contribution of equity shareholders and bond holders. The conversion will be such that a capital ratio of 9% is secured by the end of the programme

Impacts and consequences

  • The immediate consequence of this bailout agreement is that the ECB can continue to provide liquidity to the Cypriot banking system beyond Monday night’s deadline. If liquidity was withdrawn it could have precipitated the collapse of the local banking system, possibly triggering a euro exit. However the negatives are likely to win out as soon as the banks reopen and deposit outflows accelerate
  • While the new deal corrects the negative impacts of the initial deposit levy agreement, certain damage has already been done. Doubts over safety of insured deposits will remain and the possibility of another euro exit has again raised the "redenomination debate"
  • Eurogroup President and Dutch Finance Minister Jeroen Dijsselbloem said the Cyprus bailout deal should be viewed as a template for future bank recaps and nations with large banking industries must look to restructure and reduce their overall size. Dijsselbloem added that in the event of banking stresses and financial institutions fail to recapitalise, then they will ask shareholders and the bondholders to contribute and "if necessary the uninsured deposit holders". Dijsselbloem later clarified his comments in an official press release, saying that Cyprus was a "specific case with exceptional challenges which required bail-in measures" and that bailout programmes do not have models or templates. Markets sold off however regained ground once Dijsselbloem clarified his comments
  • Dijsselbloem said that European leaders are committed to "pushing back the risks" of financial system failure. He added that it will "force all financial institutions, as well as investors, to think about the risks they are taking on because they will now have to realise that it may also hurt them".  Mr Dijsselbloem acknowledged that "there is still nervousness" among some fellow finance ministers about the approach and whether it will have a negative impact on private investors in eurozone sovereign and bank debt.