18th March 2013
Fund manager Schroders says the planned raid on Cypriot bank accounts sets a dangerous precedent for the rest of Europe but for Spain in particular.
In a note titled ‘Savers beware’ issued on Monday, Schroders European economist Azad Zangana said it could set a dangerous precedent for banks in other Eurozone states requiring a bailout. It may particularly put pressure on Spain.
Under the deal on the table, Cyprus will receive €10 billion of European funds, but is being forced to fund €5.8 billion from Cypriot banks. The latter amount could come directly from depositors though the Cypriot Government is debating the issue now.
Although debate in Cyrus now suggests that more of a burden may be placed on bigger account holders, with European finance ministers also expressing concerns about the move, the initial plans were for accounts holding over €100,000 could be forced to pay a 9.9 per cent levy, while those holding less will pay 6.75 per cent. Zangana said this made a “mockery of the newly agreed €100,000 European-wide deposit guarantees scheme.”
The Schroders note continued: “Despite EU officials stating that Cyprus is a special case, the move sets a dangerous precedent for future bailouts of member states with problem banks. The move will obviously spark outrage in Cyprus, and exacerbate the distrust already present between the public and banks. However, the bigger danger for international investors is the potential spread of fears to other countries, particularly Spain which is yet to complete its banking bailout.
Kleinwort Benson was similarly concerned. In a note the bank said: “Crucially, a precedent – with the full blessing of the troika – is set: in future, any Eurozone bank that is struggling can access its depositors’ funds to plug a balance sheet hole. On previous occasions that the troika has been called upon for a bailout, this particular method has not been endorsed – even during the worst phase of the crisis, in countries such as Ireland and Spain. It is widely reported that “unique” conditions in Cyprus allowed for this deal and the troika endorsement of the levy. A large number of non-resident depositors, primarily Russians, and perceived weak institutional controls over money-laundering, weighed heavily on the troika decision; this lends credence to the claims for this to be an isolated endorsement and not one applicable to other banks or banking systems.”
The bank said there is little historical evidence to say how markets will react but there are two example of attempts in history. It writes: “Nonetheless, a precedent is set and there is little historical evidence of how markets or investors will react. In 1992, Italy’s Socialist Prime Minister Giuliano Amato imposed a one-off levy on bank accounts, a much smaller 0.6 per cent; it still is widely blamed for a permanent loss of faith in the Italian banking system. In 1936, Norway instituted a bank deposit tax, but it was reversed due to subsequent capital flight.
Explaining the rationale, Schroders continued: “Cypriot banks were badly hurt by the crisis in Greece owing to their large exposures to Greek government bonds, which were restructured twice last year. According to the Bank of Cyprus, the country’s banks held €68 billion in deposits from individuals and countries at the end of January. €43 billion was classed as being domestic residents; €5 billion was from other eurozone countries, while almost €21 billion came from the rest of the world. The suspicion is that as much as €25 billion is owned by Cypriot-based Russian companies, using the banking system as an off shore tax haven. This is part of the reason for the reluctance of eurozone partners to bailout the Cypriot banking system without some hit to domestic creditors (which includes those Russian companies).”
Schroders notes that senior bank bondholders will not suffer under the current plans.
The note adds: “In addition to the depositor tax (or hair-cut), junior bank bond holders are facing losses, while taxes on capital income and corporation tax have also been increased (the latter rising from 10 per cent to 12.5 per cent). However, senior bank bond holders and sovereign bond holders have remained unscathed.”
Kleinwort Benson was concerned that supposedly more sophisticated lenders i.e. those holding senior debt are not going to be penalised.
“In our view, the troika endorsement of this action raises the spectre of how much of a backstop the ECB may really be to a still stricken Eurozone financial quagmire. The fact that it appears to be more ready to impose penalties on depositors than on the holders of bank debt – arguably more sophisticated investors who take higher risk commensurate with higher returns – is troubling.”
Zangana also noted the wider European implications. “The Cypriot crisis is more complex than elsewhere in peripheral Europe, not because of the size of the Cypriot economy less than 0.5 per cent of eurozone GDP, but because of the Russian involvement, and the recently-discovered 7 trillion cubic feet of natural gas reserves. Once natural gas extraction is underway, Cyprus will be energy independent, and have enough left over to pay for the recapitalisation of its banks. However, there was a risk that if a European deal could not be reached, then Cyprus could enter negotiations with external countries – namely Russia – that would be happy to accept future gas revenues in payment. For Europe, not only is it important to secure one of its member states, but also the significant reserves of natural gas.”
Schroders said there is some good news in the deal for Portugal and Ireland. It says: “The European Central Bank (ECB) is in support of the deal, and must feel more confident about its ability to minimise contagion effects. The other notable outcome from the summit was the extension of loan maturities for Portugal and Ireland, which have recently had success in raising funding through the bond market. The extension of loans is reward for the pair’s efforts in meeting its key austerity targets, and should help them trigger the ECB’s outright monetary transactions (OMT) programme later this year, which in turn is likely to bring down the yield on their government bonds.”
Kleinwort Benson also worried about bank runs. It says: “The troika endorsement is worrying. This action will surely be a cause for concern for depositors in banks across the Eurozone, particularly in the troubled South. An unspoken boundary has been breached by policymakers which raises doubt over depositor protection schemes across the Eurozone. Indeed, Mario Draghi, the ECB’s President, said on March 7 that, “Cyprus’s economy is a small economy but the systemic risks may not be small.” A contagion effect may be witnessed over the coming weeks as uninsured depositors in other countries take pre-emptive measures. It is not unforeseeable that some depositors may wish to hold physical cash “under the mattress” rather than risk a levy, not unthinkable given generally anaemic cash rates at present. It is not impossible for a large bank run to be triggered. Afterall, as Mervyn King, the Governor of the Bank of England, has noted, “it’s irrational to start a bank run, but rational to participate in one.”
Kleinwort Benson concludes: “We continue to be negative on Eurozone financial stocks and European peripheral debt. Risk events of this nature continue to support our negative view on the euro. As uncertainties connected to the financial crisis are still potent, we continue to hold safe-haven assets such as gold, the US dollar and the Japanese yen – all of which allow for crucial diversification, especially in times of crisis.”