21st March 2013
Depositors with Cyprus’ banks are “essentially creditors” and there is no alternative to a ‘bail-in’ other than an exit from the euro or a full scale bailout argues Eric Chaney, chief economist at Axa Group. Chaney, who is also head of research at Axa Investment Managers, says both alternative scenarios are worse.
As the EU warned Cyprus that the alternative to a deal was the winding down of its banks – reported here on CNBC – Chaney set out what he called the bailout equation that “Cyprus needs a €16bn loan to recapitalize its hyper-sized banking system which was hit by the 2012 Greek PSI, and is extremely undercapitalised because of negligent supervision since Cyprus joined the euro in January 2008”.
In a note issued on Thursday 21 March 2013, Chaney says that Cyprus’ banks should be partially bailed in and that in normal circumstances equity and bond holders should shoulder much of the burden. However he adds: “Given the capital structure of Cypriot banks, it is a problem: 91 per cent of the liabilities are deposits. Common equities and junior debt make up only nine per cent of total liabilities, and the share of senior debt is negligible.”
“The truth is, creditors of Cyprus banks are essentially depositors. This is why the IMF, the ECB, the EU Commission and the Cypriot government quickly agreed that, in the case of Cyprus, after having wiped out shareholders and junior bond holders, the bail-in had to involve depositors. Not only this is consistent with the new regulatory framework of the EU, but it is also economically sensible: creditors – here, depositors – take risks that cannot be fully borne by taxpayers.”
“The equation becomes politically more difficult once the structure of deposits is considered: of the €68bn or so of recorded deposits, 37 per cent are from non-residents (30 per cent outside of the euro area). Hence, the bail-in must involve non euro area entities, such as Russian and Ukrainian individuals and companies and should spare small depositors.”
Chaney says a compromise has to be found. “The alternative to a depositor bail-in is either a full scale bailout or Cyprus leaving the euro. A compromise has to be found: as Jörg Asmussen of the ECB had warned before, the Cypriot case may turn systemic. There are two alternatives to a creditor bail-in: either a full scale bailout, or Cyprus leaving the euro when the ECB stops injecting liquidity in its banking system. Both are worse than a bail-in.”
Chaney adds: “Ingenious solutions have been floated by the Cypriot government. Let me quote a document available on the Ministry of Finance website, translated from Greek by my colleague Manolis Davradakis: “Depositors will receive bank stocks with value equal to the foregone value of their deposits. Provided that deposits are kept in the banking institutions for a period of at least two years, the shares can be convertible into bonds, the yield of which is to be backed by the expected natural gas revenues, in accordance with a scheme to be determined and issued by the Minister.”
“The fact that this natural gas income is not likely to materialize tomorrow, nor the day after tomorrow is another story. Look at it this way: this would be a smart way to transform very short term investments (deposits) often made for obscure reasons (high deposit rates, money laundering, tax evasion among others) into long-term investments in the real Cypriot economy.”
Finally he suggests that it prudent for investors to stay on the sidelines. “Until the Cyprus case is solved, it is prudent for those willing to invest in euro denominated assets to be very circumspect, if not to stay on the side lines,” he says.