Q&A: Cyprus bailout

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People in Cyprus have reacted with shock to news of a one-off levy of up to 10% on savings as part of a 10bn-euro (£8.7bn; $13bn) bailout agreed in Brussels. The controversial plan, negotiated with the European Union and International Monetary Fund, marks a radical departure from previous eurozone bailouts.

How would the bailout affect depositors in Cyprus?

The Cypriot finance ministry amended its plan on 19 March, after eurozone ministers called for a rethink.

Under the new proposal, savers with less than 20,000 euros on deposit would be exempt from the one-time levy. Those holding between 20,000 and 100,000 would still have a 6.75% levy – a figure that previously would have applied to all accounts below 100,000 euros.

Those with anything above 100,000 face a levy of 9.9%, as under the previous plan. Depositors would be compensated with the equivalent amount in shares in their banks. If it goes ahead, the levy would affect many non-Cypriots with bank accounts, including UK expatriates. However, depositors in Cypriot banks’ operations outside the country would not face a levy.

There is still uncertainty about the plan – it will be put to a parliament vote, slated for 19 March, which is likely to be very close.

But the whole bailout plan also requires approval from parliaments in the eurozone – and Germany’s Bundestag may be especially suspicious of it.

Was Cyprus not doing quite well before the global financial crisis?

Yes. The International Monetary Fund described the country’s economic performance before 2008 as a “long period of high growth, low unemployment, and sound public finances”. There was a recession in 2009 but it was the mildest in the eurozone. But two interlinking factors have brought Cyprus close to default – the deteriorating government finances and the country’s struggling banks.

So what went wrong?

During the good years Cyprus did build up what the IMF calls “vulnerabilities”. There was rapid growth in credit, the banks made many loans to Greece and there was a property market boom.

The banks are central to this story. They grew rapidly. By 2011, the IMF reported that their assets – which include all the loans they have made – were equivalent to 835% of annual national income, or GDP. A chunk of that is down to foreign-owned banks, but those that are Cypriot had made loans to Greek borrowers worth 160% of Cypriot GDP. There have been losses on the loans to private borrowers because of the depression that has hit the Greek economy. And the value of the debts owed by the Greek government was cut in a debt relief exercise undertaken last year. It might have helped Greece, but the Cypriot banks were hit.

What does that mean for the government finances?

Many countries have rescued their banks in the financial crisis – recapitalising them, in the jargon. It means governments put in money and get shares in return. It is controversial, but governments have taken the view that it is better for the economy than allowing important banks to fail. Cyprus cannot afford the recapitalisation to the extent that the banks need.

The government finances have been further weakened by the slow economic growth and, more recently, decline in the eurozone which have hit Cyprus too. Growing doubts in the financial markets about the government’s financial position have made it almost impossible for Cyprus to borrow.

Why the bank levy?

When countries get an international bailout, they are often expected to raise funds themselves, by raising taxes or selling state-owned assets.

The levy on bank deposits is playing the same role. It is intended to reduce the size of the bailout and therefore the amount of new debt Cyprus has to take on. But there is almost certainly a political aspect too. In the eurozone, there are concerns about money-laundering in Cyprus and the presence of large amounts of Russian-owned money in the banks. Germany is reputed to be especially unhappy about the idea of using European taxpayers’ money to rescue them.

Experts say the decision to target ordinary savers came about because Cypriot banks have fewer private bondholders than banks in other eurozone countries. In the Greek bailout it was private bondholders who had to take a “haircut” – a slice out of their investment.

Didn’t savers think they were protected?

To a degree, yes they did. The point is, the banks have not collapsed. This deal is aimed at saving them from collapse. Had they done so, then savers would have had their first 100,000 euros (£86,000) protected under the Cyprus Deposit Protection Scheme – assuming the scheme could have paid out all this compensation.

Are the UK operations of Cypriot banks affected?

No. Deposits with the UK arms of Bank of Cyprus and Laiki Bank will not face the levy, the firms confirmed on their websites. Bank of Cyprus UK is a separately incorporated UK bank and depositors are protected by the UK’s Financial Services Compensation Scheme (FSCS), which covers savings up to £85,000. Laiki said on its website that the “levy is not intended to have an effect on customer deposits held with the overseas branches of Cyprus banks, which includes Laiki Bank UK”. Deposits with Laiki UK are protected up to 100,000 euros (£86,000) by the Cyprus Deposit Protection Scheme and not the UK’s (FSCS).

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