Cypriot Cash-Grab Risks Damaging Eurozone Banking System; Will It Push Depositors Towards...

Cypriot Cash-Grab Risks Damaging Eurozone Banking System; Will It Push Depositors Towards Safe Haven Investments?

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Finance ministers from the 17-country Eurozone held an emergency video conference call on Monday, to discuss the likely terms of a controversial bailout that threatens to force Cyprus savers to accept the loss of €5.8bn from their savings Villas Peyia Cyprusaccounts.  The raid will mean an average of 10% off the value of Cypriot savings, though it is likely to be progressive with smaller savers paying proportionately less. Cyprus’s President, Nicos Anastasiades, is still trying to get the bill amended before it goes before a parliament which has promised to reject it.

The group said that Cypriot authorities could stagger the deposit seizures and offered a different rate for lower levels of savings, but insisted that the overall sum must remain the same.

In an unprecedented move, European citizens are being required to pay for the bail-out of their banking system not through public funds but directly, in their own savings cash. The natural response would be to simply empty savings accounts, so Cypriot banks have shut down to prevent a run and are expected to remain closed until at least Thursday.

But the run they hope to prevent on a national level this week may yet take place later on an international level. The Cypriot banking system is 10 times the size of the €17bn Cypriot economy, and the growth has been caused by Cyprus marketing itself internationally, as a tax haven. Consequently there are depositors from all over the Eurozone, including thousands of Russians. The Russian leader Vladimir Putin has hinted that a separate, but vital, €2.5bn loan to Cyprus may be in doubt if the move goes ahead. The long term consequences could be mass withdrawals of foreign and domestic savings from Cyprus’banking system.

In return for the €5.8bn the move aims to generate a small enough sum on the scale of European bailouts, and one that inevitably makes us think of quantative easing the Eurozone will face a triple threat. On one side, the withdrawal of promised Russian aid. On the other, loss of confidence in the banking system and in the Euro across the EU. And in the middle, the mass removal of wealth from Cyprus banking system as depositors who feel with reason that their trust has been betrayed, look for other methods of saving.

There are already several countries, notably Greece, which are groaning under the load of austerity and repayment imposed by the IMF and the European Central Bank. With membership of the Euro paying so badly already, how will the Greeks react when the EU arrogates to itself the power to raid individual as well as national finances?

That’s what Tristan Cooper, analyst at fund managers Fidelity Worldwide, calls the craziest thing about the Cyprus announcement. Mr. Cooper underlines the huge potential cost of undermining the trust between depositors and their banks and compares this the relatively small sum expected to be gained from the move.

Cypriot savers will be looking elsewhere for places to put the remains of their savings, and the likely choices will be simply hoarding cash, buying gold and other mobile precious materials, and investment in more stable foreign currencies, which will raise the US Dollar to its traditional status as the hard currency of choice. It’s also likely that larger depositors will find their way into safe haven real estate investment markets, in London and Germany, and in Canada and Australasia.

There are also concerns that the repercussions outside Cyprus might not be limited to withdrawals from Cypriot banks by foreign depositors. If depositors see that the EU might insist on similar raids in other EU countries, there may be runs there too.

Marchel Alexandrovich, at the brokers Jefferies, says that it is plainly obvious to anyone observing the current mess that what should really worry European policymakers is not the €5.8bn being saved in Cyprus, but the €2, 754bn of deposits in the Spanish banking system. He points out that €182bn of that comes from deposits outside the Euro area.

Stock markets fell, apparently in response to the news: the Dow Jones industrial average fell 62.05 points, or 0.4% and the Euro dropped 0.6%. Meanwhile government bond prices in the relatively more secure markets of France and Italy were broadly unchanged, indicating that investors do not currently expect market trouble to spread beyond Cyprus.

The greatest danger is that even if no further raids take place, and even if policymakers row back from taxing small depositors in Cyprus, as Mr. Cooper warns, the damage has been done.