Cyprus Bailout: Stupidity, Short-Sightedness, Something Else?
By Yves Smith of Naked Capitalism
Yves here. This post from Cyprus.com addresses some important misperceptions about the background leading up to the bank bailout impasse in Cyprus, including the alternatives that were available that were perversely bypassed. I also have a separate post due to launch shortly, but this article is an important stand-alone piece and debunks quite a lot of conventional wisdom.
Cross posted on Naked Capitalism from Cyprus.com with permission
A quick run-down on the impressively stupid handling of the “Cyprus bailout” by the EU.
And, before we go on, we should note that the on-the-ground situation for visitors and tourists is perfectly fine – Cypriots are not prone to rioting and even though the banks are closed, the ATMs still work. We are all at work and things are otherwise proceeding normally.
First, some background that most people know partially but not completely:
1. The Cyprus sovereign has not been particularly profligate. Debt to GDP as late as last year was in the low 70% range, lower than Germany, etc. While the last Communist government ran unnecessary fiscal deficits, the new government was elected with a more or less ‘austerity’ orientation
2. The issues with the Cyprus sovereign have come from the bailout of the banking system.
The banking sector in Cyprus is being portrayed in the mainstream press as a monstrosity of risky banks for Russian mobsters. I think it is important to put it in context:
(a) Banking assets are about 7.1x GDP relative to the EU average of 3.5x GDP and similar to Ireland and Malta.
Luxembourg, by contrast, where Anglo-Saxon firms do their tax arbitrage has banking assets of 21x GDP. So, Cyprus’s exposure is similar to that of an economy that has large financial services sector, but that still has a real economy too. It is not Luxembourg nor the Cayman Islands nor the Bahamas nor the Channel Islands and so on.
(b) Further to this point, 20B of the 70B of deposits are non-EU (aka Russia/CIS) which, while meaningful (28%), hardly dominate the system
(c) The banks are almost 100% deposit funded (something that regulators across the world have been encouraging because deposits tend to be sticky if you take care of them).
3. Q: So, given all that, why do the banks need a bailout?
A: Primarily due to their exposure to Greece, Cyprus’s neighboring economy, both on the commercial side, but most importantly and most critically because of the Greek Government Bond EU restructuring (this accounts for about 40-50% of the capital needs) which Cyprus signed up for in the spirit of EU / Greek solidarity. It was understood at the time that there would be some protection in exchange for this later on otherwise, Cyprus should have taken a harder line at the time such as ensuring the that Greek branches get covered by the Greek bailout.
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