Lessons of the Cyprus crisis

A collapse of Cyprus’ banking system appears to have been averted thanks to a last-minute rescue deal struck on March 25 by the country and its international lenders — the European Union, the European Central Bank and the International Monetary Fund.

But the seeds of the crisis have not been completely eradicated. The parties concerned will need to make further efforts to ensure that a crisis does not happen again.

Under the deal, €10 billion ($13 billion) will be secured from the three lenders. The initial bailout agreement had required that Cyprus raise €5.8 billion on its own to contribute to the bailout. To raise that amount, the government first announced that it would impose a one-time tax on bank depositors. Accounts under €100,000 would be charged 6.75 percent; those greater than €100,000 would be taxed at 9.9 percent.

The Cypriot Parliament rejected that proposal on March 19, temporarily putting a brake on the execution of the bailout plan for the tiny Mediterranean island country.

The new deal calls for a levy on uninsured deposits over €100,000 in the country’s second biggest bank, Laiki, which will be restructured. The country’s largest bank, Bank of Cyprus, will take over Laiki’s prime assets, and deposits over €100,000 at Bank of Cyprus will be frozen for the time being and used to resolve Laiki’s debts and increase the capital of Bank of Cyprus.

With a population of a little over 1 million people, Cyprus is the eurozone’s third-smallest economy, with a gross domestic product of $23.5 billion in 2012, or only about 0.2 percent of the eurozone economy. Its main industry is tourism and banking.

After the collapse of the Soviet Union, Russians started depositing their money in Cypriot banks. It is said that about one-third of the banks’ deposits is owned by Russian companies and wealthy people. It is also suspected that the banks are used by Russians for money laundering and tax evasion.

The financial crisis this time had been expected because banks in Cyprus had a large amount of bonds issued by the Greek government. They suffered badly because of Greece’s sovereign debt crisis and plummeted into a crisis.

On average, the total assets of banks in each EU member country are about 3.5 times GDP. But the corresponding figure for Cypriot banks is about seven times GDP.

If Russian money flees Cyprus, another bank crisis could happen in the country. Another problem is that a levy on bank deposits may be used again in the future as a means of solving a financial crisis. A run on deposits could happen in other countries.

The latest crisis points to the vulnerability from excessive dependence on the financial industry. It also underlines the need to create a joint European framework for better supervision of banks and for direct injection of capital into banks facing a crisis.