Cypriot bank deposit levy proposal is worrying
World sharemarkets were upset this week by the terms of the long-awaited bailout of the Cypriot banking system. The major concern of investors was not with the bailout, which was widely expected, but with the harsh precedent of the proposal to fund it by confiscating part of existing Cypriot bank deposits.
The final terms of the bailout are yet to be agreed with Cyprus. But the original proposal included a levy on previously guaranteed small bank deposits. This is a worrying development for world financial markets.
Because of protests in Cyprus, the final solution is unlikely to involve a levy on the guaranteed deposits. Larger deposits, most likely, will be subject to a levy.
In Greece, Ireland and Spain, previous banking crises were dealt with via government involvement in the bailouts. The losses resulting from the subsequent bailout of the Greek government were financed via negotiated default arrangements with the holders of Greek bonds.
Default is a risk of owning bonds and debentures but investors would expect there to be no such risk with guaranteed bank deposits. Investors are now rightly concerned that even if guaranteed deposits are not targeted by future levies in other countries, the prospect of levies as part of future bailouts will create problems for the banking systems in other struggling European countries. Not only will it make investors more cautious about owning bank deposits in those countries, but the Cypriot precedent will encourage an outflow of larger deposits and investments to stronger economies.
This week’s strength in the price of gold and the US and Australian dollar reflected investor concern about investing in the eurozone. Moreover, there’s a significant risk that reduced confidence in the European banking system will encourage investment in nonfinancial assets to avoid the risk of a Cypriot style confiscation of a part of larger bank
Even from an equity viewpoint, there’s little to be said in favour of the Cypriot solution. Bank deposits are a preferred investment of many unsophisticated investors and others seeking liquidity, for example, to run a business. Wealthy people and sophisticated investors hold relatively small percentages of their assets in cash or bank deposits.
The most worrying aspect of the terms of the original Cypriot bailout proposal is that the International Monetary Fund and European central bankers were involved in the negotiations. If these officials were prepared to confiscate part of guaranteed bank deposits to help fund the bailout, depositors in other countries facing banking problems have every reason to invest their money elsewhere, including in other more secure countries. They certainly will now be less willing to invest in their own country unless their bank deposit is government guaranteed.