Cypriot bail out sparks fears of a run on the banks

The Cypriot government and the EU/IMF finally agreed the long awaited bail out package for Cyprus on Friday, but in hugely controversial fashion. In fact, so controversial that it is not beyond the realms of possibility that when put to the Cypriot parliament for approval tomorrow, they could actually reject the deal and opt instead to leave the Euro and face almost inevitable bankruptcy instead.

The main reason for the passionate opposition from some quarters to the deal which has been struck is that, after pressure from the Germans, an integral part of the bail out deal was agreement to impose a "levy" on all holders of bank accounts in the island, equivalent to 9.9% on accounts of more than €100,000 and 6.75% on accounts under that sum.  It is the first time that the EU have made what effectively amounts to a partial confiscation of cash deposits a condition of financial assistance, and there were immediate fears that it would lead not only to a run on Cypriot banks, but that the panic could spread to account holders in other countries suffering financial difficulties, such as Greece and Spain, sparking another wave of financial problems.

There had been rumours for some time that the EU was seeking to make deposit holders share some of the burden of the bail out, although the Cypriots fought hard to resist it, knowing that it would damage the Island's lucrative financial services sector. The official reasoning for the imposition of the levy was that it was required to keep any rescue package down to a sustainable size for the future, but it is also known that some EU politicians, and most vocally the Germans, feared a political backlash if they went ahead with a loan, leaving the many wealthy Russians who hold accounts in the territory protected and not contributing the rescue cost.  

The fact that larger account holders are facing a levy will not have come as a surprise to everyone, but there is real shock that small depositors are also being hit. The EU has depositor protection in place for account holders of less than €100,000 and it is not clear how this can be squared with the Cypriot deal.

It is a national holiday in Cyprus on Monday, and so nervous banks will have to wait until Tuesday to see what the impact will be within the Island.  Meanwhile, on Monday bankers in Greece, Spain and Portugal will be working hard to calm jittery customers who may fear that similar measures could be taken elsewhere in the future now the principle has been established.