Why the overall cost is likely to be far more than the levy imposed
I cannot recall a time when, out of the blue, such a levy was imposed on ordinary savers. I’m still trying to work out the rationale of this decision to impose a levy on the savers that hold accounts with Cyprus’ banks. I can only think that the decision is more to do with politics than with economics and finance.
Who is bailing out who?
It’s a depressingly familiar tail of the rapid growth of loosely regulated expansion of credit, lots of loans and a booming property market. Post the bust, the banks remain weak and tax receipts remain low. Where have we heard that before?
The political aspect to this is the large amount of non-Eurozone deposits, in particular non-residential accounts held by Russians, the bailing out of which by EU taxpayers in particularly unpalatable in Germany. The BBC says up to half of the accounts are held by non-residents.
But what about the other half held by ordinary people? Remember when in the UK the Northern Rock went cap in hand to the Bank of England? We had queues outside branches because people feared they would lose their deposits even though about 97% of people were covered by the Bank of England’s existing guarantee. The same fear people had (however well or ill-informed) is the same in Cyprus – that ordinary people will lose their savings as a result of badly behaving and poorly regulated banks. In the case of Northern Rock, savers didn’t take the direct hit: The taxpayer did. Never mind though, the Tories in the Lords gave the chairman at the time a seat in the Lords. And we call them banana republics. In Cyprus though, the ordinary depositors are taking a very real hit.
Will it work?
It depends on what they want the levy to do, and it depends on whether they have factored in a whole series of unintended consequences. It’s these latter things that policy makers are notoriously bad at predicting. In part because some of them are impossible to measure. An example? Trust in the banking sector.
If you had money in a savings account and was told that you were going to have a 6-10% levy to help deal with the fallout of the banking crisis, you’d be angry. OK, the BBC says that savers will receive the equivalent value back in shares – which they won’t be able to sell immediately, but in the short term at least, can you see the value of those shares going in any direction other than downwards? Frances Coppola puts it more succinctly:
- their liquid assets (cash deposits) will have been replaced with illiquid ones (shares in banks that currently have little market value)
- they are forced to take the risk that the future value of those banks will not compensate them for the money surrendered to the sovereign.
“The bank is not insolvent, it is illiquid” – a phrase I heard a lot during the Northern Rock crisis.
Frances’ article goes into the financial ramifications in more detail and is worth reading. The bit that interests me is the disappearance of trust in Cyprus’ banking sector – in particular with domestic customers and small scale savers. Given that there is effectively no market for the shares that the savers will receive, there is, as Frances says no way of knowing whether the savers will receive the ‘market value’ in shares that matches their deposits. Thus for the next few years at least, people will be thinking that it is better to hold their savings either in other assets or under the mattress.
The impact of this behavioural change?
Well, where do we start? If people start shifting their money away from the formal economy to the informal economy, it makes tax collection even harder than it already is in that part of the world. Estimates for Cyprus’ informal economy is just over the 25% mark. With people understandably wanting to shift money away from domestic banks, this figure can only get bigger.
You then have the impact on wider domestic investment if people pull their deposits out – and that’s ignoring the prospect of a run on the bank that seems pretty much inevitable when they open on Tuesday. What will rise from the ashes in the medium and longer term? If people don’t want to put their savings into banks, what will the impact be on the economy if firms cannot borrow to invest in their businesses? Or will they end up borrowing from the unregulated informal sector? (In which case are there not even greater risks for both sides? How do you resolve disputes? What do you do if the other side runs off with the cash/assets and leaves you with the burden?)
Perhaps this is the wider problem with international banking: The people working in the banks don’t live in the communities that they serve. Therefore they don’t have to live with the fallout that results from their behaviour. The same could be said of the management of the Eurozone crisis in general. Are the people who are taking the hit the real decision makers responsible for the mess in the first place? Or is it a case that the many are taking the hit for the failures of the few?
Finally, what will the political fallout be? Does the agreement have democratic legitimacy in the eyes of the Cypriot people? If not, how will they react further down the line? Furthermore, if such a decision can be taken in Cyprus to penalise ordinary savers, does this set a precedent for the rest of the Eurozone? In which case does this increase both political and economic instability in places like Italy, Spain, Portugal and the Republic of Ireland? There are some costs that cannot be calculated using a calculator. Especially the human cost.