The last few days saw Cyprus take center-stage in markets across
the globe as investors found themselves facing renewed fears of the
precarious debt situation in the Eurozone spiraling out of control.
For the uninitiated, it would seem rather strange that an obscure
island nation with a population of under a million could hold the
world economy hostage. The size of Cyprus' economy is less than a
tenth of Greece's. And this would mean that the effort needed to
prop up the country's economy would be much less than what was
needed for Greece.
So what is it about Cyprus that is putting it on par in terms of
scaring the market with other peripheral nations like Spain and
Italy?
The reason for the furor is the decision of other euro-member
nations
to impose a levy on bank deposits in Cyprus
as a part of the €10-billion ($13-billion) bailout. ((
Cyprus Bank Deposits to Be Taxed in $13 Billion
Bailout
, Bloomberg, Mar 16 2013))
This unprecedented move essentially scraps one of the biggest
unwritten rules of banking - of safe-guarding the money deposited
by customers even under the worst economic situation. The fact that
the stronger member nations believe that bank deposits in a
debt-ridden country should bear the brunt of a downturn would mean
that the peripheral Eurozone nations will very likely face a
similar levy in the future. Such a scenario prompts customers to
clear their deposit accounts from a bank run in the region, to
avoid the levy - something that will only make economic recovery in
the troubled region even more difficult, if not impossible.
Here's How The Proposed Levy Works, And What It Will End
Up Doing
Picture this. You receive a letter from your bank stating that
the bank is going to deduct a part of your savings account because
it has been instructed to do so by the government. There isn't much
you can do in this situation besides emptying your account and
bringing all the cash home. When everyone does this, it leads to a
run on the bank, which spreads panic throughout the financial
sector.
This is exactly what the bank levy seeks to do for all deposits
in Cyprus. If the deposit is less than €100,000 (~$130,000),
then the levy will be 6.75%, and for higher deposits the customer
will lose 9.9% of the total amount. Even as the country's
government ponders on whether or not to accept this onerous
condition for its bailout through a vote that has been postponed
until Wednesday, people have been frantically withdrawing their
money - forcing the banks to remain closed.
Impact On Global Banking Sector As A Whole, And In Europe
In Particular
The banking sector thrives due to people's fundamental belief
that there assets are safe with the bank. When banks fall out of
favor with the public at large, there is a ripple effect seen
across the entire economy as lending takes a hit, which in turn
throttles businesses - small and big. And the fear of such a levy
being imposed on other nations in the region is driving customers
in other euro-member nations to secure their money.
Needless to say, banks in the European region would be hurt the
most by such loss of faith and rapid withdrawals of deposits which
help support the backbone of most banks capital base. This is why
the largest European banks including Deutsche Bank (
DB
), Barclays (
BCS
) and
RBS
(
RBS
) lost a significant part of their value over trading on Monday.
Banks in the U.S. also closed the day lower, with the KBW Bank
Index losing 1%.
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