Cyprus is Coming for Your Savings

Levying a tax on small savers does not exactly breed confidence in banking systems.

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Scheherazade S. Rehman is a professor of international finance/business and international affairs at The George Washington University. You can visit her homepage here and follow her on Twitter @Prof_Rehman

There seem to be times when commonsense eludes us even after years of experience. While we know this to be true in our personal lives, it is surprising when it is done at a national level, let alone a supranational level. What I’m referring to are the financial crisis management and bank bailouts happening in Europe. In particular, the eurozone which has muddled through for three long years trying to rescue itself.

It seemed that the Europeans finally got their act together last November when new European Central Bank Governor (ECB) Mario Draghi took the helm and began real crisis management. The world began to exhale finally as the Europeans began to look like they were getting their financial house under control and a real handle on their economic crisis.

But here we go again. Cyprus has asked for a bailout. This by itself is not a big event. Nor is it surprising and it should have been a non-event with only €10 billion (approx. US$13 billion) at stake. Remember the U.S. American Insurance Group (AIG) was bailed out with $175 billion, Spanish bailout $100 billion plus, Greek bailout $200 billion plus, and so on and so on.

The Cyprus bailout, however, has a condition attached to it that would irk any average citizen no matter where they reside. All bank customers in Cyprus (which essentially means everyone) are being asked to pay a one-off levy (tax) in return for the €10 billion country (bank) bailout. To date, the details are that all bank customers in Cyprus will pay a one-time tax of 6.75 percent or 9.9 percent on their bank deposits. Anyone with less than €100,000 euros would have to pay the lesser off the two tax rates while those who have more money would pay the higher tax. In an attempt to ease the sting of this tax, the depositors will receive the equivalent amount in shares in their banks. This is not much solace to many savers and is, in fact, a gross "moral hazard."

[See a collection of political cartoons on the European debt crisis.]

So basically, if you don’t pay that bank tax to save your bank, your savings may be lost. No one likes to have his or her hard earned savings be held hostage, especially by their own bank. All this was announced over the weekend and ATM machines were emptied out over the weekend. Today, luckily for the government, happens to be a public holiday in Cyprus and the government has mandated that all banks will be closed until Thursday to prevent a full blown bank run.

The parliament and government in Cyprus are trying to renegotiate a better deal with the European Union (EU) and International Monetary Fund (IMF) for smaller savers after the understandable public outcry. Parliament is due to vote in the next 24 hours on a renegotiated deal to ease the blow to small savers. There are many options being put on the table. For example, to levy the fine only on large savers or to reduce the levy to 3 percent for savers with €25,000 or less.

What exactly was the EU or IMF for that matter thinking when demanding (at worse) or agreeing (at best) on a tax upon common small savers in exchange for a €10 billion bank bailout for Cyprus? A good rebuttal to this question would be as follows: "would you [Cypriots] rather pay this one-time tax or see a full blown banking and financial system collapse in Cyprus, soon to be followed by a severe recession and 25 percent of all of you losing your jobs?"  

[Read the U.S. News Debate: Who Is Handling Its Debt Crisis Better: United States or Europe?]

I have two thoughts on the above dilemma: My first is that the EU has still not found an effective way to manage periodic banking crisis without causing systemic anxiety. Moreover, I cannot fathom that the EU and IMF collective brainpower could not have conjured up a demand that could have been less of a lightning rod and slightly more camouflaged and bureaucratic in nature. The last thing we need now is a spark that reignites the European crisis.

Remember there is no workable government in Italy, Greece is struggling with its bailout terms, and Spain is in a middle of a financial crisis mingled with a political scandal at the highest government level. Moreover, we know from the Greek experience that it is not a good idea to take it lightly (and drag out a bailout plan with rioters on the streets) when small countries in Europe finds themselves in severe financial crisis, as it could easily vibrate into larger global financial markets. On a side note, Cyprus is the smallest EU country accounting for 0.2 percent of total EU output. Nonetheless!

My second thought: there is of course, more to the story. The EU (i.e. Germany) has long suspected that they are very large sums of Russian money in Cypriot banks -- a long-time massive money-laundering scheme occurring in the Cypriot banking system. This is not a well kept secret. It is estimated that these Russian international deposits are approximately US$31 billion (US$19 billion corporate deposits and US$12 billion bank deposits). As part of the bailout deal Cyprus must agree to an international anti-money laundering audit. Needless to say the Russians are not very happy about this upcoming audit or the new proposed tax on their money, as they stand to lose approximately US$2 billion. But is using small Cypriot savers really a good venue for the EU to address Russian money laundering issues? Needless to say foreign investors will think twice before choosing a Cypriot bank or any bank from a small southern European country.

Putting the intrigue of international high finance aside, levying a tax on small savers does not exactly breed confidence in banking systems. Now all eurozone small savers know that their savings are fair game to be used in bank bailouts. But the upside is that this might fast-track the introduction of an FDIC type insurance (deposit guarantee for accounts up to, for example, €100,000 euros) for small depositors in Europe.

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