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| The Cyprus bailout isn't all bad: here are four silver linings | The Cyprus bailout isn't all bad: here are four silver linings |
| (2 days later) | |
| Most recent commentary on the Cyprus bailout has been remarkably negative. Not without reason: the excruciating process of reaching this deal was deeply flawed and will impose large additional and unnecessary costs on Cyprus and other eurozone economies. However, the deal does have some redeeming features which should not be underestimated. | Most recent commentary on the Cyprus bailout has been remarkably negative. Not without reason: the excruciating process of reaching this deal was deeply flawed and will impose large additional and unnecessary costs on Cyprus and other eurozone economies. However, the deal does have some redeeming features which should not be underestimated. |
| First and foremost, the deal provides a template for Europe's unforgivably delayed bank resolution regime. When the crisis first hit, European lawmakers prioritised passing populist legislation on hedge funds and private equity firms over tackling the root drivers of the crisis which lay in the banking system. Several countries with vulnerable banking systems then effectively blocked progress on this front. They feared that legislation that allowed problem banks to be tackled methodically would allow the EU to push for a restructuring of their banking systems. | First and foremost, the deal provides a template for Europe's unforgivably delayed bank resolution regime. When the crisis first hit, European lawmakers prioritised passing populist legislation on hedge funds and private equity firms over tackling the root drivers of the crisis which lay in the banking system. Several countries with vulnerable banking systems then effectively blocked progress on this front. They feared that legislation that allowed problem banks to be tackled methodically would allow the EU to push for a restructuring of their banking systems. |
| The absence of a methodical way to tackle troubled banks increased uncertainty, imposed unnecessary costs on taxpayers and made any solution to the eurozone crisis much harder. The shotgun approach used in Cyprus, which was forced to adopt and apply such legislation in less than a week, now means that the long-overdue EU-wide approach to bank resolution is imminent. | The absence of a methodical way to tackle troubled banks increased uncertainty, imposed unnecessary costs on taxpayers and made any solution to the eurozone crisis much harder. The shotgun approach used in Cyprus, which was forced to adopt and apply such legislation in less than a week, now means that the long-overdue EU-wide approach to bank resolution is imminent. |
| Second, the deal would enhance the confidence of depositors in the EU-mandated scheme wherein those with less than €100,000 in bank deposits were guaranteed. The original Eurogroup deal, which violated the spirit of this guarantee, was replaced by one that upheld its sanctity. | Second, the deal would enhance the confidence of depositors in the EU-mandated scheme wherein those with less than €100,000 in bank deposits were guaranteed. The original Eurogroup deal, which violated the spirit of this guarantee, was replaced by one that upheld its sanctity. |
| This is hugely important as most deposit guarantee schemes are unfunded – so ultimately rely on the trust that depositors can place in governments that they will honour the guarantee. Despite the fact that the less painful choice for the Cypriot economy as a whole would have been to break this trust by agreeing the original deal, this route was not taken. The policy shift came at a huge additional cost to the economy from the uncertainty and delay in coming up with a Plan B. | This is hugely important as most deposit guarantee schemes are unfunded – so ultimately rely on the trust that depositors can place in governments that they will honour the guarantee. Despite the fact that the less painful choice for the Cypriot economy as a whole would have been to break this trust by agreeing the original deal, this route was not taken. The policy shift came at a huge additional cost to the economy from the uncertainty and delay in coming up with a Plan B. |
| While the process by which the deal was revised hardly inspired confidence, the fact that all small depositors will be protected does mean that the guarantee was tested and found to be politically robust even in the face of very costly alternatives. What happened in Cyprus makes it virtually impossible that any other government would dare to attempt the "Cypriot stunt" of trying to impose a levy on small depositors. This in turn means a more stable core funding base for EU banks in the future. | While the process by which the deal was revised hardly inspired confidence, the fact that all small depositors will be protected does mean that the guarantee was tested and found to be politically robust even in the face of very costly alternatives. What happened in Cyprus makes it virtually impossible that any other government would dare to attempt the "Cypriot stunt" of trying to impose a levy on small depositors. This in turn means a more stable core funding base for EU banks in the future. |
| Third, events in Cyprus convincingly demonstrated the perils of having an oversized banking system. While the origins of problems in Ireland, Iceland and Cyprus were all very different, it was the disproportionate size of their banking systems in relation to the underlying economy that brought the three countries to their knees. | Third, events in Cyprus convincingly demonstrated the perils of having an oversized banking system. While the origins of problems in Ireland, Iceland and Cyprus were all very different, it was the disproportionate size of their banking systems in relation to the underlying economy that brought the three countries to their knees. |
| Given that both the domestic economy and foreign stakeholders have suffered, Cyprus will likely be a nail in the coffin of an approach that actively encourages or allows the development of supersized financial systems as a means of economic development. This will be driven by an increased reluctance of foreign depositors (as in Cyprus) or bondholders (as in Ireland) or both (as in Iceland) to risk putting money into such countries ever again. Added to this will be the reluctance of countries themselves to build top-heavy banking systems. | Given that both the domestic economy and foreign stakeholders have suffered, Cyprus will likely be a nail in the coffin of an approach that actively encourages or allows the development of supersized financial systems as a means of economic development. This will be driven by an increased reluctance of foreign depositors (as in Cyprus) or bondholders (as in Ireland) or both (as in Iceland) to risk putting money into such countries ever again. Added to this will be the reluctance of countries themselves to build top-heavy banking systems. |
| This blow to the offshore financial centre and the related offshore tax haven model (Cyprus was both) will be no bad thing for the European and global economy in the long term. | This blow to the offshore financial centre and the related offshore tax haven model (Cyprus was both) will be no bad thing for the European and global economy in the long term. |
| Fourth, events in Cyprus would have rudely woken up those who had become complacent about the eurozone crisis. The reality is that the political, social, economic and financial aspects of the crisis all continue spiralling downwards and only a grand political bargain can stem the descent. The farcical decision-making surrounding Cyprus has shown how unlikely such a bargain is. | Fourth, events in Cyprus would have rudely woken up those who had become complacent about the eurozone crisis. The reality is that the political, social, economic and financial aspects of the crisis all continue spiralling downwards and only a grand political bargain can stem the descent. The farcical decision-making surrounding Cyprus has shown how unlikely such a bargain is. |
| Importantly, Cyprus has once and for all demonstrated that those hoping that a "banking union" will be the panacea that gets us out of this mess are deluding themselves. The dream that the European Stability Mechanism will come to the aid of banks in troubled economies without invoking guarantees from the sovereign is dead. Better to face harsh reality than live in cloud cuckoo land. | Importantly, Cyprus has once and for all demonstrated that those hoping that a "banking union" will be the panacea that gets us out of this mess are deluding themselves. The dream that the European Stability Mechanism will come to the aid of banks in troubled economies without invoking guarantees from the sovereign is dead. Better to face harsh reality than live in cloud cuckoo land. |
| All in all, the Cypriot deal has not created a new reality in the eurozone, but may go down in history as the point when reality was understood by markets, depositors, bankers and policy-makers alike – and that is no mean achievement. | All in all, the Cypriot deal has not created a new reality in the eurozone, but may go down in history as the point when reality was understood by markets, depositors, bankers and policy-makers alike – and that is no mean achievement. |
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