New Deal for Cyprus, Bank Run to Follow?

Insured depositors are protected, but will the Russians flee?

There's a deal in Cyprus, according to the New York Times, leaving the insured small depositors untouched and seizing a substantial portion of larger accounts:

A one-time levy of 20 percent would be placed on uninsured deposits at one of the nation’s biggest banks, the Bank of Cyprus, to help raise 5.8 billion euros demanded by the lenders to secure a 10 billion euro, or $12.9 billion, lifeline. A separate tax of 4 percent would be assessed on uninsured deposits at all other banks, including the 26 foreign banks that operate in Cyprus.

An agreement was still far off, though, as Cyprus’s lenders left for the night without reaching an accord. The proposal still requires approval by the Cypriot Parliament and by the European Central Bank, International Monetary Fund and European Union leaders. Finance ministers from the 17 euro zone countries have scheduled an emergency meeting at 6 p.m. Sunday in Brussels.

Under the plan, savings under 100,000 euros would not be touched — a rollback after a controversial plan last week to tax insured deposits was rejected by Cyprus’s Parliament, amid outrage among ordinary savers and widespread concern that a precedent had been set for governments anywhere to tap insured bank savings in times of a national emergency.

Cypriot officials on Saturday also pulled back on a plan to raise billions of additional euros by nationalizing state-owned pension funds, after Germany, whose political and financial clout dominates euro zone policy, had indicated it opposes the move.

Cyprus’s president, Nicos Anastasiades, was meeting Saturday night with political parties to explain the plan. He was scheduled to fly to Brussels on Sunday.

Cyprus’s finance minister, Michalis Sarris, said on Saturday that there had been “significant progress toward reaching an agreement” with European officials on raising money for a bailout.

The deal still has to pass the Cypriot parliament, the IMF, the EU, and various European governments. But the deal has obvious appeal: it's mostly paid for by Russian nationals. So while I wouldn't call the need for approvals just a formality, it seems likely to get the rubberstamp from the relevant governments.

The next question is whether this triggers a bank run, with foreign deposits fleeing the country. With a 20% haircut, this seems like a fairly large risk. That doesn't mean that the deal was a bad idea--at this point, there are only bad options. But it does mean that the story won't end with the parliamentary vote.

Update: the FT has more

Under the outlines of the deal, depositors with accounts worth less than €100,000 would not be touched. But those above those levels in Laiki Bank, the second largest and most troubled financial institution, would be severely cut, the officials said. The losses on large deposits in Bank of Cyprus, which will survive as a much smaller entity, have yet to be decided, but could be as high as 40 per cent.

The deal should be enough to release a €10bn bailout package and save the island from bankruptcy.

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There will apparently be temporary capital controls to prevent the Russians from withdrawing all their money. They're only supposed to last a few days, but it's hard to see what good a few days of capital controls will do. Given that free movement of capital is one of the basics of euro membership, this poses some interesting issues if they're allowed to continue. The issues if the capital controls aren't allowed to continue are also pretty obvious.