The Cyprus Bank Bail Out: Hard to Think of a *More* Politically Costly Option

by Joshua Tucker on March 18, 2013 · 11 comments

in Political Economy

This weekend, the Eurozone was greeted with the specter of a something it had hoped was behind it: the dreaded bank run. Cyprus, a small Eurozone state, agreed to terms on a 10 billion Euro bailout that included an immediate tax on all bank deposits (a smaller but non-negligible tax on accounts under 100,000 Euros and a larger one on accounts above that threshold). That means when banks next open – if the plan goes through – everyone is going to have less money in their bank account than they did on Friday. To facilitate the plan banks are closed and electronic money transfers have been suspended, although in an interesting technological twist of fate ATMs are open, thus allowing the specter of a bank run to hover over Cyprus (and be photographed) without actually allowing people to get most of their money.

I will let the economists sort out whether financially this sort of approach makes sense, but from a political perspective it would appear to be the worst of all possible options. To make a great simplification, it would seem that there are three ways to deal with a failing bank:

  1. Use taxpayer money to save the bank

  2. Let people who loaned money to the bank (“bondholders”) lose money

  3. Let the people who have put their money in the bank (“depositors”) lose money

All of these approaches have economic costs.  But from a political perspective, we’re interested in who pays the cost, how large a proportion of the population that is, and how aware they are of paying the costs.

So let’s start with bondholders.  This is usually a fairly small group of people – many of whom are often not even citizens – who pay a large cost.  Due to this dynamic, we might think bondholders could be a powerful lobby – they have both the interest and the ability to organize – to try to forestall this sort of action.  But politically, if bondholders pay the price for bailing out a bank, we would not expect this kind of a decision to generate much backlash among the citizens of a country.  (Again, this is not to say it won’t cause all sort of economic problems accessing international markets in the first place down the road.)

At the other end of the spectrum is a government bailout (or a government loan to fund a bailout).  Here, all the citizens of a country will eventually pay a cost, but unless the government bailout comes with explicitly conditional austerity measures (think Greece, not the United States) citizens don’t know what the cost is or when they are paying it.  It may be ominous and feared, but it had the advantage for the government implementing it of at least being vague.

What the Cypriot government did seems politically to be the worst of both worlds.  By announcing an immediate tax on all bank deposits, every Cypriot citizen with money in the bank knows exactly how much money they have just lost.  But unlike the bondholder scenario, we’re talking about a significantly large proportion of the population. Moreover, since the act of responding to this impending tax has been made public by the fact that wire transfers are prohibited, every citizen of Cyprus gets to see just how upset/worried her fellow citizens are.  Again, there may be an economic rationale for this form of bailout (but even that I assume will be swamped by negative side effects if the bank runs spread to other European countries), politically it seems hard to come up with something more likely to generate immediate and relevant ill will. (It does remind me of a Doonesbury cartoon from the 1984 presidential election campaign, when Mondale is asked to elaborate on his plan for raising taxes and he gladly begins to name all the people who will pay higher taxes under his plan…)

The only political rationale I could think of for this sort of policy is if you only had a small proportion of citizens with money in the bank, and/or if your power base lay in the poorer segments of society that were unlikely to have bank accounts.  So there are some places in the world where you might expect this type of policy to potentially pay off politically, but I doubt Cyprus is one of them.  (I couldn’t find this figure from an admittedly quick Google search – if anyone knows it, please put in comments below). However, my guess is that if you exempted all accounts under 100,000 Euros, then you quickly move from a situation where the tax only affects “the rich” as opposed to “everyone”.  I put “the rich” in parentheses because of course everyone has different definitions of who is “rich”, but at least the deal could be sold in that manner.  Ironically, it may turn out that the rich are more likely to have diversified assets and thus a smaller proportion of their wealth in Cypriot banks than the simply “well off”, but again there are others who know more about such facts than I do.

Therefore if the actual version of the deal that ends up getting implemented exempts all accounts under 100,000 Euros, you can be pretty confident that the basis of that arrangement is as much political as it is economic.  And to be clear, while economically it might be just as as consequential (does Italy really want everyone with over 100,000 Euros in savings in an Italian bank wiring that money to Geneva or London this week?), politically such a change will ensure the Cypriot government that it suddenly has many, many fewer citizens suffering an immediate loss from the bailout (and Spain and Italy could have many fewer citizens worried about the export of such a tax, although now that the full fledged tax is on the table it remains to be seen whether a Cypriot retreat would banish the specter of such a tax from the minds of other European citizens).  Thus we may be watching a policy designed without politics in mind coming face to face with political reality.


Martin Edwards March 18, 2013 at 7:45 am

It’s also surprising that no one is taking responsibility for this wonderful policy. One would think it ideal for the ECB to demonstrate that they owned it as a means to better signal resolve.

Mr Dave March 18, 2013 at 7:59 am

Do you really think the money is safer in London? I’m emptying my UK accounts this afternoon!

Erik Voeten March 18, 2013 at 8:50 am

The problem is that this was not really Cyprus’ choice but the IMF/EU/Germany. I still cannot believe they proposed something so risky. Why on earth would you want to increase the risk of a bank run all over Europe for what is a modest amount? Incredibly shortsighted.

jonathan March 18, 2013 at 11:47 am

I was mostly interested in the signaling aspects. I’ve read Russian deposits are somewhere around $20B Euros. So this is a confiscation of nearly $2B Euros of foreign money, not counting any other foreign money.

1. That is a clear signal to avoid a class of nations’ banks. That has negative implications for investment in those countries. This could look to some as a power consolidation by the most powerful interests in Europe. They signal they not only pull the strings but that money which doesn’t flow through them is at risk.
2. That is a clear signal to foreigners, meaning certainly Russia, that their interests are subordinate within the Eurozone and that their assets can simply be taken. This has foreign policy implications because now Russia has to think about how they’ve just been punished by the Eurozone nations. And that makes me wonder how Russia interprets this signaling.

I’m of course lumping Russian money together as Russian, but we’ve seen Russia act vigorously whenever general Russian interests are threatened.

Just thoughts. We’ll see.

Scott Monje March 18, 2013 at 12:07 pm

Interesting points regarding the implications for relations with Russia. But does any sort of banking collapse really have positive implications for foreign investment? And if the Russian depositors are really interested in money laundering (as alleged, not necessarily proved), then they’re likely to move their money to another place with loose banking rules, which I’d assume wouldn’t be in the core countries of Europe.

Scott Monje March 18, 2013 at 11:54 am

According to NPR this morning, the Cypriot banks simply haven’t issued many bonds; depositors are their primary source of funds. Political calculations leaning the other way are (1) the Germans’ bailout fatigue and (2) the reputation of the Cypriot banks as money-laundering sites for Russian oligarchs. So the banking sector, by attracting oligarchs, may well have grown larger than the Cypriot government can afford to bail out. (Just guessing on that one.) The Germans are reluctant to contribute to a bailout, especially if the beneficiaries are Russian oligarchs. On the other hand, if they do rejigger the solution so as to tax only the larger deposits, a lot of the depositors are not going to be Cypriot citizens.

Scott Monje March 18, 2013 at 2:07 pm

“Non-EU resident deposits,” mostly from Russia, are estimated at 188% of the entire Cyprus GDP.

IonM March 18, 2013 at 12:14 pm

Cyprus functioned as a tax haven (offshore, but in the EU) in Europe and given that Russian oligarchs and Russian corrupt officials were hiding their moneys there, it seems that IMF/EU/GErmany imposed a tax on them. However, I suppose these Russian corrupt officials and wealthy will want “to keep quiet”, especially after Putin passed the law barring Russian officials from opening banking accounts abroad.

Left Coast Bernard March 18, 2013 at 1:45 pm

You left out requiring the bank to purchase insurance to protect some or all of its depositors, and you left out requiring the bank’s shareholders to contribute the bank’s assets to protect its depositors.

Your solution 1 only arises because the EU people have in mind that governments should make bondholders, often other banks, secure without having previously required the banks to purchase insurance to protect the money given to them by large investors.

Nameless March 19, 2013 at 2:02 am

The article does not fully address just how horrible politically this action is. The issue is not even whether people with sub-100k deposits get haircuts. Just the existence of the haircut for non-residents is a thoroughly suicidal move. It can be likened to trying to help a starving person by cutting off his leg (under the premise that one-legged person needs to eat less.)

It’s one thing to raid accounts of residents; residents are generally docile and they don’t have much choice anyway. (The fact that, after several close brush-ups with euro exit, Greeks still hold their savings in Greek banks, is an excellent illustration of that.) It’s different when your intended victims are rich, educated and cosmopolitan nonresidents.
You can be sure that there are thousands of rich Russians right now frantically trying to open bank accounts in any country they can, intending to move all their savings out of Cypriot banks the moment that wire transfers out of the country are enabled. As the saying goes, “fool me once, shame on you; fool me twice, shame on me.” Whether or not the 10% haircut on large deposits is actually implemented, you can’t unring a bell, and you can’t convince depositors that Cyprus is a safe place to keep money any more.

What’s going happen as soon as wire transfers are back on (presumably, on Thursday morning), is a massive bank run on all Cypriot banks by all nonresident depositors. Since nonresidents account for more than half of all deposits in Cypriot banks, and for them moving money is one mouse click away, banks will promptly fold.

Cyprus tried to be 9.9% Iceland and it is about to learn that it can’t. When facing a banking collapse, you can either be 0% or 100% Iceland, there’s no middle ground.

IonM March 19, 2013 at 7:14 am

A couple of reactions from the Russian media: some banks on Cyprus were providing credit to many Russian companies, so some Russian economists are worried that the “haircut” will affect those companies as well. Putin called the decision dangerous, unprofessional, and unfair, while Medvedev and Russian businessmen say it’s outright confiscation of foreign money same like in Soviet times (only in Russian here: and; the Russian finance minister says that Russia might restructure the credit Russia offered to Cyprus and advises that Russians keep their funds in Russian banks.

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