Cyprus

Since the financial crisis of 2007/2008 in the United States, there has been a worldwide domino effect resulting in negative consequences for the economies of a number of countries. The Dominion of Cyprus remained relatively unscathed immediately preceding this economic downturn with a contraction of the economy as result of decreased tourism. In 2011, however, as a result of haircuts upwards of 50% on the Greek bonds that Cypriot banks had heavily invested in, Cyprus was no longer able to support its financial sector and was forced to seek a bailout from the European Union. The proposed bailout plan for Cyprus was not only unexpected, but an action that had never before been done in the history of banking crises. This controversial “bail-in” plan has many serious implications for state of financial markets worldwide.

The European Union agreed upon a bail-in plan in which bank deposits would be used to support the struggling Cypriot banks. Specifically, a levy of 9.9% on the savings of depositors with balances over 100,000, and 6.75% on depositors under 100,000 will be paid in return for equity in the banks. Nearly 6 billion euros would be saved from the European taxpayers while Cypriot government figured they could just “spread the pain” resulting in nearly 7% payments from the insured depositors. With this plan to pass, depositors not only in the European union, but around world would now fear the risk of a breach in the explicit promise that they can be sure of getting their money back in the face of an financial crisis. With this precedent set, the chance of wide spread, unsettling bank runs all would go way up.

Another implication of this plan sheds light on the European Union potentially taking unfair advantage over Cyprus. Morally there seems to be no significant reason for the hard working Cypriots to take such a drastic hit while sovereign-debt investors and senior bondholders remain relatively untouched. Although the European union will ensure that this plan is a one-time-strenuous-circumstance action, many people will question the union’s equity and ultimate longevity. Particular cynicism will arise from other less dominant countries that are either already in the euro zone or in Latvia’s case, planning to join in the near future.

With a decreasing tolerance by the public regarding taxpayer bailouts, it is clear that new bailout strategies must be made when in the midst of financial crises. The bail-in plan for Cyprus seemed to provide a nice way around this issue, yet it is in fact quite shortsighted and self-defeating. Not only would Cyprus experience substantial capital flight from a number of doubtful investors, the adverse affects on other financial markets would be extremely powerful. Instability and untrustworthiness would spread between the banks and its depositors. Ultimately this would widely affect the over-all public confidence in the financial system as a whole.