The great Cypriot bank robbery

The proposed tax on bank deposits in Cyprus in return for a 10 billion euro bailout from the IMF and European Union strikes at the heart of the most precious asset in retail banking: depositor confidence.

In previous bailouts the beneficiary country has had to contribute in some form, and this one is no exception.  The problem is a lack of suitable assets.  This is a country about the size of Birmingham but with a lot more sunshine and Russians, who happen to have substantial deposits there.

The current plan is to take a one-off tax on deposits over 20,000 euros; those holding between 20,000 and 100,000 would have a 6.75% levy and those with deposits above 100,000 face a levy of 9.9%.  Depositors would be compensated with the equivalent amount in shares in their banks, which is a bit rich as it is forcing depositors to take a risk position in the banks that are at the heart of the problem (Cypriot banks have loaned a total of 160% of Cypriot GDP to Greek banks).

The predictable outcome has been depositor panic, with cash machines being emptied and the banking system shut until Thursday.  The UK Ministry of Defence has announced that it will fly one million euros to the island to assist UK armed forces personnel to make payments in the event that they can’t get hold of cash or use their debit cards.  This is dramatic, headline-making stuff that undermines confidence in banking systems generally.

As I noted in a previous blog, the amount of cash in circulation in the UK is steadily rising, and jumped sharply in the immediate aftermath of the banking crisis as citizens used cash as a store of value (the Bank of Mattress).  Events in Cyprus are highly unlikely to change depositor behaviour in the UK, but it is likely to unsettle depositors in countries that are under fiscal stress and have a culture of tax avoidance.  These are already heavy cash-centric economies, and the threat (however remote) of a ‘tax’ raid on their deposits will only exacerbate the move into cash, particularly since low interest rates mean that the opportunity cost of holding paper money is low.

If the deposit levy goes ahead it will undermine confidence in the security of bank deposits, and that can only be bad news for the stability and efficient running of banking systems across Europe.