By Paul Hansen, Director Retail Investing, STANLIB
The background
Cypriot banks have for several years been offering investors euro returns well above average. For example Cypriot banks were paying 4.5% compared to 1.5% offered by German banks. This made Cypriot banks a very attractive investment destination. Before long the deposits held by Cypriot banks swelled to 126.4bn euros, seven times the size of the economy compared to just 78bn euros six years ago.
The banks amassed funds from wealthy foreigners to the point where the size of the banks were too much for the country to handle. Wealthy Russian families and Russian corporates in particular chose Cyprus as a major investment destination accounting for around 30% of all deposits. There have been concerns for some time that these deposits may have involved money laundering.
Too good to be true
As all rational investors know, if someone is offering a return well above the market, they are taking additional risk. In this case Cypriot banks had huge exposure to Greece and lost around 4.5bn euros on Greek sovereign debt.
The banks needed to be bailed out and the Eurozone drove a hard bargain requiring the Cypriot government to put up some of the funds for the bailout.
The deal
Cyprus agreed to a significant restructuring of its banking sector, along with other measures such as tax rises and privatisations. The measures are designed to raise billions towards the bailout, but protect bank customers with deposits of 100,000 euros or less. Deposits at Bank of Cyprus of more than 100,000 euros were frozen and the banks were closed for a week allowing only limited withdrawals.
Deposits above 100,000 euros will be tapped by the government to raise billions towards the bailout. It is not clear how much of the money will be taken, but a government spokesman suggests customers should expect to lose about 30% of the balance.
The precedent
The indication from the leaders of the Eurozone is that Cyprus was used to make an example. The country had only recently joined the European Union and in that time had shown scant respect for European banking rules or good corporate governance, including a blind eye to possible money laundering.
Moreover the bulk of the investors affected were very wealthy; unlike Iceland these deposits were not made up of pension fund assets. Rather than setting a precedent for European governments to tap into citizen's savings, it was a message to all European governments to carefully manage their financial systems in accordance with European Union rules.