Cyprus Deposit-Tax Worries Spark Fears of Bank Run in Southern Europe

Devan Biswas
18 Mar, 2013
New York City

Cyprus bank depositors are facing a

[R]5:30 PM Frankfurt – Cyprus bank depositors are facing a €5.8 billion tax, despite the past promises otherwise. Cyprus and European regulators in an about face sought to tax bank deposits sparking the fears of a bank run in the peripheral euro zone.[/R]

Cyprus lawmakers postponed the debate on bank depositors for the second time in as many days.

Cyprus is the fifth nation seeking a bailout from the European lenders in three years just as the euro zone debt crisis appeared to be contained.

In a significant departure from previous assurances given by the leaders of the nation and European regulators, Cyprus is likely to be the first nation to demand a tax from bank depositors.

The move was widely feared by the depositors and in January about €1.7 billion was withdrawn from the banking system.

However, many in Cyprus and in the euro zone feel that European leaders may have crossed a sacred line and taken on tall risks on reneging the promises of ensuring the safety of bank deposits smaller than €100,000.

Regardless of how Cypriot lawmakers vote on the provision demanded by the troika, savers and especially older citizens are more likely to reconsider leaving large deposits in banks.

Cyprus, with gross domestic product of €18 billion or $25 billion, accounts for only 0.3% of the euro zone economy and has 1.1 million citizens. Cyprus is the third largest economy in the euro zone, larger only than Estonia and Malta.

Despite the independence from the U.K. rule, British army still maintains a large presence on the island with 3,000 military personnel and nearly €2 billion of bank deposits.

Cyprus government debt totaled €14 billion at the end of last year, according to the eurostat, the European statistics agency. And unemployment on the island was 14.7% at the end of January.

The precise amount of deposits in the Cyprus banks is not clear but estimates range between €65 billion and €68 billion of deposits at the end of February. Nearly €25.8 billion of deposits are held by the non-residents and roughly €15 billion are held by Russian companies and individuals.

Cyprus has the largest oversized banking system compared to its gross domestic product, even larger than troubled Ireland. Cyprus banks hold deposits four times the island’s GDP.

Cyprus has double-taxation avoidance treaty with Russia and Cyprus based companies are the largest foreign investors according to the Russian central bank.

The current proposal demands 9.9% one-time tax on all depositors with a balance of €100,000 or more and 6.75% tax on smaller accounts.

The angry Cypriot citizens protested in front of the Parliament today as the President walked in to hold a cabinet meeting.

In a televised appearance on the weekend, President Nicos Anastasiades stressed without the bailout, banks may fail in Cyprus and the nation may have to leave the euro zone.

Banks in Cyprus are in a difficult situation because banks have not issued large amount of debt and there are very few secured and unsecured bond holders. With the limited availability to pass on the burden of bailout to bondholders the troika of lenders is forced to turn to depositors.

Cyprus is looking for €10 billion of bailout and the European Central Bank, European Commission and the International Monetary Fund have demanded that Cyprus raise €5.8 billion from depositors with other conditions attached.

Divided lawmakers are scheduled to vote on Tuesday 4 p.m. local time, according to the Parliament and the vote may be delayed until Friday.

President Anastasiades controlled party holds 30 seats in a 56-member Parliament but several lawmakers are wavering on the approval of the measures and one lawmaker is traveling outside the country.

He went on to add that the International Monetary Fund had proposed a tax as much as 40% and asked the government to eliminate two of largest banks and merge them with the healthier banks that could wipe out most of the depositors at the weaker banks.

The divided lawmakers are looking to lower the one-time tax on depositors with deposits of less than €100,000.

Lawmakers are working on proposal to eliminate the tax on all accounts with less than €20,000 and lower the tax rate to 3% on accounts between €20,000 and €100,000. Lawmakers are also seeking to raise tax to 15% on all accounts with €500,000 or more.

Russian stock market index fell 1.5% on the news of the Cyprus tax proposal as several large Russian companies and wealthy individuals hold accounts in Cyprus.

The island nation has also acquired reputation to attract capital from Russia and other nations for money laundering and criminal groups based in the former Soviet Union.

Russian President Valdimir Putin strongly criticized the tax proposal and said through his spokesman Dmitry Peskov that if the proposal is adopted it would be “unfair, unprofessional and dangerous.”

Banks are closed tomorrow and are likely to be closed until Friday if lawmakers fail to agree on the final proposal that satisfies the troika. Banks were also instructed to take the tax amount for all ATM withdrawals since the weekend.

Banks across the euro zone traded sharply lower on the worries that the proposal to tax depositors may set off a bank run in several highly indebted nations like Greece, Spain and Italy.

The European Central Bank has so far provided a guarantee to offer a financial and liquidity support if the island nation needs help but similar slow moving bank runs in several peripheral nations of the euro zone simultaneously could stretch the central bank’s ability.