Cyprus has clinched a last-ditch deal with international lenders to shut down its second largest bank and inflict heavy losses on uninsured depositors, including wealthy Russians, in return for a €10 billion ($12.4 billion) bailout.
The agreement came hours before a deadline to avert a collapse of the banking system in fraught negotiations between President Nicos Anastasiades and heads of the European Union, the European Central Bank and the International Monetary Fund.
Swiftly endorsed by euro zone finance ministers, the plan will spare the east Mediterranean island a financial meltdown by winding down Popular Bank of Cyprus, also known as Laiki, and shifting deposits below €100,000 to the Bank of Cyprus to create a ”good bank”.
Deposits above €100,000 in both banks, which are not guaranteed under EU law, will be frozen and used to resolve Laiki’s debts and recapitalise Bank of Cyprus through a deposit/equity conversion.
The raid on uninsured Laiki depositors is expected to raise €4.2 billion, Eurogroup chairman Jeroen Dijssebloem said.
Laiki will effectively be shuttered, with thousands of job losses. Officials said senior bondholders in Laiki would be wiped out and those in Bank of Cyprus would have to make a contribution.
An EU spokesman said no across-the-board levy or tax would be imposed on deposits in Cypriot banks, although the hit on large account holders in the two biggest banks is likely to be far greater than initially planned. A first attempt at a deal last week collapsed when the Cypriot Parliament rejected a proposed levy on all deposits.
German Finance Minister Wolfgang Schaeuble said lawmakers would not need to vote on the new scheme, since they had already enacted a law setting procedures for bank resolution.
“It can’t be done without a bail-in in both banks . . . This is bitter for Cyprus but we now have the result that the [German] government always stood up for,” Mr Schaeuble told reporters, saying he was sure the German Parliament would approve.
Conservative leader Mr Anastasiades, barely a month in office and wrestling with Cyprus’s worst crisis since a 1974 invasion by Turkish forces split the island in two, was forced to back down on his efforts to shield big account holders.
Diplomats said the President had fought hard to preserve the country’s business model as an offshore financial centre drawing huge sums from wealthy Russians and Britons but had lost.
The EU and IMF required that Cyprus raise €5.8 billion from its banking sector towards its own financial rescue in return for €10 billion in international loans. The head of the EU rescue fund said Cyprus should receive the first emergency funds in May.
With banks closed for the last week, the Central Bank of Cyprus imposed a €100 per day limit on withdrawals from cash machines at the two biggest banks to avert a run.
French Finance Minister Pierre Moscovici rejected charges that the EU had brought Cypriots to their knees, saying it was the island’s offshore business model that had failed.
“To all those who say that we are strangling an entire people . . . Cyprus is a casino economy that was on the brink of bankruptcy,” he said.
Analysts had said failure to clinch a deal could cause a financial market selloff, but some said the island’s small size – it accounts for just 0.2 per cent of the euro zone’s economic output – meant contagion would be limited.
The abandoned plan for a levy on bank deposits had unsettled investors since it represented an unprecedented step in Europe’s handling of a debt crisis that has spread from Greece, to Ireland, Portugal, Spain and Italy.
Cyprus’s banking sector, with assets eight times the size of its economy, has been crippled by exposure to Greece, where private bondholders suffered a 75 per cent “haircut” last year.
Without a deal by the end of Monday, the ECB said it would have cut off emergency funds to the banks, spelling certain collapse and potentially pushing the country out of the euro.
Given that Cyprus's GDP is less than a quarter of the market capitalisation of the CBA, plus the fact that most of Cyprus's bank deposits were not widely held by foreign banks, it is difficult to see this situation contaminating global financial markets.
This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.