restrictive bank deposits.... uniquely unsafe

Fallacy of a decent investment

Imagine you have a deposit with a local bank which you had placed after careful analysis. You had concluded that there weren't much risks associated with the deposit although it might not be as safe as a government bond. It made a good deal earning decent, almost guaranteed, interest payments for you. In addition, some part of the deposit was fully guaranteed by the federal insurance. Not a great investment you thought but considering your personal finance, risk profile and behaviour, you thought it was alright. 

Bang! You woke up on a nice morning and found that the bank has suddenly decided to levy some sort of a charge on your deposit. You were not asked for permission; neither was there any choice. Now, you are one disgruntled investor.

Solving a troubled nation...the action

This is what has actually happened in Cyprus. Cyprus is currently in trouble due to its debt and could face bankruptcy if the bailout it is seeking does not come. It could also go out of the eurozone. The country's debt-to-GDP ratio is likely to go to 140% if that Euro 10 billion bailout is not there. In short, Cyprus needs money rather badly right now. However, a precondition to this bailout is: collecting about Euro 5.8 billion from the depositors. Cyprus is left with little choice.

The drama is just beginning to unfold. 

The breach of trust

This brings down to the fundamental principle of the investor rights: If a business goes under first payments are made to the senior security holders and last payments, if any, would go to equity investors. However, Cyprus banks are violating this basic principle. Losses are borne largely by the depositors, not much by the bond holders; and common stockholders....we don't know. But is this a fair game?

Cyprus has bank deposits aggregating to about $65 billion; which means about $4.4 billion (at 6.75%) to $6.4 billion (at 9.9%) will be collected from the depositors' money. These depositors include all kinds of savers: individuals, retired, institutions and corporations, both local and foreign. 

Greece, Ireland, Portugal and Spain, all of them have sought bailouts of some kind in the recent past. However, nothing of the Cyprus kind was seen before. There are probably political reasons around collecting money from the depositors. 

The reaction

Surely, if the charge is levied the repercussions would be noticeable: Investors would lose faith in bank deposits in any country, but particularly in the eurozone. The flight of capital would take off to somewhere outside of the eurozone. Banks would collect less in deposits, which means they will have to go to bond and stock markets for raising capital. Bank deposits would demand extra premium (to compensate for default and restrictions risk). The cost of capital for banks would go up significantly. 

Trouble when it walked in

Euro will still be troubled: Common  currency, common central bank and common monetary policy; countries giving up their right to print currency; surrender of the countries' sovereign powers - all of this would lose credibility, not because of Cyprus factor alone but due to collective troubles of the eurozone. 

The eurozone and Euro can be summed up by quoting Taylor Swift: I knew you were trouble when you walked in. The basic crime of Euro is having been born.