This is the first of a four part series that will deal with the recent bail-in that occurred in Cyprus. This pivotal, watershed event is absolutely vital for everyone to understand. There are huge systemic risks built into the banking system that too few people comprehend. Cyprus is simply the first domino to fall. It is the proverbial canary in the coal mine.
This post will focus on documenting exactly what happened in Cyprus and laying out the timeline of events. Future posts will then analyze the impact of the crisis, how the system made sure the burden was borne by ordinary depositors (and not the very wealthy or large corporations) and how this bail-in sets a dangerous precedent for future bank failures in Europe and elsewhere (including Canada).
Although most people only learned of the financial crisis in Cyprus when it blew sky high in March 2013, the reality is that, as with most peripheral countries in the Eurozone, things had been deteriorating in Cyprus for some time before that. Starting from 2009 here’s how events unfolded in Cyprus:
- Like most countries, Cyprus’ economy was hit hard by the recession in 2009 and experience a strong contraction of over 1.5% GDP.
- During 2010 and 2011 Cyprus’ economy experienced tepid growth and failed to recover to the pre-2009 levels. During this same period the large Cypriot banks amassed a huge amount of high-yield Greek bonds. While the GDP of Cyprus was under €20 billion, the banks had accumulated over €22 billion in Greek bonds. For a while this worked out great: The Greek bonds had long since been downgraded to junk status meaning that they paid high interest to the banks.
- But with such high returns came risk. And, in October 2011 Greek bond holders got burned – big time. As part of Greece’s second bailout, Greece agreed to impose a 53.5% haircut on bond holders (except for the European Central Bank which was exempted from taking any loses; coincidentally the ECB was part of the so-called Troika that drafted the terms of that bail-out). In an instant, the Cypriot banks had just shy of €12 billion wiped off their balance sheets. These banks were instantly insufficiently capitalized and in dire straits.
- By January 2012 Cyprus was relying on a €2.5 billion emergency loan it had secured from the Russians to cover the growing deficit and refinance existing bonds as they rolled over.
- By March 2012 Moody’s (one of the major rating agencies) had downgraded Cypriot bonds to junk and then in June Fitch followed suit. These rating downgrades disqualified Cypriot bonds from being accepted as collateral by the ECB. It also meant that many mutual funds, pension funds, ETFs, etc., which have rules about the rating of the bonds they purchase, could no longer purchase or hold Cypriot bonds. This instantly and severely reduced demand for Cypriot bonds.
- On June 25, 2012, the same day as the Fitch ratings downgrade, Cyprus formally requested a bailout from the EU.
- Throughout the rest of 2012 and into March 2013 negotiations between the so-called Troika (ECB, IMF, European Commission) and Cyprus continued. The glimpses the public saw of proposals all centered around conditions similar to previous EU bailouts – namely tax hikes and austerity.
- On Saturday March 16, 2013 the final terms of the bombshell deal were announced. Rather than a pure bailout (in which funds from the outside are used), these terms required a partial bail-in where assets (i.e. deposits) from inside the failing banks would also be used. In exchange for the €10 billion in bailout funds, Cyprus would raise an additional €6 billion by imposing a one time bank levy of 9.9% for uninsured deposits (i.e. those over €100,000) and 6.75% for insured deposits (i.e. those under €100,000). ATM withdraw limits of €400 were imposed as Cypriots flocked to ATMs trying to withdraw money. Many ATMs in the country simply run out of cash even with the €400 limit.
- Sunday March 17th starts to see the vehement reaction of Cypriot people to this unprecedented seizure of deposits. As the deep unpopularity of the levy becomes clear, the Cypriot government postpones the emergency session of parliament that had been scheduled to vote on the bailout terms from Sunday to Monday. A bank holiday is declared for Monday meaning that, aside from limited ATM withdraws, Cypriots will be unable to remove their exposed funds from the banks,
- On Monday March 18th the Cypriot government is in panic as the rage of both the people and Russian government (many of whose wealthy citizens have large holdings in the Cyprus banks) reaches a crescendo. The decision is made to again delay the parliamentary vote until Tuesday and it is announced that the bank ‘holiday’ is being extended until Thursday, March 21st. The run on ATMs continues and banks start to unilaterally reduce the maximum withdraw below the government imposed €400.
- Tuesday March 18th sees the Cyprus politicians bow to the overwhelming public pressure and reject the bailout terms from the Troika. Cyprus desperately seeks alternative investment from the Russians and wealthy Middle Eastern investors. On Wednesday it announces another extension of the bank holiday until at least Tuesday, March 26th. The prospect of Cyprus exiting the Euro starts to be openly discussed amongst Troika officials.
- For the remainder of the week (March 19th until the 24th) ATM withdraw limits remain in place eventually dropping to €100. Bailout terms gradually start to turn away from applying a levy against insured deposits and towards applying a larger levy against uninsured deposits.
- On March 25th bailout terms are agreed upon by the Cypriot government and the Troika. The deal essentially separates the two largest banks at the center of the crisis (the Bank of Cyprus and Laiki Bank) into a ‘good’ bank and ‘bad’ bank. Under the deal, Laiki becomes the bad bank that will be wound down. Its bond holders are to be completely wiped out (i.e their bonds are worth €0). All good assets and insured deposits are to be transferred to the Bank of Cyprus. Uninsured deposits at both banks (those greater than €100,000) are to remain completely frozen until it is determined how much must be confiscated for Cyprus to raise the €4 billion required under the deal. Capital controls are also imposed including a €300 daily withdraw limit from banks and ATMs, a €2000 per month limit on transfers out of country and an outright ban on cashing cheques or opening new accounts. It is announced that these capital controls will be in place for a limited time (2 weeks) while the terms are finalized and Laiki wound down. Banks are reopened under the new capital controls March 28th having been closed since March 16th.
- Throughout the rest of March and April 2013 the capital controls are repeatedly extended and the estimated hit against the frozen uninsured deposits creeps from 20% up to more than 80%.
- On April 30th the final bailout terms are approved by Cyprus and the exact terms of the bail-in announced (see below).
The Current Situation
With the final approval of the bailout and bail-in on April 30th, here’s where things stand today for the uninsured deposits:
- 37.5% has been converted to shares in the Bank of Cyprus (at a nominal value of €1).
- 22.5% will remain frozen pending an updated audit of the Bank of Cyprus expected at the end of June. This 22.5% may then also be converted to shares in the Bank of Cyprus depending on the result of the audit.
- 30% will remain temporarily frozen. These funds may also be converted into shares at a later time or otherwise confiscated by the Bank of Cyprus.
It is important to understand the game that is being played with converting cash into shares in the Bank of Cyprus. The shares are converted at a nominal value of €1. That’s great except the Bank of Cyprus share price is only around €0.20 these days. So, if you had €10,000 converted to shares under these terms and then sold your shares you’d only get €2000 – thus you’d realize an 80% loss. In other words, the ‘converted’ funds are almost entirely written off due to the nominal value chosen for the conversion.
So, uninsured depositors have already effectively lost 30% (37.5% * .8) and have an additional 52.5% frozen for the foreseeable future and subject to loss. Assuming the share price doesn’t drop further (not something I’d bet on) another 42% (52.5% * .8) will be stolen. This gives us a grand total 72% loss imposed on uninsured deposits.
In the meantime there continues to be draconian capital controls imposed on Cypriots – an indication the worst may not yet be over. Here’s a summary of those capital controls still in effect today:
- €300 per day withdraw limit (at ATM or bank teller).
- €5000 per month in transfers outside the country.
- €3000 per month can be taken out of the country by travellers.
- Cashing of cheques not permitted (but depositing of cheques is).
Expectations are starting to be unofficially set that these capital controls will likely remain in place through the summer.
The next post in this series will look at some of the impacts from these events. I’ll look at both the impact on the ordinary Cypriot as well as the impact on the wealthy foreign depositors and institutions with funds in Cypriot banks. As you might expect, there is a large discrepancy between how these two groups were treated. I’ll try to expose some of the ways in which the banksters and uber-rich were allowed to circumvent the system and ultimately ensure that the ordinary Cypriot depositor would be the one left holding the bag.
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