18 March 2013

FT: Levy plan bleak day for banking union

The decision to strip €5.8 billion from the savings accounts of Cypriot banking customers has blown a hole in the EU's reforms billed as the route out of the eurozone crisis, while potentially undermining a growing reliance at banks around the world on funding their operations with customer deposits.

Though there is little direct knock-on from the Cyprus debacle for equity or bond markets, investors were rattled that the terms of the bailout seemed to tear up the principles of creditor hierarchy, setting a precedent that could be replicated elsewhere in the eurozone. Shares in some big Spanish and Italian banks slumped as much as 5 per cent and bond spreads widened.

One official described it as “a bleak day for banking union” – the grand and unfinished project to shore up the eurozone through a single supervision, resolution and deposit insurance system. The most immediate effect is on the credibility of the deposit insurance regime, a country-level promise to protect savings under €100,000 that the EU rushed through to build confidence after the 2008 financial crisis.

Michel Barnier, the EU commissioner responsible for the financial sector, wants depositors under €100,000 to be exempt from the Cypriot levy. In any case, hopes for a pan-eurozone deposit guarantee scheme now look to be dashed.

In a blunt note to clients on Monday, analysts at Morgan Stanley said the move “goes beyond expectations, raising concerns of a possible policy mistake”.

The second effect is on the credibility of the planned EU regime to wind up failing banks. The plan would give states the tools to address a banking crisis without relying on taxpayers – such as by writing down uninsured creditors. Once this regime is agreed, a proposal is expected to establish a resolution authority for the banking union.

However, the decision in Cyprus has shown that these principles can be overturned when required. By exempting bondholders and hitting depositors, the bailout has, in essence, upended the hierarchy of creditor risk the new regime was trying to introduce.

People who defend the Cypriot plan say the funding structure was the reason why there was no alternative to hitting depositors – junior bonds, which are being wiped out, amounted to just €2.5 billion, while the €0.2 billion of senior unsecured bonds have been left alone, on the grounds that to give them a haircut would generate a negligible economic contribution but undermine investor sentiment.

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