19 March 2013

FT: Cyprus reveals chinks in ECB armour

The ECB was closely involved in drawing up the rescue package for Cyprus that created alarm about bank customers being hit in the future across much of southern Europe, and called into question eurozone leaders' commitment to correcting construction flaws in EMU.

Two aspects of the ECB’s role are striking. First was its threat to bring down the Cypriot banking system if a deal was not reached – which jarred with the assurance last July by Mario Draghi, president, that the ECB would do “whatever it takes” to preserve the eurozone’s integrity (a pledge that accounts for much of the subsequent global equity rally).

The ECB took a harder stance than with Ireland or even Greece, subject of earlier bailouts, where it preferred deliberate “constructive ambiguity” – leaving unclear exactly what it would do if a package was not agreed.

Second was the ECB’s failure to stop Cyprus trying to finance its part of the rescue plan by imposing a levy even on bank deposits smaller than €100,000, the level supposedly guaranteed under a cross-EU pact. Throughout the eurozone crisis, the ECB has understood likely market reactions; it would have realised the incendiary consequences of such a step. Of course the ECB was in an acutely difficult position; funding the bailout involved terrible choices, a way out had to be found. But the ECB could have insisted on higher levies on deposits above €100,000. Not only is it an enthusiastic backer of a European banking union, which would eventually include common deposit protection; as an unelected institution, it has to worry about its reputation and popular legitimacy.

One explanation for why the ECB failed to prevent the Cyprus crisis escalating could be that Mr Draghi took his eye off the ball. Talks were left to Jörg Asmussen, the former German finance ministry official who sits on the ECB’s executive board. Another, perhaps more plausible explanation, is that the politics and arithmetic of Cyprus’s banking and financial problems were simply so intractable that the ECB judged any outcome would be unsatisfactory – but that the improvement in financial markets since last July would prevent contagion effects becoming catastrophic.

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