25 March 2013

Graham Bishop's Blog: Cyprus - Will the deal last? Probably not

The Eurogroup finally agreed a deal with Cyprus link. It bears a great similarity to what was offered a week ago but the losses in Laiki and Bank of Cyprus (BoC) are now borne completely by shareholders, bondholders and large/uninsured depositors. For Laiki, the probability is that those classes will be wiped out completely; for BoC, large depositors may lose perhaps 20 per cent on current calculations as sufficient of their deposits are converted into equity to give a 9 per cent capital ratio. The loans offered to Cyprus remain unchanged at up to €10 billion.

This story is a long way from over. The economic outlook is now much worse than say a month ago and that will flow through into loan losses at other banks. To the extent that uninsured depositors also had back-to-back loans, then it may prove more difficult to collect repayment of the loans especially if they are outside Cyprus. The business model of Cyprus is comprehensively shattered and it will urgently need development aid rather than new debt.

This agreement has broken new ground in the eurozone’s search for solutions to excessive debt that should never have been undertaken by a host government, or permitted by the eurozone. The search for political mechanisms to give the collective power to stop this happening in the future still point inexorably towards a much greater degree of 'political union’.  Financial markets will now apply far more discipline to weak banks and governments as no-one will believe that there will never be PSI again. Indeed, Cyprus will struggle to avoid that as the economy unravels. Uninsured personal/corporate depositors are now quite clear about what can happen in a bank resolution.

This episode also has a regional political dimension: Turkey staked an unambiguous claim on behalf of Turkish Cypriots to a share of any gas that eventually comes ashore.

Rolling Blog

© Graham Bishop