Stability of the Cypriot financial system under threat

A measure to tax all the deposits in Cypriot banks under new special taxing policies is something unparalleled, never seen before. Today, the Cypriot Parliament will decide whether or not to approve the decision of the President, which is linked to obtaining financial assistance fr om the European Union in the amount of 10 billion Euros.

The proposed tax rate amounts to 6.75% for deposits of less than 100 thousand Euros and 9.9% for deposits of more than 100 thousand Euros. Statistics from the Central Bank of Cyprus puts the amount of money held in Cypriot banks at the end of January 2013 at 68.4 billion Euros. 

Interest rates on term deposits in Cypriot banks constitute 2.5-4.5% per annum. Thus, even small investors will lose at least 1.5 years of interest on deposits. But the tax will affect all accounts, including demand deposits and current accounts. 

The nominal effect of this measure will range from 4.6 to 6.8 billion Euros, which represents from 1/4 to more than one third of GDP in Cyprus for 2011, but the consequences of this action may be much more serious than just the loss of certain funds of depositors in Cypriot banks.

First of all, across the EU, bank deposits of up to 100 thousand Euros are insured. However, the Cypriot tax will affect small investors, for whom it will be, to a certain extent, worse than a bank failure. I.e. this new tax has a very negative impact on the customer confidence in the banking system of Cyprus and, therefore, their resource base. Despite the fact that the measure is declared as just a one-off, most customers will probably be willing to take their money out of the Cypriot banks. Already as of January 2013, 1.7 billion Euros (about 2.5% of total deposits) has left Cypriot banks. If this process continues, the stability of the Cypriot financial system is threatened. 

Secondly, there are concerns that the measure could set a precedent for the budgetary problems of other EU countries. And it threatens to undermine the confidence in the banks in those countries wh ere the issue of the budget deficit is greatest and who, like Cyprus, are dependent on financial assistance from the EU. And if the financial system and the economy of Cyprus are small in relation to the European economy as a whole, the total size of the other countries is much more significant. 

M.U. Khromov – Senior specialist of the Centre for Structural Research