For over three years, investors have been giving themselves angina over the fate of Europe. Every bit of data, from stock markets to interest rates to IMF projections have been weighed and worried over, without much in the way of tangible results. Like the relentless gang violence of the late 80s/early 90s, investors have learned to tune out Europe.
So it came as something of a shock when, on March 16th, the EU invaded Russian territory in the guise of a 9.9% tax on bank deposits in excess of 100,000 euro and a 6.9% tax on everyone else, marking the first in what will undoubtedly
lead to a series of confiscations across Europe be a "one-off" that will never happen again.
(Source: Reuters, IMF)
What's In A Name?
One of the reasons it's so easy to dismiss itty-bitty Cyprus is because it's, well...Cyprus. The tremors would be real if we replaced the word "Cyprus" with a proxy Americans are more familiar with.
For instance, if the headlines read -
LEVY ON SWISS BANK ACCOUNTS
EU GIVES SWITZERLAND MONDAY ULTIMATUM
SWISS FEDERAL COUNCIL FEARS RUN ON BANKS
- the gravity of the situation would doubtless impress itself more deeply on the Western psyche; though as we'll see, the two situations (one real, the other hypothetical) are similar in scope.
The measures will
result in a panic among European savers as they slowly realize that nothing is sacred raise €5.8 billion, according to Dutch Finance Minister Jeroen Dijsselbloem, who leads the group of euro-area ministers.
Cyprian President Nicos Anastassiades then hit the air waves in an attempt to calm depositors by promising revenues from natural gas reserves to those who keep their money in Cypriot banks for the next two years, with the entirely predictable result of a run on the banks and local ATMs, largely centered on Laiki ("Popular") Bank.
The following charts illustrate the various vulnerabilities of the Cypriot banks. This data is somewhat dated, as both the Bank of Cyprus and Laiki Bank stopped publishing information for investors between 2011/2012. The real figures are likely much worse.)
Fig. 1: Credit Risk (Bank of Cyprus, Interim Condensed Consolidated Financial Statements for the nine months ended 30 September 2012)
(Source: Bank of Cyprus)
Fig. 2: Laiki/Popular Bank (Non-Performing Loans by Region)
(Source: Laiki Banking Group)
Fig. 2: Customer Deposits as % of Total Assets (Bank of Cyprus)
(Source: Bank of Cyprus)
Fig 3: Declining Deposit Spreads In Cyprus Due To Deteriorating Outlook
Fig. 4: Companies vs. Banking System Deposits
(Source: Cyprus Registrar of Deposits, Central Bank)
Fig. 5: Deposits As % Of Total Assets
(Source: Cyprus Registrar of Deposits)
Money has its own geography. Dismissing a raid on Cypriot deposits because Cyprus is small is like dismissing a raid on banks in the Cayman Islands. The chart below outlines the true scale of the problem.
Figure 6: GVA of Cypriot Banks as a % of the European Financial Sector
(Source: Haver Research)
That's right: The impact of Cypriot banks on the financial and insurance sector is nearly that of Irish banks.
This banking sector cannot be bailed out by anyone but the ECB. Approximately two years ago (April, 2011), Cyprus lost access to the bond markets. The tiny island's bonds are currently rated CCC by S&P, BBB- by Fitch, and Caa3 by Moody's.
However, as many of Cyprus's citizens are neither native born or particularly European, there's little love for Cyprus among the technocrats in Brussels, and less loyalty to the European Project in Cyprus.
This state of affairs significantly decreases Brussels's leverage, as the usual emotional appeals are impossible. For example: Ireland is largely populated with people raised on Irish history, which in turn lends weight to emotional pleas for stoic endurance. Though weakening, Europhile sentiment is the mainstream in both France and Germany. (A few thousand years of war in your own backyard can have that effect.) Nostalgia-based appeals to Spanish solidarity/honor augment purely economic considerations in Spain.
Such appeals are the playground of politicians, and have been by and large successful.
Cyprus, on the other hand, is filled with British expats and Russian playboys. Many more of its "native residents" are nothing of the kind. European solidarity and stoicism don't sell in such an environment. Nevertheless, a massive bank restructuring and capital controls are more likely at this point than an exit from the Eurozone.
The fate of Cyprus will be watched very closely by the rest of Southern Europe in the year to come. In fact, that may be the Troika's intention.