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Cyprus: A Bank Run For A Bailout?

Over the weekend, the Cypriot leaders and the Troika came up with a bailout deal for the EZ's third smallest economy. Thing is, the current deal structure is inspiring Cypriot citizens to empty out their bank accounts.

What the heck brought this on?

In mid-2012 Cyprus joined the euro zone's bailoutstreet boys when it asked for a bailout package from the Troika. The Greek debt restructuring mess took a huge hit on the island's Greek debt exposure and compounded its problems with rising government debt, credit rating downgrades, and a faltering economy.

Those problems left Cyprus with a 3.4% GDP contraction in Q4 2012; a debt-to-GDP ratio of 127% in Q3 2012, which is only second to Greece's 153% among the euro zone nations, and an unemployment rate of 12%. With the government nowhere close to finding a solution and Cyprus' two largest banks - Cyprus Popular Bank PCL and Bank of Cyprus PCL losing cash fast, Cypriot leaders decided to step up their bailout requests.

What exactly is included in the latest bailout deal?

After crunching some numbers, it was determined back in January that Cyprus would need over 17 billion EUR to fix its finances, 10 billion of which would be needed for the sole purpose of stabilizing the banking system. No doubt, that's a tall order for a country whose GDP clocks in under 18 billion a year.

To seal the bailout deal and help bring Cyprus' debt-to-GDP ratio back to 100%, euro zone finance decided to levy a one-time tax on all bank deposits. Deposits under 100,000 EUR will get taxed at a rate of 6.75%, while larger accounts will get hit with a staggering 9.9% tax rate. If Cyprus' government gives this plan the green light, it could impose the tax before banking hours on Tuesday and raise an estimated 5.8 billion EUR.

For their troubles (and their hard-earned dough), Cyprus citizens will receive bank shares. Yeah, it's true that they won't be walking away empty handed, but they ain't exactly getting the sweetest deal either. Remember, these banks are practically bankrupt! Meanwhile, those who decide to keep their funds for at least two more years will receive government bonds.

It's also interesting to note that Nicosia, the capital of Cyprus, has decided to take things a little further by making plans to raise its corporate-tax rate to 12.5% from 10%. It's has taken proactive steps to help with the country's ailing finances by imposing a tax on interest income and reviewing its anti-money laundering legislation.

How are the markets reacting to the news?

Not surprisingly, Cypriots rushed to the nearest ATMs as soon as they heard of the impending taxes. The fact that banks have withdrawal limits of €400 didn't stop them from emptying out several machines over the weekend.

What's worrying more investors is the possibility that the bank run could extend beyond Cyrpus. Now that depositors from Greece, Spain, Italy, and the other euro zone nations know that the Troika isn't above touching their hard-earned moolah, I wouldn't be surprised if they start dumping their cash somewhere else. If a widespread bank run takes place, the region's banks would have a harder time meeting their capital requirements, which could lead to defaulted debts and a bigger banking crisis.

Worry over the euro zone's banking woes has dragged on New Zealand and Asian shares as soon as the markets opened today. In the forex scene the euro opened with huge downside gaps against its counterparts. EUR/USD opened 120 pips lower than its Friday closing price while EUR/JPY started the week with a whopping 240-pip loss. What a coup for the bears!

With the Cyprus parliament expected to give the bailout deal the thumbs up today, I wouldn't be surprised to see more euro weakness. After all, if this deal gets passed, there's a good chance that the markets will shift their attention towards the larger indebted countries such as Greece, Spain, and Italy for signs of a bank run. As much as I hate to say it, this could very well be the start of another round of the euro zone debt crisis.