European Haircuts – The Latest Styles from Cyprus and Greece
According to GQ, the hottest haircut trends for 2013 are things like the slick comb over, the short crop, the medium and messy, and the long and parted. Cyprus and Greece have been going a different path; pioneering haircuts that have investors around the world feeling jittery. And by “haircut,” I mean “writedown,” or “loss.” On Saturday, the tiny island nation of Cyprus announced it would raise about €5.8 billion by taxing bank deposits – including individual deposits with only small account balances. This proposal is a means of easing the pain of a bailout agreement. The announcement, which hasn’t stated specific thresholds or percentages, sent a shudder of panic through Cypriots and the wider investment community. Originally, the plan called for a 6.75% tax on amounts less than €100,000, and 9.9% on amounts over €100,000. That means if you had €1,000 in your bank account, after the tax, you’d miraculously lose €67.50. The problem with all of this for investors is not the scope for financial contagion to other periphery markets; the Cypriot economy is relatively small – somewhere around US$25 billion, according to the IMF. No, what has investors spooked is the implication of the bank-deposit haircut.
After Greece’s creditors were forced, in 2012, to take a haircut of around 50% on their holdings of Greek sovereign debt as part of a bailout agreement, investors are now seeing each new style of haircut as a model for something that could happen in Portugal, Italy, or Spain.
Furthermore, with Cypriot savers below the European Deposit Guarantee threshold (€100,000) also being included in the haircut, there are renewed concerns about the stability of deposits in weaker banking systems. Clearly, existing deposit-guarantee schemes are only as strong as the sovereign that backs them – something that is unlikely to go unnoticed by the rest of the region.
Following outrage in Cyprus and concerns that the government does not have sufficient support to approve this legislation, the distribution of the one-off tax is likely to be adjusted to reduce the hit to small depositors. But even if the tax on insured deposits is ditched, there is likely to be a change in depositor behaviour…once bitten, twice shy.
A bank-deposit haircut could be a spark that starts a full-fledged bank run, which is exactly what Spain and Italy don’t need. Now, while short-term bank runs are unlikely at this stage – near-term impacts on bank deposits in Spain and Italy are limited so far – depositors across the euro area will be aware that they are taking on significant credit risk if they leave their funds in weaker banks, especially if these weak banks are backed by weak sovereigns. Over the longer-term, there is a risk that this one-off tax could further weaken the banking system in the peripheral countries as depositors look to move their funds to the stronger banks or even the stronger sovereigns.
Depositors and investors are unlikely to feel reassured until Italy and Spain start to reassure them that their countries won’t consider similar measures – and even then, the credibility of those promises may be questionable. After all, Germany has shown itself to be even more unwilling to help the periphery than markets had expected – what happens if Italy or Spain find themselves with a renewed crisis on their hands?
Remember, bad haircuts (real or financial) take months and months to grow back to something presentable. If too much is chopped, it could even be years.