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Last minute bailout for Cyprus

March 25, 2013

Cyprus has struck a last-minute agreement with international lenders to save its banks from insolvency and keep it in the eurozone. The deal, though, comes at a significant cost for some.

(L-R) International Monetary Fund chief Christine Lagarde, German Finance Minister Wolfgang Schaeuble and French minister of Economy, Finances and Foreign Trade Pierre Moscovici smile as they attend an extraordinary Eurozone meeting on March 24, 2013 at the EU Headquarters in Brussels. Photo JOHN THYS/AFP/Getty Images)
Image: AFP/Getty Images

The deal, which came in the early hours of Monday after more than 10 hours of negotiations in Brussels, will bring about a major downsizing of Cyprus's troubled banking sector. It also includes pledges by the Cypriot government to cut its budget, implement structural reforms and privatize many state assets.

The small Mediterranean country's second-largest bank, Laiki, is to be transformed into a “bad bank” holding toxic assets and uninsured deposits. Insured deposits of under 100,000 euros ($130,000) are to be shifted to the Bank of Cyprus, the country's biggest lender.

After the agreement was finally reached, the head of the 17-nation Eurogroup, which uses the euro common currency, expressed relief.

"We've put an end to the uncertainty that has affected Cyprus and the euro area over the past week," Jeroen Dijsselbloem said, referring to days of back-and-forth that began after the two sides reached a previous agreement just over a week ago.

That plan would have seen a minimum of 6.75 percent deducted from all Cypriot bank accounts, no matter how small their deposits were. This sparked mass protests and was later rejected by the country's legislature.

Small deposit holders spared

The deal agreed this Monday secures accounts with less than 100,000 euros, but deposits above that levels are expected to be hit hard, with analysts saying investors with money in Laiki in particular could face losses of up to 40 percent. No precise figures were immediately available.

"This will have to be worked out in the coming weeks," Dijsselbloem said, adding that the plan was expected to raise 4.2 billion euros.

Cyprus had been facing a Monday deadline to reach a deal with the so-called “troika” of international lenders, the European Union (EU), European Central Bank (ECB), and International Monetary Fund (IMF). The ECB had threatened to cut off emergency funds to Cypriot financial institutions unless the country managed to raise 5.8 billion from its banking sector, to unlock the 10-billion-euro bailout.

Like Dijsselbloem, Cypriot Finance Minister Michails Sarris was relieved that a deal had finally been agreed.

"It's not that we won a battle, but we really have avoided a disastrous exit from the eurozone," Sarris said. "A long period of uncertainty and insecurity surrounding the Cyprus economy has ended."

Schäuble confident

The deal still has to be approved by the parliaments of several of the eurozone countries that will help foot the bill, including Germany. However, Finance Minister Wolfgang Schäuble expressed confidence that the Bundestag would ratify the deal, which he said included key German demands.

"The Cypriot banking sector will have to be scaled back in relation to the size of the Cypriot economy to what is the European average," Schäuble said. "I am pleased that we achieved what had always been our position."

Schäuble also said following the passage of a number of bills related to the banking sector on Friday, the Cypriot parliament would not have to vote on the new bailout deal for it to come into force. Those measures included nationalizing pension funds and provisions to split lenders into good and bad banks, which is to be used in the case of Laiki.

Capital controls

The events of the past week created a great deal of uneasiness among the Cypriot public, many of whom lined up at ATM's to withdraw what they could. The lenders themselves were closed all of last week to prevent a possible run on the banks. The government has since imposed capital controls, limiting withdrawals to 100 euros per day, and it's not clear when the banks will reopen.

While acknowledging that Cypriots will have to endure considerable short-term pain, the European commissioner in charge of economic and monetary policy said the bailout should help establish a more solid foundation.

"The near future will be very difficult for the country and its people," Olli Rehn said. "But (the measures) will be necessary for the Cypriot people to rebuild their economy on a new basis."

pfd/hc (AP, Reuters, AFP, dpa)

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