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Make a model of it, not a mess
How the euro zone’s leaders should deal with Cyprus’s bust banks
Mar 16th 2013 |From the print edition
THE country has fewer than a million inhabitants and its economy makes up less than 0.2% of the euro zone’s GDP. It is hard to believe that Europe’s policymakers would squander their progress in calming the single currency’s crisis by botching the bail-out of such a minnow. Yet, judging by the bickering over how to handle Cyprus’s bust banks and help its cash-strapped government, the rescue plan that looks likely to emerge in the coming weeks will be full of fudged numbers and will fail to solve Cyprus’s problems. It will be a messy deal—and a missed opportunity.
The euro zone’s policymakers should use the plight of Cyprus not only to encourage reform on the island. They should also seize the chance to push ahead towards a banking union. They should do so by using European rescue funds to restructure, recapitalise and reform Cyprus’s broken banks.
Like Ireland and Iceland, Cyprus is a small island with an outsize banking system. Thanks to a growth strategy based on becoming an offshore financial centre, particularly for dodgy Russian money, the balance-sheets of Cyprus’s banks soared, reaching 800% of its GDP in 2011. Several banks had big exposures in Greece. When Greek debt was restructured, they were hit hard. For a while Cyprus was tided over by a loan from Russia. Last June it asked for help from European rescue funds. Since then officials have dithered, both within Cyprus (in the run-up to a recent presidential election) and beyond.
Cyprus plainly needs help. The debate among the rescuers is how and on what terms (see article). One camp, which includes the European Central Bank, wants the model to be Ireland. The government in Cyprus would bail out its banks in full, borrowing money from the European Stability Mechanism to do so. The trouble is that this would bankrupt it, leaving it with an unpayable debt stock of as much as 140% of GDP. A government debt-restructuring would be all but inevitable, along the lines of Greece, not Ireland (and Greece was supposed to be a one-off). The politics of this are also terrible: squeezed European taxpayers would be bailing out rich Russian depositors.
In the other camp, the IMF and the German government want to reduce the size of any loan to Cyprus by forcing it to “bail in” the creditors of Cypriot banks, both bondholders (a tiny share of the liabilities) and uninsured depositors (who account for a lot). But this could cause panic among depositors in Italy, Spain and other euro countries with troubled banks.
Rather than haggle between these two unappealing alternatives, Europe’s policymakers should think more boldly. Cyprus’s bank bail-out should not go through its government at all. Instead, rescue funds should flow directly into restructured Cypriot banks. This would kick-start a new, safer European banking model, one which breaks the pernicious link between bust banks and bankrupt governments. Each bank should be dealt with on its merits, but as a condition for any capital injection shareholders and junior bondholders should be wiped out (and negligent bosses removed). The thorniest issue in Cyprus is the uninsured depositors. At some stage Europe should have laws that force them to lose money in a bust. But, given the risk of precipitating panic elsewhere, this newspaper does not advocate writing them down now.
Last June Europe’s politicians agreed that rescue funds could be used to recapitalise banks. Ever since then several countries, including Germany, have tried to wriggle out of that commitment. Europe’s leaders claim they want to move towards a banking union. Cyprus should be the first step.