Despite the critical headlines and comments on the Cyprus rescue package, it is as well to recognise that it is a rescue package. Without a deal on the 'bail-out:bail-in' package the alternative would have been a total collapse of the Cypriot banking sector; an abrupt disappearance of Cyprus from the Eurozone, and a probable default on Cypriot sovereign debt. Had that happened the headlines would have been far worse and the pain for ordinary Cypriots far worse. So far none of the critics of the rescue package have suggested an alternative solution, only, perhaps not unreasonably (see below), that those with bank deposits less than 100,000 euro should be exempted from the tax/levy.
It is also worth pointing out that the decision on the raising of the 5.8 billion euro lies with the Cypriot government which is still debating whether to accept the initial proposals to include in the 'bail-in' a 6.75% levy on those with less than 100,000 euro. One of the proposals being considered is to reduce this levy to 3%. It should also be noted that the payment of the levy will be in exchange for shares in the banks for an equivalent amount. The alternative to Cypriot bank depositors paying a, small, tax would be for taxpayers more generally to have funded the 5.8 billion euro required.
A number of the bank depositors seriously hit by the 9.9% levy will be wealthy private Russian investors who have placed money in Cypriot banks in recent years, for reasons that are not entirely clear; though low tax rates are one reason. Estimates suggest that 19 billion of deposits in Cypriot banks are from Russian companies and rich individuals. This is the reason for the substantial Russian loan (2.5 billion euro in 2011) to the Cyprus government to assist with their public debt problems. The Eurogroup is expecting this loan to be extended for 5 years.
The argument will also be made that the creators of the problem (the bank's shareholders and directors) are not being penalised. However, that is the nature of a bank rescue (or any other type of company rescue); shareholders and directors continue unharmed, except for their bank's reputation.
The criticism that the rescue package runs counter to the EU proposals to protect depositors when banks run into problems, appears to be valid. The suggestion is that the case of Cyprus makes it possible that all deposit holders across the EU, or at least the Eurozone, will feel less safe in placing deposits with banks. However, there are a number of points to note. Cyprus is a special case, both in relation to the large number of external deposit holders, and particularly Russian depositors. Related to this point, is the sheer size of the Cypriot banking sector compared to the GDP of Cyprus, estimated to be somewhere between 5 and 8 times the GDP of Cyprus. Finally, the tax base of Cyprus is small in relation to the money which was required to be raised, and necessitated the deposit levy. (It is of course also true that there is tax evasion and avoidance by companies and rich Cypriot business owners (not all of whom are Cypriots). All of these reasons mean that none of the other Eurozone countries are in a similar position, and depositors in their banks need not be concerned.
Protection for depositors in EU banks is provided under the EU Directive, but it is not unlimited, but covers deposits, in UK banks for instance, up to £85,000 (100,000 euro). However, when a bank is wound down the costs are shared between the shareholders, the depositors, and the taxpayers, so that, beyond the insured amount, it is always likely to be the case that depositors would share in the costs on winding up.
Finally, it is also the case that the real problems may have yet to come to light. As the Cypriot banking sector is reduced in size, as part of the bail out agreement, and the amount of the bad debts is revealed, there are likely to be more shock in store. This has been the case elsewhere, particularly in relation to property, domestic and commercial.