Q&A: Cyprus deal
- 28 March 2013
- From the section Business
Cyprus has agreed a 10bn euros bailout with the European Union and the International Monetary Fund (IMF) in an attempt to stave off the collapse of its banking sector and the wider economy.
What has been agreed?
Cyprus has agreed to a significant restructuring of its banking sector, along with other measures such as tax rises and privatisations. The measures are designed to raise billions towards the bailout, but protect bank customers with deposits of 100,000 euros or less.
Cyprus's second largest bank - Laiki Bank - will be closed down and deposits above 100,000 euros moved into a "bad bank". Deposits below 100,000 euros will be moved into Bank of Cyprus, the country's biggest bank, which is being significantly restructured.
Deposits at Bank of Cyprus of more than 100,000 euros are being frozen.
At both banks, deposits above 100,000 euros will be used by the government to contribute billions towards the bailout. It is not clear how much of the money will be taken, but a government spokesman has suggested customers should expect about 40% of the balance to be converted into bank shares.
What about the bank levy?
In the original EU-IMF deal, all customers of Cypriot banks were to face a one-off tax on their deposits, starting at 6.75% for the smallest deposits.
That was designed to raise 5.8bn euros towards the cost of the bailout. But it proved hugely unpopular with the Cypriot public and was voted down by Cyprus's parliament.
There is no bank levy in the new deal, but the bank restructuring measures mean deposits over 100,000 euros will effectively be used to pay the bulk of the 5.8bn euro bill.
The measures cannot be voted down by Cyprus's parliament, as new bank restructuring laws have already been agreed and voted through by MPs.
Why are there capital controls?
After being closed for almost two weeks, Cyprus' banks have reopened - but with strict controls on how much money can be withdrawn.
This is to prevent a bank run, where customers try to withdraw all their money at once due to a lack of confidence in the banking sector. In the past, bank runs have caused banks to collapse.
In Cyprus, customers are limited to withdrawing 300 euros a day, taking no more than 1,000 euros in cash on trips out of the country, and transferring no more than 5,000 euros a month on debit or credit cards.
Bigger transactions need the approval of Cypriot authorities.
The measures were due to stay in place for just a few days, but Cypriot authorities are already indicating that they are likely to keep them in place for longer. Iceland introduced temporary capital controls in 2008, which are still in place today.
Are the UK operations of Cypriot banks affected?
Bank of Cyprus UK has 50,000 UK customers. Although it is a subsidiary of Bank of Cyprus, it is a separately incorporated UK bank and depositors are protected by the UK's Financial Services Compensation Scheme (FSCS), which covers savings up to £85,000. It said the crisis in Cyprus would have no effect on its deposits.
Laiki Bank has four branches in Britain and serves 13,000 customers.
Unlike Bank of Cyprus UK, its UK operations are directly controlled from Cyprus, and so are not covered by the FSCS. It says deposits up to 100,000 euros are guaranteed and customers are free to make withdraws if they wish.
However, the UK Finance Minister, George Osborne, says the UK government is in talks with Cypriot authorities to find "a British solution" to Laiki's UK branches.
So is the crisis over?
Not necessarily. In the short term, the risk of the Cypriot banking sector collapsing has receded, and the bailout funds will allow the government to pay its own debts and undertake the restructuring of the banks without facing economic collapse or exiting the euro.
But in other respects the outlook is less certain. Cyprus must enact tough austerity measures to rebuild its economy, and regain trust among investors in its banking sector and government. It is unclear whether the Cypriot public, angered by how the crisis has been handled so far, will support that.
It is also unclear how much trust is left in Cyprus's banks, and so when fears over a bank run will recede.
Finally, the whole episode has damaged confidence in European authorities' ability to handle economic crises.
What went wrong in Cyprus?
Before the financial crisis struck in 2008, Cyprus was seen to have a healthy economy, with high growth, low unemployment and sound public finances.
But during the good years, the island's banking sector grew rapidly. By 2011, the IMF reported that their assets - which include all the loans they have made - were equivalent to 835% of annual national income, or GDP. A chunk of that is down to foreign-owned banks, but those that are Cypriot had made loans to Greek borrowers worth 160% of Cypriot GDP.
When Greece became engulfed in crisis in 2010, Cypriot banks were hit hard, and the government did not have the money to bail them out itself. Government finances have been further weakened by slow economic growth and international lenders have stopped offering loans.
Negotiations on a bailout with the EU were delayed by the previous socialist government. President Nicos Anastasiades, a conservative who favoured a swift agreement with Europe, assumed office in late February.
Why was a bank levy considered?
When countries get an international bailout, they are often expected to contribute to the solution by raising funds themselves, usually by increasing taxes or selling state-owned assets.
The levy on bank deposits was designed to play the same role. It was intended to reduce the size of the bailout and therefore the amount of new debt Cyprus had to take on.
But there is almost certainly a political aspect, too. In the eurozone, there are concerns about money-laundering in Cyprus and the presence of large amounts of Russian-owned money in the banks. Germany is reputed to be especially unhappy about the idea of using European taxpayers' money to rescue them.
Experts say the decision to target ordinary savers came about because Cypriot banks have fewer private bondholders than banks in other eurozone countries. In the Greek bailout, it was private bondholders who had to take a "haircut" - a slice out of their investment.
However, the deal provoked outrage in Cyprus, parliament promptly voted against it, and it is increasingly seen as a blunder by European and Cypriot authorities.