Goldman Sachs is out with a reaction to the Cyprus bailout deal negotiated over the weekend, the most controversial part of which entails a haircut on bank deposits, something that hasn’t yet been seen until now in the euro crisis saga.
Photo: Wikimedia Commons German PM Angela Merkel and Cypriot President Nicos Anastasiades
Goldman analyst Francisco Garzarelli says that while the deal could cause some short-term volatility, the fallout from Cyprus will likely be contained, assuming the controversial measures are able to survive a vote in the Cypriot parliament this week (which remains an open question).
The biggest worry is about how depositors in other peripheral euro area countries like Spain will perceive the deal, and whether they will question the safety of the deposits in their own banks, which could also be in need of another bailout in the future.
Garzarelli thinks that the ECB stands at the ready, writing, “Should there be evidence of deposit flight in peripheral countries, ad hoc operations, including the use of ELA facilities, are possible.”
He does say, however, that there are still two key takeaways from the Cyprus bailout deal.
The first point is that this deal is a natural continuation of a trend developing on the euro bank bailouts front: private creditors are being asked to share more and more of the burden of restructuring.
In this case, it meant that depositors had to the loss, as there weren’t many private bondholders to impose a haircut on to begin with. The point, though, is that the government is on the hook for less than if it underwrote the whole bailout with taxpayer money.
This was the main reason why the EU and the IMF wanted deposit haircuts in the first place – a bailout from the EU that footed the entire cost of the restructuring would have caused Cypriot government debt to rise to what the IMF deems unsustainable levels, and that means the IMF couldn’t get involved.
All of this is to say that the structure of the deal could be positive for Cypriot government debt, according to Garzarelli:
The new ‘policy doctrine’. Tackling Europe’s private and public debt-overhang involves making distributional choices. Starting with the rescue package for the Spanish cajas, Euro area authorities have resolved to a more extensive, and at times creative, burden sharing with bank creditors. The losses inflicted to holders of junior claims on Bankia in Spain and SNS in the Netherlands provide recent examples. The distance with what happened in Ireland, where the government underwrote in full bank liabilities, could not be greater. We flagged this key policy shift several months ago, arguing that public debt was likely to benefit on a relative basis to bank debt. Provided efforts to fulfil conditionality are made, as in the case in Portugal, Ireland and Spain, government bond holders have benefitted from the transformation of private debt into longer dated subsidized loans provided by the EFSF/ESM. Although these institutions are de iure senior creditors, in all existing programs their status has been relaxed and the funds are disbursed on a pari passu basis. In principle, the fortunes of Cypriot government bonds could be similar to Portugal’s. But this depends on the Cypriot Parliament, which is being called to decide whether to endorse the deal or not, and the government, which will have to manage the adjustment.
Second, given the trend toward increased burden-sharing, investors and lenders will be more selective about who their counterparties are. This means weaker banks will increasingly have to pay up more for funding than stronger banks.
The bank capital question. Especially in recession stricken European countries, including Italy, investors continue to question the capital adequacy of the mid-tier and small financial institutions, especially those that are un-listed and with less transparent balance sheets. Such scrutiny will not go away, and the Spanish and Cypriot precedents will reinforce the segmentation of the funding costs, both across EMU countries and increasingly within national banking systems. The ECB can provide liquidity, not capital. The vexed question of the direct interventions by the ESM in Euro area banks will come again to the fore.
Those are Goldman’s takeaways. Developments today – including a proposed revision to the distribution of the haircut on depositors – foretell an interesting week ahead in Cyprus.
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