Over the weekend, a 10 billion euro bailout for Cyprus was announced. A key condition to qualify for the bailout was a tax on bank depositors, which was supposed to raise 5.8 billion. This is expected to cause bank runs in Cyprus when banks are open on Tuesday (Monday is a bank holiday in Cyprus). This has caused fears that a new template, taxing depositors to fund bailouts, will be used in the future. This is especially damaging to confidence since Spain and Italy are not out of the woods. Global markets reacted negatively, some falling 2% on opening bell.
We think this is just another hurdle for markets to cross before global equities climb higher. That Cyprus is in need of a bailout is not new, negotiations have been ongoing for months. That the EU and the IMF want to counter money laundering in Cyprus is also not new. Unfortunately, the proposed method of imposing taxes ranging from 6.75% to 9.99% on deposits means the ordinary saver is harshly penalised. This will most likely cause bank runs, as some co-operative banks which remained opened on Saturday experienced.
Although the EU has said that the treatment on deposits in the Cyprus bailout is one-off, we will need to see greater commitment and assurance from policy makers. The real test will come when Europe opens for business on Monday. Will there be a rush by Italians and Spaniards to withdraw their deposits if they have not already done so? Bear in mind that the eurozone crisis is into its third year. Many Europeans have already shifted their deposits from weaker Southern European banks to stronger Northern European banks. Even if there is a mini bank run and panic in European markets, we suspect that would prompt the EU to issue a strong statement on protecting depositors in future bailout programs. The ECB will also be forced to support banks via liquidity lines. This will reduce the uncertainty as to the future treatment of depositors and end any bank runs that may occur.
The deal on Cyprus is not concluded. The Cyprus parliament needs to pass the bailout package. Terms of the deal may change as divisions arise as to the best way forward for the country. In any case, we should see more volatility in the days ahead but when terms of the Cyprus deal improve and/or the EU and ECB comes out to support Spain and Italy's depositors, investors will begin to focus on the ongoing improvement in the global economy. Hence we see the current market weakness as a buying opportunity.
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