Cypriot Bank Bailout Taking Shape: Extremely Fluid Situation Bears Close Scrutiny
While many details need to be disclosed, including Cyprus bank deposit holders’ liquidity, international lenders reached a deal with Cyprus this morning (March 23, 2013) on a €10 billion bailout deal that would prevent the collapse of its banking system and keep the country within the Eurozone.
Cyprus needs to find a way to raise nearly €6 billion to satisfy the conditions of a €10 billion EU rescue or face meltdown when banks reopen Tuesday after a 10-day hiatus. As part of the deal, it has been reported that Cyprus has agreed to close its second largest bank (Cyprus Popular) and shrink its banking system overall.
As cited today by the Council on Foreign Relations, the amended deal comes a week after the Cypriot parliament rejected a proposed bank levy on small and large deposits, avoids the controversial levy on small bank accounts. The deal however will force large losses on big deposits in the Island's two largest lenders, Bank of Cyprus and Cyprus Popular. A plan to resolve the challenges facing Laiki Bank is also in the works.
It should be noted that the Cypriot banking sector holdings, including foreign deposits, is 8-times larger than the total economic output of the nation itself, which was $25 billion at YE 2011. Cyprus has a population of just 860,000.
The new deal will not be put to a vote in the Cypriot parliament.
It also appears to many commentators that after such a severe blow to its lucrative banking sector, Cyprus will be pushed into a harsh recession. Some sources in the Troika - the International Monetary Fund, the European Commission and the European Central Bank - tentatively estimate that Cypriot GDP will shrink by about 10% before any hope of recovery. Perhaps the biggest question is this, writes The Economist, “Once the banks have been cleaned up and shrunk, where will Cyprus find economic growth?" Our observation is that tax rate reductions in Cyprus could create growth; however structural change is necessary to reduce social costs and increase job formation.
"Cyprus's economy is going to suffer greatly over the next few years, and its citizens are going to blame Europe for their woes; it's entirely possible that they will voluntarily leave the Euro, if the alternative is negative economic growth as far as the eye can see, along with a massively overvalued currency," writes Felix Salmon for Reuters.
We will continue to monitor the situation in Cyprus and the Eurozone and provide observations as appropriate. Investors need to continue to exercise caution with investments in, and with exposure to, the Eurozone and review their asset allocation model and compare to their investment policy statement and risk tolerance and include additional considerations.
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