Another Headache for the EU

26 Mar, 2013

The Eurozone has found another focus in its continuing debt crisis as Cyprus squabbles over discussions of a proposed bailout plan for its oversized banking sector. Cyprus is ill-regarded in the international community as a tax haven for wealthy individuals that wish to hide their assets overseas.

Similar to Greece, Cyprus’ banking problem stems from prolific government spending with respect to its tax incomes. The oversized bureaucracy of the Cypriot government has drained the nation’s coffers and its junk bond rating restricts foreign investment.

Furthermore, the banks in Cyprus hold large portions of sovereign Greek bonds and have comparatively low fractional reserve requirements. Greek bonds are essentially worthless and have been a contributing factor in driving the banks in Cyprus to the brink of bankruptcy. With a low reserve requirement for financial institutions, the money supply in many cash-strapped European states is fragile. Some estimates suggest that a mere five percent withdrawal of bank holdings would cause further financial ruin to these countries on the edge of solvency. As there is a risk for banks to go bankrupt, a new influx of money is required to prop them up and keep them functioning.

Initially, Cyprus looked to its European partners for assistance, but failed to reach a compromise that satisfied both EU lawmakers and the Cypriot population. Russian aid was also considered a potential solution, although fears over a geopolitical shift in power and influence towards the gas and oil-rich Moscow have spurred EU politicians to decry the Russian proposal. It is feared that the Russians have an interest in Cyprus as an offshore banking haven and the discovery of natural gas off its coasts. However, it is undeniable that the suggestion of a Russian bailout and a trip undertaken by the Cyprus finance minister to Moscow last week already demonstrates a great change in the European balance of power and the effectiveness of the EU to solve its own problems. Talks in Moscow fell through on March 22nd and have both eliminated Russia as a possible savior and quelled Europe’s fears of increasing Russian influence.

A European bailout plan included a proposal of taxing deposits worth over €100,000 initially faced fierce and swift rejection from the Cypriot government, who referred to it as “bank robbery.” Bank restructuring laws that will raise €5.8 billion have been approved by the government and fulfill European requirements for the €10 billion bailout money. Last-minute overnight talks by Cypriot lawmakers achieved agreement to restructure the banking sector. BBC analysts suggest that this deal could cost wealthy bank clients with over €100,000 in holdings to lose as much as 40 percent of their deposited wealth. This controversial levy contributed to today’s resignation of Andreas Artemis, the Chairman of Cyprus’ biggest bank.

Also among the new European-enforced terms are limits on daily withdrawals, restrictions on cash checking and credit card usage, and limitations on capital movement. Despite imposing such seemingly draconian measures, the Cypriot Parliament successfully averted a financial meltdown by taking the necessary steps.

Cyprus’ problem relates to the greater financial challenges throughout Europe, notably in Greece, Ireland, Italy, Portugal and Spain. Although Cyprus will weather this storm, the Eurozone as a whole will not emerge unscathed. Future economic crises and growing German disenchantment with constant bailouts will continue to test the EU’s strength, credibility, and solidarity.

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