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Deposit grab in Cyprus risks new Euro crisis

(MoneyWatch) An attempt to seize money from savings accounts on the tiny island nation of Cyprus has fueled fears that the European financial crisis is far from over, as international lenders now fret that their deposits could be seized from any EU bank.

Early Saturday morning the Cypriot government announced it had reached a $12.94 billion bailout agreement with international lenders. Negotiators said that in order to make the debt burden sustainable, depositors in Cypriot banks would contribute an additional $7.5 billion to finance the rescue. Under the plan, all accounts in the nation's banks with less than $129,370 would be hit with a 6.75 percent fee, which negotiators refer to as a tax; for those with more than that the fee would be 9.9 percent of the amount on deposit.

Many of those larger depositors are Russian, leading Russian President Vladimir Putin to label the proposed policy "unfair, unprofessional and dangerous."

This is the first time since the financial crisis began that a penalty has been imposed on bank depositors. On Saturday, Jeroen Dijsselbloem, the Dutch finance minister who chaired the group of EU negotiators, said he could not rule out taxes on depositors in the future, although he said such a measure was not being actively considered.

Although the government ordered banks to remain closed until Thursday, long lines formed at ATMs on the island as Cypriots desperately tried to get funds out of the banks. A snap poll on Sunday showed 71 percent of citizens oppose the plan. The same fear of having funds seized unilaterally is raising concerns about the EU's entire banking system.

In a note to investors, Mark J. Grant of Southwest Capital wrote:

"People and institutions alike, all across Europe, have to be thinking and wondering about their money in the banks in Spain, Portugal, Italy and, frankly, in every country in Europe. If the European Union can steal money from the bank accounts in Cyprus then what is stopping them from stealing money from any bank in any country in Europe. In the rush to lessen the amount of money required from the nations of Europe to finance Cyprus these people have made a disastrous decision that will affect all of Europe far past the size of Cyprus or the amount of money involved."

This could spur even more withdrawals from banks in Spain, Italy and Greece which already owe more than they are worth.

Getting additional funds for the bailout was not the only reason for imposing the fee, though. According to analysts at IHS Global Insight, "...primarily the German, Dutch and Finnish participants had continually complained that if Troika funds went to save the Cypriot bank sector, they would end up serving to keep whole Russian depositors, responsible for an estimated one-half of the funds with Cypriot banks, who had used Cyprus to launder illegally gained cash and to avoid taxes."

Desmond Lachman, a fellow at the American Enterprise Institute and a former managing director at Salomon Smith Barney, as well as deputy director at the International Monetary Fund, echoed such analysis, and called the move "a dreadful precedent for the rest of Europe."

"The only way that Europe's seemingly irrational policy prescription for Cyprus can be explained is that it was the result of a political compromise," he said. "In anticipation of German elections scheduled for September 2013, Mrs. Merkel, the German Chancellor, had to assure her electorate that German taxpayer money would not be effectively used to bailout the Russian oligarchs who have large deposits at the Cypriot banks."

According to Vladimir Miklashevsky, an analyst with Danske Bank, "Cypriot banks' obligations to Russian banks were up to $10 billion in early 2013. With the haircuts, Russian depositors would lose $2 billion."

On Monday, EU negotiators said they would not require the Cyprus government to collect the funds from smaller depositors as long as the nation came up with the required $7.6 billion in funding. This would also be a problem among international investors as it means junior bondholders for the Cyprus banks would have to give up money they are owed. That happened in the most recent bailout of Greece, but the EU leaders promised it would be a "one-time only" occurrence.

Despite all the turmoil the bailout plan may not be approved. Cyprus's ruling party holds a one-seat majority in the nation's parliament, which still has to OK the plan. A vote has been scheduled for Tuesday.

While the reaction on the markets was less severe than feared, the fireworks may not be over, warned London-based Capital Economics.

"Admittedly, the euro fell below $1.30 against the dollar on Monday, banking shares in Spain posted declines of up to 5%, and 10-year government bond yields in Spain and Italy rose slightly. But there have been much bigger moves in the past and we think there could be more to come."

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