Analysis: Cyprus bank levy risks dangerous euro zone precedent

A hit imposed on Cypriot bank depositors by the euro zone has shocked and alarmed politicians and bankers who fear the currency bloc has set a precedent that will unnerve investors and citizens alike.

After all-night Friday talks, euro finance ministers agreed a 10 billion euro ($13 billion) bailout for the stricken Mediterranean island and said since so much of its debt was rooted in its banks, that sector would have to bear a large part of the burden.

In a radical departure from previous aid packages - and one that gave rise to incredulity and anger across Cyprus - the ministers are forcing the nation's savers to pay up to 10 percent of their deposits to raise almost 6 billion euros.

The European Central Bank's pledge to buy euro zone government bonds in unlimited amounts if needed has calmed the beleaguered currency bloc for the past five months. But if investors fear the Cypriot template could be repeated in any future rescues, that calm could be shattered.

Without a bailout, Cyprus would default, which could unravel the investor confidence fostered by the ECB.

Politicians, bankers and analysts said the levy could undermine banks in other euro zone countries, even though the ministers insisted it was a one-off and Cyprus represents just 0.2 percent of euro zone economic output.

"The unprecedented move is an extreme measure, and in our view it will spread some panic across the EMU periphery, and we cannot rule out some capital outflows," said Annalisa Piazza at Newedge Strategy.

"In the short run we expect some effects on periphery's (bond yield) spreads and some weakening of the euro cannot be ruled out," Piazza said.

The decision sent Cypriots scurrying to the cash points, most of which were emptied within hours. Most have been unable to access their bank accounts since Saturday morning, a move unlikely to engender calm.

Euro zone policymakers made a point of saying they would monitor any signs of money moving out of Cyprus but did not say how they might react in the event.

"For us, Cyprus is systemically relevant. Despite the small size of the economy, disorderly developments in Cyprus could undermine the important progress made in 2012 in stabilizing the euro zone," ECB policymaker Joerg Asmussen said after the Eurogroup meeting concluded before dawn on Saturday.

A Cypriot bank holiday on Monday will limit any immediate reaction. The deposit levy - set at 9.9 percent on bank deposits exceeding 100,000 euros and 6.7 percent on anything below that - will be imposed on Tuesday, if voted through in parliament.

That is not certain to happen, but fear of the alternative - probable default - will focus minds.

Cyprus's parliament postponed until Monday an emergency session to discuss the levy, which President Nicos Anastasiades urged lawmakers to support. Three parties in the 56-member chamber, where no party has an absolute majority, have already said they will not back the plan.

"The government can be reasonably confident of only around 26-28 votes at the most, while the opposition may be confident of around 26," said JPMorgan analyst Alex White. "Our best estimates of a potential vote have it too close to call at this stage."

Beyond Cyprus's borders, there was little sign of public alarm, and banks and state authorities were quick to offer reassurance.

Bank of Cyprus and Laiki Bank put messages on their British websites to assure depositors that the levy does not apply to Cypriot banks overseas. The Bank of Spain said there were no signs of capital flight from Spain.

"The scope of potential contagion to other peripheral countries in terms of deposit outflows and sovereign debt is considerably more limited than if such a decision would have been taken in previous programs," analysts at Barclays said in a note. "We consider the likelihood of a bank run in other periphery countries to be limited, including in Greece."

Ireland's finance ministry said the levy was a one-off measure for Cyprus that had no implications for Irish deposit holders.

"APPALLED"

But outside euro zone policymaking circles there was considerable disquiet.

"I understand that electorates in Germany and northern Europe demand some sacrifice. However, when you accept a solution that basically expropriates 10 percent of deposits, you set a dangerous precedent," Vladimir Dlouhy, former Czech economy minister and now international advisor for Goldman Sachs told Reuters in Berlin. "If we get into deeper trouble, God help us, they may try to take 50 percent."

Spain is a good test case for any contagion.

Latest figures from the ECB showed deposits were stable in Spain in January. Spain's banks are awash with liquidity after receiving 40 billion euros from a European rescue last year, and the government is borrowing easily from the market, so is nowhere near seeking a bailout.

But ordinary bank account holders may not necessarily take comfort from such facts.

The International Monetary Fund urged the bloc on Friday to press ahead with a common deposit guarantee scheme to banish any threat of a bank run. That has been a red line for EU paymaster Germany.

"The Cypriot bailout terms can't be viewed in isolation. The signals sent to troubled euro zone countries and to foreign depositors are unmistakable. While this isn't a Lehman moment, the same lack of systemic concerns is evident," said Simon Evenett, professor of international trade at St Gallen University in Switzerland.

Sharon Bowles, chair of the European Parliament's Economic and Monetary Affairs Committee, said she was appalled.

"Deposit guarantees were brought in ... so that citizens across the EU would not have incentives to move funds from country to country. That has now been blown apart," she said in a statement. "If this were a bank they would be in court for mis-selling."

Much of the money in Cypriot banks belongs to Russians and Britons. Though there was no protest from London or Moscow, there was no shortage from elsewhere.

"Although the representatives at the bailout press conference tried to present this as a one-off, they were not willing to rule out similar measures elsewhere - not that it would have mattered much, as the trust is gone anyway," Lars Seier Christensen, CEO of Denmark's Saxo Bank, posted on his blog. "If you can do this once, you can do it again."

($1 = 0.7654 euros)

(Reporting by Michele Kambas, Sonya Dowsett, Swaha Pattanaik, Tim Castle, Paul Taylor, Kirstin Ridley, Jamie McGeever and Alex Smith, writing by Mike Peacock; Editing by Will Waterman)