Euro Crisis: Cypriot Bank Levy Would Be Terrible, But It's the Least Worst Option

After a lull in economic upheaval, the latest euro zone nation to face a banking crisis seems to now be Cyprus. The small, Mediterranean island, better known for being divided into a Turkish North and a Grecian South than for its profligate ways, now has had its banks experience a loss of confidence from investors and consumers alike. Pressured by the European Central Bank (ECB) to find a solution, the newly elected Cypriot government has turned to a bailout proposed by the European Commission-ECB-International Monetary Fund troika which requires a bank levy that would essentially expropriate money from savers in the country. As of Tuesday, the Cypriot parliament unanimously rejected the proposal, with 36 members of parliament voting against and 19 abstaining.

Part of the reason for the scheme’s harshness is Cyprus’s reputation as a haven for money-laundering. Nearly 40% of all bank deposits in Cyprus are held by foreigners, and the vast majority of those accounts belong to Russians. With a GDP of only $18 billion, Cyprus was Russia’s largest single source of Foreign Direct Investment (FDI) in 2011, contributing around $14 billion, or just a quarter of FDI. Thus the scheme, which would exempt those with savings under 20,000€, and then progressively tax those with savings between 20,000€ and 100,000€ at 6.75% and those with deposits above 100,000€ at 9.90% percent, is aimed at large, foreign depositors, as opposed to the small holding, domestic savers.

On its own, Cyprus is a small country even by European standards. Its $18 billion GDP accounts for only 0.2% of the EU’s total GDP. What is recognized as "Cyprus" by the international community is only half the country, the north having being occupied by Turkey under the guise of a "Turkish Republic of Northern Cyprus." Yet the fear of contagion - that a Cypriot collapse may destabilise the banking systems of other nations - remains very serious.

It may be tempting for many in Cyprus to "stick it to the man" and reject calls for a bailout, but the stark reality is that its banks will all but certainly collapse without a capital injection, causing all deposits over 100,000€ ($130,000) to be lost as per Cyprus’ deposit insurance scheme.The non-EU depositors (read: Russians) wouldn't even get that. Thus letting the banks fail is not an option. But the Cypriots have, and are considering other options. Russian natural gas giant Gazprom has actually offered to privately bail-out Cyprus to the tune of 10€ billion in return for the entirety of the nation’s natural gas rights.

Meanwhile, members of the Cypriot parliament have suggested that they turn to China as an alternative source of funds. While such scenarios may seem like something from a turn of the century banana republic or a futuristic Phillip K. Dick novel, such loans are reality in Africa. And it was in Nigeria, the continent’s largest country, where the governor of the central bank Sanusi Lamido cautioned those who see China as a friend or a saviour in a recent Financial Times editorial. It would do well for the Cypriots to heed his words before "looking east" for help. Additionally, policymakers in Brussels, Berlin, and Paris, would balk at the intrusion of the east into the EU, furthering the impression that Brussels is weak when faced from rising powers.

The choice Cyprus faces is not pleasant, and the prospect of a bank levy represents a significant erosion of the rights of savers. However the alternatives are either complete default or the intrusion of foreign powers into the financial affairs of a European nation — a prospect that should sincerely frighten governments and markets across the West, Cyprus included. Perhaps the IMF should consider less stringent terms, as it is already, and leave out the bank levy. But this seems unlikely. So, then it seems that Cyprus has to swallow a very bitter pill. However, unlike the other options, it does not cause its hair to fall out or neglects to address one symptom or another.