Cypriot bailout and use of market mechanism is commendable - The Hill's Congress Blog

Cypriot bailout and use of market mechanism is commendable - The Hill's Congress Blog

Cyprus Crisis May Speed EU's Deposit Insurance Plan

By Evan Weinberger

Law360, New York (March 20, 2013, 7:36 PM ET) -- The European Union may now be forced to quickly establish a eurozonewide deposit insurance scheme to restore faith in the continent's banking system, experts say, after policymakers caused a confidence crisis this week by proposing to fund a bailout of Cyprus with a tax on the country's bank deposits.

The proposed bailout of Cyprus pushed by the so-called Troika — the EU, the European Central Bank and the International Monetary Fund — has spooked depositors around the continent by calling for a levy on all deposits held in Cypriot banks. That has caused fears of runs because of a lack of confidence, and one of the key steps to restoring that confidence is to establish the deposit insurance scheme, said Cleary Gottlieb Steen & Hamilton LLP partner Lee Buchheit.

And that may force the EU to move more quickly on a key part of its financial regulatory overhaul, which began with plans to give the ECB the authority to regulate large eurozone banks.

"The approach they've taken, and I think it's a sensible one, is that you cannot put the eurozonewide deposit insurance cart in front of the unified supervision horse," Buchheit said. "They may find that they need a eurowide depository insurance sooner than they thought."

The changes to the eurozone financial regulatory system were a response to the European debt crisis that began in Ireland, moved through Greece, Portugal, Italy and Spain and has now spread to Cyprus, a Mediterranean island with a gross domestic product smaller than Vermont's.

Cyprus developed into an international banking hub, and the country's banks held assets equal to approximately 700 percent of its GDP as of the end of December, according to a Tuesday report from the Institute of International Finance Inc.

Cypriot banks were battered by Greece's bailout, which included a major haircut for holders of Greek debt.

Those conditions helped pave the way for the latest chapter of the European debt crisis. Although Cyprus needs only around $13 billion to bail out its banking system — a paltry sum compared to the hundreds of billions that have been distributed in other EU bailouts — the mechanics proved difficult.

That was the spark for the plan to tax deposit holders, including those with account balances smaller than €100,000, or around $129,000, the cut off for depository insurance provided by the Central Bank of Cyprus.

Cypriot citizens chafed, and there were reports that some were withdrawing bank deposits to avoid the tax, further harming the country's banking system. The Cypriot parliament voted down the bailout plan Tuesday, and policymakers are now struggling to find a new solution.

Even contemplating taxing deposits broke a major taboo, however, said Paul Hastings LLP partner Kevin Petrasic.

"This really strikes at the integrity of the banking system," he said.

Confidence is key in banking. If depositors think that their money is safe, they will keep their money in the bank. If not, there will be a run, Petrasic said.

Since the idea of taxing deposits was announced, citizens of peripheral European countries have eyed their accounts warily, despite assurances from EU leaders that the Cyprus situation was unique.

"There is no way to put that toothpaste back into the tube," Buchheit said.

One way to at least put a cap on the confidence flow is to establish a system similar to the deposit insurance created by the Federal Deposit Insurance Corp., which backs deposits up to $250,000 and has been one of the key players in preventing U.S. bank runs since its creation during the Great Depression.

The EU, as part of its plan to shore up the eurozone financial system, included creating a unified bank regulator operating out of the European Central Bank that will oversee any banks with at least €30 billion, or around $39 billion, in assets or total assets representing 25 percent or more of its home country's GDP.

The European Parliament on Tuesday announced a deal that all but cemented the plan.

A second leg of the reform plan was to create a eurozonewide deposit insurance scheme that would pool funds from all countries operating on the euro into a single fund that could be disbursed to holders of deposits in any member bank.

The Cypriot crisis has again exposed a problem facing EU policymakers. Taxpayers in countries like Germany are tired of bailing out countries on the eurozone's periphery, and citizens in countries with debt problems are tired of having austerity measures thrust upon them by rich neighbors.

That could make it more difficult than normal to negotiate a deposit insurance scheme, said Hung Tran of the Institute of International Finance.

"What we have seen is there are more and more signs of solidarity fatigue in the core countries and reform fatigue in the peripheral countries," he said.

Still, if countries in the eurozone want to make sure the currency survives, they are eventually going to have to agree to a deposit insurance deal, Buchheit said. The more stable countries would just prefer to wait a little longer.

"I think people like the Germans will wait to see that the supervisory function is doing its job," Buchheit said.

But with the crisis in Cyprus turning into a confidence crisis across the eurozone, they may not have that choice.

"They have to build trust across Europe, not just in Cyprus," Pace University finance professor Surendra K. Kaushik said.

--Editing by John Quinn and Katherine Rautenberg.

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Narendra Modi's Political and Governance Leadership

In my conversations with different people in a recent short visit to India, the following ten reasons were cited for the popularity of Narendra Modi’s leadership of Gujarat state and his projection as a national leader, and potentially a Prime Ministerial candidate of National Democratic Alliance (NDA), in the upcoming Parliamentary Elections in 2014: 

1. Success in attracting business investment in Gujarat for growth of industry, jobs and  general           economic development.

2.  Bringing smart bureaucracy under control for effective and positive governance for growth and     progress.

3. Streamlining bureaucratic process for quick decision making and performance of government machinery to resolve people’s problems for positive results.

4. Control /elimination of corruption and discouragement associated with it to remove uncertainty in the population.

5. Effective encouragement and promotion of the entrepreneurial spirit and activity in the people of Gujarat.

6. Personal honesty and integrity.

7.  Fearless discussion of national and international issues.

8.  Clear thinking and policy in the interest of the people of Gujarat state and the nation.

9.  Powerful and effective oratory and communication of his views and dialog with the people of Gujarat and India. 
10.  Demonstration of economic prosperity of Gujarat to win re-elections as an achiever- politician.