What are the implications of the Cyprus bailout?

The deal assumes that of €15.8 billion (£13.5 billion) refinancing needs, €5.8 billion will be funded through a levy on deposits in Cypriot banks. This levy amounts to 6.75 per cent for deposits of less than €100,000 and 9.9 per cent for deposits over €100,000.

While the plan is yet to be finalised, news of the deal caused a rush to the cash machines in Cyprus as people tried to withdraw money. Germany, for example, must approve the plan, but is not due to vote until April.

This is the first time the 17-nation eurozone has sanctioned dipping into savers' pockets to finance a bail-out. However, depositors in Cypriot banks outside the country, including in Greece, will be unaffected by the levy.

The Cypriot parliament will have to put the new rules into law to make the remaining €10 billion of eurozone support available, and is expected to meet on Monday to discuss this. The banks are not scheduled to open before Tuesday.

According to analysts at Societe Generale, the Cypriot government is in negotiations to reduce the impact on smaller accounts to about 3.5 per cent, while at the same time increase the charge on larger accounts.

Failure to implement a deposit levy to raise the funds would be likely to result in a withdrawal of financial support by the eurozone. As a consequence, at least according to the Cypriot government, the country would then have to default and potentially leave the eurozone.

Risk of a bank run?

The big concern is that the news will provoke fear about the safety of bank savings across Europe.

'Anyone with significant bank deposits is now going to ask "could that happen to me?",' pointed out financial analyst Louise Cooper of CooperCity. 'And if there is any doubt as to the safety of savings, then expect withdrawals.

'One hopes that the Troika who devised the Cypriot solution have warned Europe's banks to have cash ready in case of larger-than-expected withdrawals this week. A solution to create stability may just create the exact opposite.'

Impact on Cyprus

Analysts at Credit Suisse believed there would be 'significant political and economic costs' for Cyprus, explaining: 'The newly-elected government will be weakened by this deal. The wealth effect, fiscal tightening and shock to confidence are likely to lead to a sharp fall in economic output.

'And there remains a risk of significant deposit outflows from Cyprus.'

Impact on the eurozone

While there are risks for the rest of the states on the periphery of the single currency area, analysts do not believe they will be particularly extreme in the short term.

'The most obvious source of contagion would be through the banking sector, where the precedent the decision in Cyprus sets could weaken confidence in vulnerable institutions in other countries,' commented analysts at Credit Suisse.

'However, with bank bailouts well under way in other peripheral countries and the particular nature of the Cypriot banking sector, such reactions might not materialise.'

Analysts at Societe Generale explained: 'The eurozone has been quite clear in its regulatory programme that future bank bail-outs will involve the "bail-in" of creditors to the banks. The specific issue for the Cypriot banks is that there are no creditors to the banks other than depositors.'

They noted the total debt securities issued by the Cypriot banking system amount to just €1.7 billion, or 1.3 per cent of the €126 billion of total liabilities. In Italy, debt securities fund €954 million out of €4.2 billion of assets or 22.7 per cent. In Portugal, the figure is 18.1 per cent, in Spain 11.1 per cent and in Ireland 6.6 per cent. Only Greece is in a similar situation, where debt funds just 0.7 per cent of the balance sheet.

Additionally, Cypriot banks are in a much worse situation than any other banking system in Europe. The two major banks were the only ones that failed to reach the 9 per cent European Banking Authority (EBA) capital target in July 2012 and did not have a viable government backstop.

Where the repercussions could be more severe and damaging in the longer term is in its impact on the political landscape, according to the Credit Suisse analysts.

'These events are likely to weaken the pro-EU political centre in yet another country. As elections in Greece and Italy have shown, the risk the economic and financial crisis is exposing is a steady rise in support for new and radical political parties in the periphery, for whom membership of the euro is not a necessity. Such a trend now looks inevitable in Cyprus,' they stated.

'And more broadly, these actions will further erode popular support for the euro and EU in the periphery: preserving membership of the euro will increasingly be about preserving the value of wealth, rather than a political goal. And in the long term that does not look particularly sustainable.'

Impact on stockmarkets

On Monday, Japan's Nikkei 225 index fell 2.7 per cent, while Hong Kong's Hang Seng and Australia's ASX 200 dipped 2 per cent on fears that the bail-out could trigger an escalation of the eurozone debt crisis.

This move was mirrored by European markets, with the FTSE 100 in the UK down 1 per cent in early trading, while France and Italy slipped 2 per cent.

Impact on currency

The euro fell nearly 3 per cent against the Japanese yen, and also dipped to a three-month low against the US dollar.

However, after the initial euro decline, analysts at Morgan Stanley expected a rebound, explaining: 'First, global liquidity conditions will continue to support risk-taking in the medium term. Second, the economic and monetary union runs a current account surplus as most peripheral countries have reduced their foreign funding needs.

'All in all, we believe the euro will come under initial pressure this week, but should stabilize near 1.27 against the US dollar. The British pound, Australian dollar, Canadian dollar and US dollar should benefit from this euro weakness.'

Impact on gold

Alasdair Macleod, head of research at GoldMoney, predicted depositors all around the eurozone were likely to seek alternatives to bank deposits, leading to 'cash withdrawals, capital flight into Swiss and other banks, and into physical gold'.

This article was written by our sister website www.iii.co.uk

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