Trust in banking sector lost?

It was supposed to be a busy weekend and turned out to be even more busy than I had expected, so just a short note…

The bombshell of the week was the decision to levy a one-off tax on bank deposits in Cyprus. The tidings such a measure was about to be introduced struck me out of the blue. I was aware banks registered in the Mediterranean island divided between Greek and Turkish zones were ailing, I knew Polish banks for months had refused to accept letter of credits and guarantees issued by Cypriot banks, I realised how big exposure of those banks to Greek bonds was, I knew the country enjoyed the status of tax haven, thus attracting businessmen who eagerly had registered their holding companies there.

And now this small economy is on a brink of collapse, chiefly due to fragility of its overgrown banking system and reliance on income from low-rate taxation. The country will probably recover, with substantial help in form of emergency loans, but its citizens will be bearing the brunt of the crisis for years to come.

The recent plan to seize a percentage of deposits amassed in Cypriot banks is an unprecedented expedient undermining trust in banking sector. For years people have been taught to put their money to banks, as this guaranteed safety. Polish banking law defines banking activity as such where risk is taken away from a depositor by an entity having the status of ‘bank’. All developed countries have deposit insurance system which serves as safety valve preventing depositors from rushing to banks en masse to withdraw their money.

This seems to be the thing of the past. It turns out if a country is on a string of creditors, in order to avoid insolvency the country has to meet even the most unlawful requirements lenders come up with… After days of haggling and fighting growing social unrest, Cypriot government today reached a deal with EU / INF creditors. The one-off tax of 4% or 20% will be levied only on deposits above 100,000 EUR (the only question is whether it will cover only surplus above the threshold) and recent news say nothing of any form of compensation for depositors.

Exactly… The most interesting thing about the whole media coverage of Cyprus bank tax is that in most cases the aspect of compensation has been omitted. Several economists spoke about a brazen rip-off, while few stressed depositors at least a few days ago were planned to be given shares in their banks in return. This reveals the other side of the coin. If somebody does not need their money within a few months, this might turn out to be a great deal. If the price at which shares are granted reflect the banks’ dire standing and those bank are restructured successfully, depositors will earn a superb return. Why almost nobody mentioned this? In such shape, the Cyprus bank tax would be a classic example of conversion of debt to equity. Raising capital and reducing liabilities of banks would increase their resilience and help rebuild trust in them. With such compensation scheme in place, the whole plan hangs together and I would dare to say, is well-devised. Oddly enough, I am one of the few fellows discerning upsides of the operation; the operation which again proves the easiest way to raise money is to go where money can be found easily…