After Week of Talks, ECB and Cyprus Reach Deal

729-bankcyrpus-620x349The economic state of Cyprus is posing a severe threat to the stability of the European Union. Cyprus, whose banking system was pushed to the brink of collapse, has been in desperate need of a bailout from the European Central Bank. Mario Draghi and the ECB pledged last year to do whatever is necessary to preserve the Euro. However, countries that seek the assistance of the bloc’s central bank would have to agree to austere reform measures. Cyprus, the ECB, and the International Monetary Fund have struggled to reach an agreement on the conditions of a bailout for more than a week.

Cyprus, a nation that attributes half its gross domestic product to its financial services sector, has seen its banking industry take a turn for the worse as a result of considerable losses on investments in Greek debt. However, the nation of Cyprus will not be completely bailed out by the ECB, as the nation is expected to contribute to the bailout cause, or possibly face an exit from the European Union.

Both the International Monetary Fund and the rest of the EU have expressed that the depositors in Cypriot banks should contribute to the bailout fund due to the little regulation that has allowed the Cypriot banking industry to become the most significant sector of the nation’s economy. Earlier this week Cypriot President Nicos Anastasiades proposed a tax on all deposits in Cypriot banks. A tax of 6.75% would be levied on accounts amounting to less than €100,000, and a tax of 9.9% on accounts amounting to more than €100,000. Anastasiades’s proposal was clearly an attempt to keep large depositors happy, specifically those from other nations that use Cypriot banks as a tax haven. Although this idea would have contributed €5.8 billion to the bailout effort, it was rejected by the nation’s parliament.

Talks late Sunday into early Monday proved constructive, as it appears that Cyprus and the EU have agreed on a bailout deal. The deal will lead to the closing of the nation’s second largest bank, Cyprus Popular Bank PCL, and the downsizing of its largest bank, Bank of Cyprus PCL. The original proposal of President Anastasiades was modified as depositors of more than €100,000 will be the main contributors to the nation’s bailout.

The specifics of the deal are not yet finalized, but the nation is just relieved to reach an agreement. Earlier in the week the nation was desperate. Cyprus considered turning to the Orthodox Church, which stated that it was ready to mortgage its considerable assets to provide the government with liquidity. Cyprus also considered granting Russia access to its natural gas deposits in exchange for financial relief, as many Russian citizens who deposit in Cypriot banks have a vested interest in the nation’s survival. This would have led to even more turmoil for Cyprus as the northern part of the nation where the deposits are located has been controlled by Turkey for almost forty years.

The ECB program providing emergency liquidity to Cyprus would have ended on Monday night if a deal was not reached. All parties involved in the talks feared runs on the banks last week and chose to keep banks closed. However, a deal does not mean that the bad times are over for Cyprus, as it is predicted that the nation’s economy could shrink by more than 10% in the coming years. People have been questioning the viability of the Cypriot economic model for some time, and the situation has proven that one-dimensional economies are significantly affected by trends in the global economy. A financial services-focused economy is very vulnerable during a time of financial recovery and uncertainty, and it will be interesting to see the effect financial reform in Cyprus will have on the nation, and the European Union at large.

Sources:

http://www.huffingtonpost.co.uk/2013/03/21/cyprus-bailout-orthodox-church_n_2922162.html

http://www.nytimes.com/2013/03/25/business/global/cyprus-and-european-officials-scrambles-to-end-bank-crisis.html?pagewanted=2&_r=0&ref=cyprus

http://online.wsj.com/article/SB10001424127887323419104578376283901526750.html

http://online.wsj.com/article/SB10001424127887324789504578380550995616128.html?mod=WSJ_economy_LEADStoryTop

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