By Alexander Grotevant
In recent years, the Eurozone Crisis has brought several members of the Eurozone eerily close to bankruptcy. Cyprus, its most recent victim, has been receiving a great deal of attention over the course of the past few weeks due to their struggling economy and the temporary closing of their banks. While a bailout deal has been reached, the crisis has certainly brought back economic fears for investors all around the world.
The crisis came about as a result of the Cypriot financial sector’s size relative to the country’s GDP. High interest rates, lax tax policies and easy access to the banks have attracted foreigners to putting money into Cyprus’s banking system. While there is certainly a great deal of money being put into the banking system, the Cypriot banks decided to risk buying up Greek government bonds back when Greece experienced its sharp economic decline. Unfortunately, this investment backfired and left Cyprus owing a lot of money.
According to Eurogroup President Jeroen Dijsselbloem, Cyprus’s banking sector has become more than five times the size of GDP. Dijsselbloem and others in the group believe that these numbers could mean the country’s public debt could outweigh GDP by 2020.
Undoubtedly, Cyprus was in need of serious financial support. Despite their initial request for a bailout, other members of the Eurozone did not support another bailout. This left Cyprus with no other option but to tax its banks’ personal savings accounts six to 10 percent in order to pay off the national debt. Upon hearing this plan, customers ran to their banks and attempted to withdraw all the money they could. In an attempt to prevent everyone from taking all of their money out of the banks, the government declared a national holiday and closed the nation’s banks.
The banks remained closed for over a week until a bailout deal was finally reached. One could argue that Cyprus’s economy is too small to impact the health of the Eurozone as a whole, thus making a bailout unnecessary. However, history has shown that members of the Eurozone prefer offering financial assistance to struggling economies over simply allowing them to fail.
The terms of this bailout are certainly unique and have heavy implications on Cypriot society. To begin, individuals with more than €100,000 in their account will have about 40 percent of their savings turned into bank shares. The controversy behind these bank shares is that they hold no guaranteed value for the future.
Another component of the bailout is that the country’s second largest bank, Laiki Bank, will be closed. Its €4.2 billion from accounts that exceeded €100,000 will be placed in a “bad bank” separate from more stable assets.
Essentially, all Laiki Bank investors will see their investments disappear, which has never happened before in a Eurozone bailout.
Additionally, customers are facing severe capital control measures that include daily withdrawal limitations, no cashing of checks and limited credit card transactions for individuals and businesses. Cyprus’s ministry of finance claims that these measures might only last days or weeks, but analysts are wary of this.
Guntram Wolff, the vice-director of a Brussels-based think tank, reminds us, “Iceland introduced them (capital control measures) after their banking crisis—five years later they are still in place.” Ultimately, there is still a great deal of uncertainty surrounding the implications of the bailout in Cyprus.
While it is not perfect, the bailout has certainly prevented Cyprus from becoming the first country forced out of the Eurozone. Unfortunately, however, the bailout does not seem to be enough to prevent Cyprus from experiencing a recession that some experts believe could last years.
The crisis in Cyprus is the latest in the chain of economic struggles within the Eurozone. While the bailout has protected Cyprus in the short-run, it is important for the region as a whole to find a way to prevent the need for more bailouts. Ultimately, this crisis should serve as a reminder that closer monitoring of financial institutions is imperative for countries in today’s global economy. Most importantly, however, countries must learn from their past mistakes to prevent similar economic crises in the future.
Trackback from your site.