It took all night to reach a deal, and details are thin at this hour, but the EU has dropped its insistence on protecting stockholders and bondholders in the Cyprus megabanks. One will be wound down “immediately,” which I think means without reopening in the interim. The fate of the other may be marked as TBD, to be determined, like so many other details in the plan. The important thing from the point of view of the EU is that the EU has given up whatever leverage it had to force the bank to stay open. If Cyprus finds that the bank is insolvent it will be obliged to close it.
This is a stunning about-face for the EU which as recently as last Sunday was still holding to its insistence that megabanks could not close. It was that stubborn policy that was putting the future of the EU and its member countries in doubt, and backing away from it, even if it continues to say that Cyprus is a special case, has to be considered a psychological breakthrough. Perhaps Europe can change after all.
That said, things will not be easy in Europe. There is no stopping the deposit flight from EU banks that the EU set into motion a week ago. This will hit some banks more than others, but now, at least, there is the possibility that banks that are fundamentally unstable can be wound down.
This weekend showed the EU to be weaker than it appeared even last Friday. Talks went late into the night mainly because it was so hard for the key EU nations to agree among themselves. Germany and France appear to be the key stumbling blocks in the EU, but perhaps that is only because they hold so much influence at this point.
Cyprus, for its part, avoided the broad confiscation of deposits that the EU had put forward a week ago. Insured deposits will be protected. Uninsured deposits in the megabanks, though, will be frozen, apparently available to pay bank debts in Cyprus but not for any other purpose. These deposits will be released only as bank assets are sold to make cash available, likely a ten-year process. With so much doubt about the true market value of many of the assets, it would be hard to make any other arrangement. By the same logic, one hopes that payments to bondholders will be similarly frozen, if they are not actually suspended.
The EU created the financial pressure on Cyprus by creating a crisis in Greece, on which Cyprus so much depends. It then escalated the problems in Cyprus a week ago by insisting on a policy that didn’t make any sense. The EU keeps repeating how small Cyprus is. It is important not for its financial scale, but as a sanity test for the EU. If it cannot make policy that passes the sanity test in one place, how will it make effective policy when it needs to in the heart of the EU?