Last week, Nicosia removed an obstacle to Cyprus’s economic recovery by finalising the terms of the depositor writedown agreed in March as a condition for a eurozone rescue loan. Not before time. Certainty about the “haircut” on uninsured deposits – set at 47.5 per cent – and the Bank of Cyprus’s concomitant recapitalisation and exit from administration are vital first steps out of the credit crunch that is strangling the economy.
Successive Cypriot leaders made the country’s current crisis worse by postponing the ineluctable reckoning with reality. Only at the last minute did Nicosia secure a rescue loan with its euro partners, and they nearly bungled that in an unconscionable attempt to shift the burden of bank losses from large deposit holders to small ones.
This time, too, the government has overplayed its hand, unsuccessfully holding out for a smaller writedown. The troika of official lenders rightly demanded that deposits above €100,000 should shoulder sufficient losses to put BoC on a solid capital footing. The bank will now have a core capital ratio of 12.4 per cent, and is estimated still to retain a 9 per cent cushion when the rescue programme ends. Haircut depositors, now stockholders in the new BoC, have a large stake in any upswing.
Despite what its politicians may have thought, this is to Cyprus’s benefit. Ample capital is the surest way back to market funding for the broken Cypriot banking sector. Better funding prospects, in turn, will enable BoC better to play its role in supporting the economy. If anything, it needs yet more equity.
So long as capital controls remain in place, however, that role will be curtailed. The need to keep deposit flight within manageable levels is understandable. But the measures adopted by the troika and Nicosia to bar money from exiting the country have also put excessive brakes on its circulation within the national economy.
While some controls have been relaxed, size limits remain on some electronic transfers within Cyprus. Seized deposits above the 47.5 per cent haircut will only partly be returned as liquid funds to their owners. The bulk takes the form of term deposits, inaccessible for up to two more years.
So long as adequate deposit funding remains in place, there is no need to limit transfers between Cypriot deposit holders. The newly imposed lock-in on returned deposits should be lifted for transfers to other local accounts. The sooner the domestic economy gets off the ground again, the sooner the threat of capital flight will abate.