Reason prevails but the damage is done.

With their 11th-hour agreement with Cyprus for a €10bn bailout, eurozone policy makers avoided the worst: a catastrophic implosion of the island’s banking system and a hasty exit from the eurozone.

The deal reverses some initial errors. It targets depositors in troubled banks rather than indiscriminately across the sector. Insured deposits under €100,000 are safe. There will be restrictions on deposit withdrawals and transfers tailored to each bank rather than across-the-board capital controls.

But the way the bailout negotiations were handled over a tumultuous 10 days has done serious harm to the eurozone and further undermined the credibility of its crisis response.

Here’s how.

1) Deposits are no longer safe

Eurozone finance ministers’ consent for the abortive Cypriot proposal to impose a 6.75 per cent levy on insured deposits of less than €100,000 is widely acknowledged to have been a big mistake. Bank customers elsewhere in southern Europe may not be rushing to their banks in panic. But the agreement to breach the EU-wide deposit guarantee – rapidly rescinded once the eurozone authorities realised their error – has undermined faith in the one concrete element of the planned banking union to be already in place.

2) Capital flight

The bailout is more or less based on an original German/International Monetary Fund plan to bail in depositors at Cyprus’s two biggest lenders Bank of Cyprus and Laiki. Nicosia, with some support from the European Commission, resisted this proposal, arguing that it would destroy the island’s status as an international financial centre. Such an outcome now seems inevitable since big depositors are facing even heftier losses than originally envisaged.

3) Unsustainable debt

The IMF, Germany and other eurozone creditor governments insisted all along that the reason for bailing in depositors was to ensure that an international bailout of the island would not saddle it with an unsustainable debt load. But the hit on big foreign depositors and the chaotic nature of these bailout negotiations is going to wreak havoc on the Cypriot economy. Société Générale is forecasting a 20 per cent drop in GDP by 2017.

The IMF wanted to avoid a repeat of the Greek imbroglio – an undeliverable programme and a ballooning debt – but it is hard to see it doing so in the case of Cyprus.

4) Troika disunited

The heated negotiations over Cyprus have taken their toll on the so-called troika in charge of bailout terms – the IMF, the European Commission and the European Central Bank. The IMF was consistent in pushing for a bail-in of big depositors in the two weak Cypriot banks. But, as the FT’s Peter Spiegel points out, there are now concerns that it has become too hardline for the fraught politics of the eurozone. The Commission bears responsibility for backing a levy on insured deposits and has lost the trust of the IMF. With its warning about cutting emergency liquidity assistance to the island’s banks, the ECB found itself in the uncomfortable position of pointing a gun to Cypriot heads.

5) Poisonous politics

President Nicos Anastasiades’ handling of the negotiations – he reportedly both threatened to quit and to take his country out of the eurozone on Sunday night – infuriated eurozone policy makers. They were evidently frustrated by his determination to protect big foreign depositors from bigger contributions to the bailout.

But in contrast with his Communist predecessor, he was a relatively pro-European, pro-reform leader with a fresh and solid democratic mandate.

Has the eurozone precipitated his political demise? The fact that the bailout deal requires the approval of eurozone parliaments but not Cyprus’s raises questions about democratic legitimacy – and resentment at the treatment meted out to one of the EU’s smallest members by its big power brokers.

6) Germany resolute

The blame for the Cyprus fiasco was originally pinned on Germany – incorrectly. It was not Berlin that wanted to penalise smaller depositors even if it pushed Nicosia to find a €5.8bn contribution up front at all costs. But the events of the last 10 days have steeled Germany’s determination to offload the burden of bailouts from eurozone (especially German) taxpayers to investors and creditors. It is pause for thought for those still hoping that Germany will one day assume greater sharing of eurozone liabilities in return for tighter control of national budgets.

The writer is Europe news editor

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