Analysts now forecast a second bailout for Cyprus

Tim Wallace
Follow Tim
CAPITAL controls in Cyprus can only slow the flood of funds out of the banks, analysts warned over the weekend, likely leaving the state in need of more help in future.

Even if a lasting deal is struck, they fear harm has already been done to the other peripheral states by undermining confidence in the Eurozone’s crisis management skills.

Analysts believe confidence will not be restored simply by bailing the government out and restructuring the banks, as the state’s underlying economic worries will not be solved.

“It is distinctly possible that confidence in the banking sector will not be restored by its imminent restructuring. This loss of confidence sees some very discernible possibility a further banking sector bailout might be required,” said Rabobank’s Richard McGuire. “Even if capital controls are successful in stemming any outflow of funds from the banks they will be powerless to affect the likely dwindling inflows.”

The radical proposals put forward to raise the cash also risk spreading to other troubled Eurozone nations.

“Even if smaller deposits escape a levy as now looks likely, the fact that such a move was even under very serious consideration has surely rattled faith in the EU’s deposit guarantee,” said Capital Economics’ Jennifer McKeown. “Meanwhile, the fact that Eurozone policymakers were prepared to cross the Rubicon of raiding ordinary peoples’ savings for the sake of a pretty tiny amount of money – less than two per cent of the European Stability Mechanism’s funds – has underlined the depth of the resistance to further outright bail-outs.”

Those concerns mean depositors in other countries like Spain and Italy may in future be more willing to flee to safe havens like Germany just in case their deposits are raided or capital controls are later put in place, undermining banks in those countries.

Increased risk of capital flight in other countries could end up accelerating those crises, Rabobank fears.

Furthermore, the European Central Banks’ threat to cut off support for Cyprus’ banks could show the limit of Mario Draghi’s pledge to do “whatever it takes” to keep the Eurozone together, again undermining confidence.

Q and A: What is the ECB’s deadline for Cyprus?

Q What has the European Central Bank (ECB) proposed?

A The ECB told Cyprus it has until today to come up with a deal to recapitalise its banks or it will cut of its emergency liquidity support.

Q Why does that matter?

A Normally banks can tap the ECB for liquidity support using high-quality securities, like government bonds, as collateral. But since mid-2012 Cyprus’ government bonds have been deemed too risky to use. So Cypriot banks have had to use the emergency scheme to access liquidity, exchanging illiquid assets for liquidity, with large haircuts. If they lose that access, they will be in serious trouble and be unable to function any longer.

Q Will it happen?

A ECB head Mario Draghi had previously claimed he would do whatever it takes to save the euro, so even making this threat is a big step away from his previous line. If he does not withdraw the support it risks being regarded as an enormous fudge and the ECB’s deadlines and ultimatums risk not being taken seriously in future. Draghi will be hoping a deal is struck overnight that will save him from having to make the call.