As the proposed deposit account tax on Cypriot savers goes back to the drawing board after a failed vote, the world sits on edge as it waits to see what kind of proposal is in store to resolve the burgeoning bank system. Not many people realize that Cyprus has been building up a substantial imbalance on in its banking system, to the point at which it is no longer even eligible for emergency liquidity assistance from the ECB. The end result is a situation where the government needs to come up with dramatic alternatives to fund the growing gap between the nation’s GDP, and its outstanding obligations.
Ignoring the decision to try and tax the deposit holdings of personal savers, the leadership of Cyprus has raised an interesting proposition to try and exchange its outstanding debts for royalty-instruments that provide investors with a portion of the tax revenues generated from natural gas extraction in the region for a short-period of time that would compensate them for taking on the secured risk. In taking this step, Cyprus is effectively taking the bail-out into the government’s hands by allowing investors to take on incomes that would otherwise belong to the government.
While the securitization of the debts does effectively reduce the risk of the country’s financial crisis to the point at which it is able to meet its short-fall gap, it raises the question of how it is that the government itself will be able to afford such a measure, given that it is already borrowing so much to put its debt/GDP ratio at 120%. This means that the government would need to dramatically restrict spending over the periods for which the gas royalty securities are outstanding, and would wind up cutting services that consumers cannot make up for on their own. The end result is that the savers of Cyprus still wind up having to pay for the debt deal, as austerity measures crack down on their standard of living similarly to how a 10% deposit tax would.
Seeing that securitization is a pretty patchy solution to a greater issue outstanding, parliament members have already started discussing more direct alternatives to resolving the issues in hand. For one, it has been noted that the Euro-group could very easily allow Cyprus to continue on with a 120% debt/GDP metric, while enforcing austerity measures that would simply allow them to pay off the obligation over time.
That being said, even taking on austerity measures and reducing interest rates on deposit accounts is estimated to leave as much as 3B Euros left on the table in need of immediate funding. In terms of the immediate funding needs, it has been noted that banks in Cyprus are earning extremely high interest earnings (4-6% on a mortgage) on loans, to the point at which they are earning a nominal profit on all of the financial transactions going through the country as a whole.
As such, discussions of putting the banks up for sale to foreign entities, as well as to enforce a kind of bail-out requiring wealthier holders to buy-in on additional bond sales that would extend obligation timelines on the have also been proposed. However, the implications of such an action again become convolution due to the foreign risks associated with the transaction.
Specifically, because of the way in which many of the foreign deposit-holders are wealthy Russians avoiding tax obligations, there is an issue with the way in which the most likely acquisition candidates for a Cypriot bank would be a Russian entity, which would involve it in Russian reporting standards, and then simply result in another instance of capital flight as foreign holders leave the country again in search of a tax haven.
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