Newsfeeds this week have come alive with reports of a European bailout plan that would literally rob Cypriot savers of as much as 10% of their personal accounts. The policy has already been dubbed as the Cypriot ‘bank robbery’ by domestic savers that are having their accounts throttled to cover out the sloppy debts of other European countries. However, the issues becomes particularly complex as we start to look at how it is that a bill like this makes sense, and how it is that policy-makers actually took steps to make this an actual tax on foreign funds, rather than a burden on a smaller European nation.
Specifically, investors need to understand how it is that this mechanism was actually meant to be a tax placed on wealthy Russians that use the Cyprus as a tax haven for their own gains. The end result is that European leaders are now coming up with creative ways of placing taxes on non-residents of the EU, to bail out their own financial short-falls. By looking at this issue as a predictive indicator of policies to come, we can start to ask questions about whether or not this is the start of a forced Asian bailout for Europe?
Looking back to 2007, Cyprus has seen phenomenal growth in its bank-held deposits, to the point at which assets on hand were nearly seven times the actual GDP of the economy itself (126B Euros on deposit vs 18B Euro economy), with this deposit amount nearly doubling over the course of a few years. This growth was mainly attributed to inflows from wealthy foreigners that were looking to both avoid taxes, and take advantage of the phenomenal interest rates that were being offered by the retail banks.
Extending from 5.5% for a personal savings account all the way up to 12% for a certified deposit, a savings account in Cyprus was an extremely valuable product to hold over the last few years. Assuming a US investor were to take their funds, change them into Euros, and invest them for 3 years in a Cypriot bank, the return against US funds (without taking into account the depreciation of the Euro against the USD) would work out to approximately a 2-4% premium against US bank rates.
This means that investors would be earning the same amount of return form a savings account in Cyprus as they would on the dividends on a blue chip stock, provided they hedged their currency exposure. This works out to a total return of about 12% over 3 years for a foreign investor in Cyprus, ignoring domestic taxes. Here’s where things start to get interesting.
The Cypriot ‘bank robbery’ proposes that savers holding more than 100,000 Euros pay out 9.9% of their account holdings, while smaller savers would need to pay out 6.75%. This means that savers would essentially be required to pay back the interest that they have earned over the last three years, but would be allowed to keep 6% (for small savers) and 2% (for larger savers). The end result of such a transaction would simply bring these rates of return on these placements back down to reality, where it is that all the rest of Europe is earning on their returns.
Granted, this correction does not adjust for the fact that Cypriot savers were also paying a premium on their loan rates, it does result in a situation that would correct what is arguably an inefficient interest rate, in a way which taxes foreign money to bail out a domestic shortfall. The question then comes down to one of whether or not the detriments of burning foreign deposit holders could be justified without backlash, and as to whether or not an arrangement could be worked out that allowed domestic borrowers in Cyprus to get a rebate on the loan payments.