The meltdown of the tiny eastern Mediterranean economy of Cyprus briefly threatened to shatter the sense of calm that has recently prevailed over the eurozone economy. Equity market confidence was hit on concerns that the paymasters from the 'troika' of the European Commission, European Central Bank and International Monetary Fund have redrawn the blueprint for bailouts to target investors in banks rather than asking taxpayers to continue footing the bill.
A show of revulsion by the Cypriot populace led to a revision of the initial terms, which had targeted a tax on all bank savings account, narrowing down those hit with a levy to accounts holding more than €100,000 at two banks - the troubled Laiki Bank, which will be liquidated with bond holders wiped out, and the Bank of Cyprus. The key figure - the size of the levy on the accounts affected - is not yet clear but it threatens to be as high as 40 per cent. That represents a heavy price for some savers to pay, but the deal was welcomed across many European capitals as the first step in lancing up the bloated Cypriot banking sector, which had grown to eight times the size of the Cypriot economy on a huge influx of funds from Russia in particular.
For Cyprus, the future appears bleak, with some predicting that GDP will shrink by 20 per cent in the coming years. Banks will not reopen until the end of this week and when they do stringent capital controls will aim to prevent large deposit holders from running for the hills.
Cyprus is small beer in the wider scheme of the eurozone economy, but the willingness of the core institutions, with the implicit support of Germany, to take a harder line on bank creditors including deposit holders has shaken confidence among bank investors. It could also affect bank funding in the more fragile European countries, as ING Investment Management chief economist Willem Verhagen said: "One can expect a structural increase in the risk premium on bank funding costs, which could have negative repercussions for credit supply and private sector borrowing costs".
