Why the Cyprus bailout could trigger a disastrous run on banks

New York: You can be lulled into thinking that you don’t need to worry about what’s going on in Cyprus. After all, it’s a scenic far-flung island in the Mediterranean. But a decision by eurozone finance ministers to impose a tax of up to 10 percent on bank depositors in Cyprus as part of the country’s bail-out could buffet not just Europe, but the rest of the world.

The Cyprus bailout is the first time European leaders are forcing depositors in Cypriot banks to share in the cost of a bailout. The eurozone’s bizarre decision in Cyprus, could prompt depositors at weak banks all over Europe, in places like Spain, Italy, and Greece, to ponder whether this is the beginning of a new era of bailouts, an era in which bank depositors are going to lose some of their money.

[caption id=“attachment_666353” align=“alignleft” width=“380”]  Protesters take part in an anti-bailout rally outside the parliament in Nicosia. Reuters[/caption]

Will this prompt ordinary folks in Europe to yank their money from the banks?

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“It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying ’time to stage a run on your banks!’” Nobel Prize-winning economist and New York Times columnist Paul Krugman wrote in a blog post.

Eurozone officials said on Saturday morning that the decision would not act as a precedent for future financial rescues. But protestors in Cyprus warned that the raid on their bank deposits served as a warning bell for other weakened European economies.

One banner read, “EU. Who is next? Spain or Italy?”

If Europe suddenly experience a good old-fashioned bank run. That could be a disaster for Europe and its trading partners. It wouldn’t be good at all for the Indian economy. The European Union accounted for 17.2 percent of India’s exports in the six months ended September 2011, according to the commerce ministry, making it India’s largest trading partner.

India’s rupee dropped to 54.2725 per dollar on Monday, the most in two weeks as the unprecedented levy on Cyprus’s bank savings threatened to throw Europe back into crisis.

Talk of the bank deposit tax has already caused a run on the banks in Cyprus. Depositors ran helter-skelter over the weekend and on Monday to ATMs to try and withdraw their money before it could be seized. A debate and possible vote on the bailout plan has been delayed until Tuesday. Meanwhile, the banks in Cyprus, already shut on Monday for a bank holiday, will remain closed on Tuesday and Wednesday to avert panic bank withdrawals.

Cyprus went to the eurozone to get a bailout in July, the same way Ireland, Greece, and other European countries have. The powers-that-be, mainly Germany, gave Cyprus a bailout and insisted that the depositors pay part of the tab. Under the current deal reached in Brussels on the weekend accounts under 100,000 euros will have 6.75 percent of the funds seized, while accounts over 100,000 euros will have 9.9 percent seized.

The controversial tax on deposits is a precondition to Cyprus receiving the $13.07 billion bailout from the IMF and the country’s eurozone partners. News agencies quoted a Greek finance ministry source saying Cyprus could exempt smaller savings accounts from the levy than first planned but this has done little to assuage protestors.