Cyprus is a large island in the eastern Mediterranean Sea, with a population of 1.2 million – about equal to that of New Hampshire – and an area half that of New Hampshire. It’s divided between North and South Cyprus because of an invasion by Turkey in 1974. Cyprus joined the Euro-zone ten years ago, and had a banking crisis about five years later in the aftermath of the Greek debt crisis. The IMF and European Central Bank organized a bailout that required the two largest Cypriot banks to impose a deposit levy on uninsured depositors.
There were grim predictions that Cyprus would be first in a line of dominoes to topple, resulting in the ultimate break-up of the Euro-zone. This was the first time that bank depositors – as opposed to bondholders – had suffered losses in the Euro-zone. The fear was that depositors would withdraw their funds to protect themselves, leading to a credit crunch and long-term structural damage to the Cypriot economy. Depositors in other Euro-zone countries would take note, and the banking crisis would spread.
What happened was just the opposite. After a period of contraction, Cyprus’ economy gradually improved and is now growing at 4% annually. Cyprus retains its tourism, trading, and finance infrastructure. Cypriot banks lost about 20% of their domestic deposits and almost 50% of offshore funds, but then the banking system stabilized. Small, insured deposits weren’t hurt, and that money remains part of the banking system.
Source: Brown, Evangelou, & Stix, VoxEU
The IMF and ECB rescue worked. Other Europeans correctly saw that the Cypriot Banking Crisis was a one-off event, triggered by their close ties to Greece and large percentage of offshore deposits. Even though 55% of all households in Cyprus experienced financial losses, the crisis didn’t cause a bank run across Europe.
Cyprus has a small economy, half the size of Vermont’s. By stabilizing their banking system, European authorities were able to avoid contagion and stave off any further spread of the Euro crisis. Although Cypriot households remain skeptical of their banks’ security, that attitude in not shared by the rest of the Euro-zone. What happened in Cyprus stays in Cyprus.
Douglas R. Tengdin, CFA