Cyprus has been clawed back from the brink of a
likely banking sector default in last-minute negotiations, but a week
of desperate wrangling has outlined the shortcomings of the 17-member
euro currency bloc.
Cyprus lurched from proposing an unacceptable levy on small depositors, to a solution focused on the root of the problem - the unsustainable balance sheets of its largest banks - but demanding huge investor losses that are likely to slow the economy for years.
"It is not yet the end of the story," said Zsolt Darvas of Bruegel think tank. "The risk of Cyprus exiting the euro has not yet been diminished completely."
The agreed solution will impose losses that could amount to 50 per cent of all deposits over 100,000 euros (130,000 dollars) held in the country's two largest banks, which make up an estimated 80 per cent of the banking sector.
But the ultimate effect on small savers could be worse than the initially suggested levy on their deposits, some analysts argued.
The non-linear nature of the losses, hitting some investors hard and sparing others, could push companies into bankruptcy that might otherwise have been spared, Darvas said.
"While there are people celebrating that the little guy has not been (subjected to losses), the overall impact on the average Cypriot citizen who had deposits of less than 100,000 euros may actually be worse," added Sony Kapoor of Re-define think tank.
Cyprus showed that "the crisis is far from over, that we still have very significant problems in the banking systems in a number of countries ... and that we are still lacking effective mechanisms to deal with them," said Fabian Zuleeg of the European Policy Centre think tank.
Much of the drama could have been avoided if the common euro currency were accompanied by a banking union, EU officials say, with shared rules and liabilities to break the link between bank debt and sovereigns.
Initial steps have been taken toward a banking union, with a eurozone banking supervisor due to take up work next year. But the added pillars of joint bank resolution and deposit guarantees remain a long way off.
"It is shocking that, 5 years into what started out as a banking crisis, the EU has failed even to begin a proper process of putting in place bank resolution legislation," Kapoor said.
Without a bank resolution mechanism, failing banks become the subject of late-night emergency talks, as in the case of Cyprus, with solutions adopted at the 11th hour.
"The political cost of this kind of development is very significant," Zuleeg said of developments in Cyprus. "The trust between euro area member states has also gone down."
Cyprus has also shown that without joint deposit guarantees laws obliging EU members to protect savings below 100,000 euros are of little help when a state is threatened with insolvency - a point German Finance Minister Wolfgang Schaeble made last week.
And while the idea of "bailing in" small depositors had since been shot down, now that it had been mooted it would take longer "to get the genie back into the bottle," according to analyst Carsten Brzeski of ING bank.
Darvas was confident that Cyprus, the eurozone and the international bailout partners had made the best of a difficult situation.
"Given the circumstances I am convinced that they have chosen the least disruptive options," he said.
He saw last week's events as an example of "why we need the banking union very much," as it would have fostered early intervention in Cypriot lenders and provided a standard procedure for banking resolution.
But Kapoor was more pessimistic, describing Cyprus as a "wake-up call" to those who believed such joint eurozone rules and guarantees were a realistic option.
"The banking union has already become a farce," he said, pointing to stringent conditions demanded by Germany.
Without a meaningful long-term perspective to rebalance economic differences in the euro area, including the necessary financial support to make the process sustainable, Kapoor said, "it's time to seriously start thinking about walking away."
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