| BRUSSELS, March 23
BRUSSELS, March 23 Lawyers have a saying that
hard cases make bad law.
Whatever happens this weekend on a bailout for Cyprus will
set precedents for the euro zone's future banking union,
investor confidence in the single currency area and political
relations among European states.
Europe's political leaders, and their finance ministers, are
having to decide in practice at breakneck speed on issues on
which they have not yet agreed in theory.
Among those issues is whether euro membership is really
irreversible for all member states, or only for countries deemed
systemic, and what the true meaning is of the European Union's
agreed guarantee of 100,000 euros in bank deposits.
"Lex Cyprus" will likely be a template for future bailouts,
bank resolution and the protection - or not - of creditors and
depositors, even if euro zone leaders swear on the bones of
saints, as they did for Greece, that this is a unique case.
Some precedents have already been set in a chaotic week of
stumbling crisis management.
For the first time, European leaders made clear they were
willing to cut loose a member of the 17-nation currency area,
leaving it to default and abandon the euro if it did not meet
the conditions set for a financial rescue.
The European Central Bank said it would pull the plug on
Cypriot banks kept afloat by emergency lending assistance unless
Cyprus had a bailout in place by next Monday night.
Even though the ECB does not yet have supervisory authority
over European banks, or powers to resolve failed institutions,
it effectively acted as a resolution authority since withholding
liquidity would have the same effect as withdrawing a banking
A senior European Union official warned that in that case,
the biggest banks would have to be wound down, and Nicosia would
have to fend for itself and revert to issuing national money.
"If the financial sector collapses, then they simply have to
face a very significant devaluation, and faced with that
situation, they would have no other way but to start having
their own currency," the official told Reuters on Thursday.
The combined ultimatums from Frankfurt and Brussels may have
been intended primarily to jolt Cypriots into accepting a levy
on large bank deposits that lawmakers had rejected, but it sent
a message that recalcitrant small countries can be expelled.
That is the opposite of what EU leaders sought to signal
when they went the extra mile last year to grant Greece more
time and money to keep it in the euro zone.
"Why did we say this for Cyprus when we didn't say it for
Greece?" a euro zone central banker said. "Cyprus is 0.2 percent
of the euro zone economy and Greece is 2 percent. Size matters."
Like other European policymakers quoted in this report, he
spoke on condition of anonymity because of the acute sensitivity
of the negotiations.
EU paymaster Germany, with a general election in September,
was keen to show it could say "no" and stick with it after
domestic critics complained that Berlin had been stampeded into
previous bailouts by anxious euro zone partners.
Last week's EU-mandated attempt to impose a one-off levy on
all bank deposits in Cyprus, rejected by the Cypriot parliament
and subsequently disowned by euro zone finance ministers, set
another precedent that caused an outcry among investors and many
Stunned by the backlash, the ministers changed their minds
within three days, blaming the Cypriot government for the plan
to hit smaller savers, and said deposits below the 100,000 euro
threshold should not after all be raided.
"I understand that electorates in Germany and northern
Europe demand some sacrifice. However, when you accept a
solution that basically expropriates 10 percent of deposits, you
set a dangerous precedent," Vladimir Dlouhy, a former Czech
economy minister and now international advisor at Goldman Sachs,
told Reuters. "If we get into deeper trouble, God help us, they
may try to take 50 percent."
The latest word from Cyprus suggests the levy on holdings of
over 100,000 euros at Bank of Cyprus could go as high as 25
percent. Many of the accounts are held by Russians and other
The psychological damage may have been done.
There has been no bank run in Spain, Italy or Ireland, but
depositors now know, if they did not suspect it before, that in
extreme circumstances their savings in euro zone banks may not
be as safe as they had imagined.
Tellingly, the International Monetary Fund urged the EU a
week ago to press ahead with a common deposit guarantee, a red
line for Germany which fears it will end up footing the bill.
The European Commission sought to distinguish between
protecting deposits if a bank collapsed, in which case accounts
of up to 100,000 euros were guaranteed by EU law, and "fiscal
measures", from which there was no such protection.
Cypriots were not alone in seeing the levy as an attempted
"bank robbery" rather than a tax, since it touched capital
rather than income.
In reality, even the EU guarantee in case of a bank failure
is less certain than it sounds, since there is no procedure so
far for other euro zone countries to help a country that does
not have the money to compensate depositors.
In the case of Cyprus, not only would accounts with more
than 100,000 euros be potentially wiped out in a bank failure,
but European officials say there is little chance the Cypriot
state would be able to reimburse all "guaranteed" deposits.
Berlin, in particular, opposes the idea of mutualising
national deposit insurance schemes and the European Commission
has yet to put forward a proposal for a financial backstop for
the planned European banking union.
One idea that may get around the German objection would be
to require national resolution funds to take out reinsurance
contracts with the euro zone's rescue fund, perhaps paying
differentiated risk premiums.
If, as now seems likely, only accounts larger than 100,000
euros are hit in Cyprus, euro zone policymakers may be obliged
by the public outcry to give stronger force to the deposit
guarantee than they had originally intended.
In that case, the Cyprus outcome also risks upending the
traditional hierarchy of claims in case of a bank failure, since
big depositors will suffer a "haircut" but senior bondholders,
of whom there are few in Cypriot banks, will not.
The Cyprus case does confirm another EU precedent in the
treatment of small member states, which could have serious
consequences for public support for European integration.
As with Ireland's repeat referendums on the EU's Nice and
Lisbon treaties and Greece's two general elections last year,
the bloc has a habit of pushing small states to vote again until
they produce the desired answer.
When France voted against a European constitutional treaty
in 2005, no one suggested the French be made to return to the
(Writing by Paul Taylor, editing by Mike Peacock)