Cyprus: everything you need to know

The tax, the Russians, the insurance, the surprise, and the future.

The tax

The Cypriot government is to impose a levy of 9.9 per cent on deposits of more than €100,000, and 6.75 per cent on deposits of less than that. Or maybe those numbers are 3.5 per cent for the poorer depositors and 12.5 per cent for the richer ones, according to the FT last night. Or maybe it's actually 3 per cent for €0-100k, 10 per cent for €100-500k, and 15 per cent for €500k+, according to Dow Jones' Matina Stavis this morning.

Update: or maybe it's 0 per cent for some as-yet-unidentified portion at the bottom, according to Reuters.

For what it's worth, Stavis Reuters seems most up-to-date, and the proposal she's got hold of is apparently the one set to be negotiated in the Cypriot parliament today.

The Russians

The reason for the tax is the, er, "unusual" make-up of the Cypriot banking system. It is an offshore finance capital which caters to a lot of very wealthy Russians. And it's big - or rather, Cyprus is little. The cost of recapitalising the banks is around sixty per cent of the country's entire GDP, and that's a cost which Cyprus' government can't afford.

At the same time, Cyprus is a small enough nation within the EU that the core nations - for which, read "Germany" - can afford to play hardball. Germany is sick and tired of paying to recapitalise periphery banks, and is doubly unhappy about having to do it when a lot of the deposits in this particular country's banks are borderline - or actually - laundered money. But given the size of Cyprus, most other euro nations could handle its exit from the euro with ease – which isn't the case for, say, Greece – and so the ECB had the courage to make Cyprus an offer it couldn't refuse: either fund some of its bailout with a levy on large depositors, or the ECB would suspend emergency capitalisation for one of Cyprus' two struggling banks, in effect forcing bankruptcy and an exit from the eurozone (Cyprexit? Cyxit? Cexit?).

But it appears Cyprus went further than Germany demanded. Ekathimerini reports that the German finance ministry only requested a levy on deposits over €100,000. Finance Minister Wolfgang Schaeuble is quoted:

We would obviously have respected the deposit guarantee for accounts up to 100,000. But those who did not want a bail-in were the Cypriot government, also the European Commission and the ECB, they decided on this solution and they now must explain this to the Cypriot people.

As Paweł Morski writes:

If the infliction of losses on small depositors has a purpose, it’s probably to reassure the Russians that they are not being discriminated against. Yes, I may have thrown up a little in my mouth typing that.

The exact numbers suggested on Friday night - the ones which have already been modified - make it look like Cyprus went even further, specifically levying a 6.75 per cent levy on small depositors just to ensure that the levy on larger depositors didn't break 10 per cent. Now that that barrier has been broken, hopefully the distinction will keep growing until small depositors pay nothing, and the entire burden is on those who can afford to pay it.

The insurance

The levy on small depositors is unanimously agreed to be the worst thing about Cyprus' case. There is debate about whether or not bank depositors should have to stomach some of the cost, because, to quote Morski again, "when you deposit money in a bank you’re making a loan". There is debate about whether the ECB is continuing its anti-democratic trend, started with the technocratic ousting of Silvio Berlusconi last year, or whether the two choices it presented Cyprus really are the only two options reasonably available to it. There is debate about whether the levy is actually even legal, because, as Joseph Cotterill points out, it may not be "reasonably foreseeable and adequately accessible" enough to satisfy Article 1 of Protocol 1 of the ECHR, which governs the legality of wealth taxes.

But on the penalisation of the poor, all are in agreement: it was a bloody stupid move. The biggest reason is that the levy on deposits under €100,000 hits insured depositors: people who are legally protected from losing their money even in the event of a bank crash. Deposit insurance is disliked by many titans of finance, because it creates a so-called "moral hazard", allowing banks and savers alike to forget that their money is technically at risk and behave in ways that they shouldn't. Nonetheless, it has one major advantage, which keeps it alive in nearly every western nation: it prevents bank runs.

If you know that your money is safe even if your bank fails, the motivation to remove your money from a bank which might fail is greatly reduced. And given, of course, one of the things which makes a bank fail is that everyone who thinks it might takes their money out, deposit insurance ought to - and does - prevent systemic crises turning into waves of collapsed banks.

By hitting poor depositors, who thought that their money would be safe, the Cypriot government has created the risk, however small, of a bank run in its own nation and others. Because if you are an Italian depositor worried about the state of your own banks, are you going to be quite as certain as you were that you're insured in the event of a collapse?

Even worse, incidentally, is the fact that deposit insurance is actually required by the EU, and €100,000 is the threshold set by the Deposit Guarantees Scheme Directive. That's why no-one told Cyprus to hit its poor, but it did it anyway.

Finally, as well as stupid, the levy on small accounts is likely to be borderline pointless. Bank deposits in most nations vaguely follow the 80:20 rule: 80 per cent of deposits come from 20 per cent of customers. The changes in the proposed levies back that up: a 5pp increase in the levy on deposits over half a million paid for a 3.75pp decrease on deposits under €100,000. The poor are being taxed, not to aid the fiscal situation of Cyprus, but to fit a bizarre definition of fairness - as well as to stay in "the laundry business".

The surprise

There's one thing that the Cypriot parliament got right: this news was a surprise to nearly everyone. ("Nearly", because there had been unhelpful murmurings about depositors taking a hit for a couple of months, which will have led to some draw-downs). If you want to hit savers, you need to do it before they have a chance to react; otherwise, you're going to see deposits being withdrawn and shoved in shoeboxes under the bed.

The announcement coming, as it did, late on a Friday night of a bank holiday weekend was a stroke of good planning. So good, in fact, that some commentators got a bit caught up in the flow of things, and suggested that the move was a good test of whether any country had what it takes to leave the Euro: keep it a secret, announce on a bank holiday, close the ATMs and freeze funds to prevent capital flight.

Of course, Cyprus then blew it. Rather than passing legislation over the weekend and enacting the levy before markets opened late Sunday night, the country is still debating what should happen as Monday morning becomes Monday afternoon. Don't get me wrong, debate is good. But here, speed is probably better. There's already queues outside ATMs; who knows what will happen if the banks open before the tax is levied?

The future

In the short run, things should work out OK. From its savers and the ECB, Cyprus now has the cash to recapitalise its banks; and it managed to do so without defaulting on its sovereign debt, which is nice for the bondholders at least.

Despite the fact that a Rubicon has undeniably been crossed, this isn't, as some commentators are warning, Lehman II. Cyprus is, from its size to its banking sector to its questionable financial specialisation, nearly unique in the eurozone. As Faisal Islam writes, it won't be long until government ministers are lining up to reassure their citizens that they are not Cyprus - and, unless they are Cyprus, they'll probably be right.

Of course, where most ministers dare to tread walks George Osborne, who has already been quoted saying that Britain is Cyprus, and that if we don't "retain the confidence of world markets", we would go the same way. Joe Weisenthal pulls no punches: Osborne's "Ignorant Comments About Cyprus Are Why The UK Economy Is Such A Disaster".

But in the long-term, the blackmail of Cyprus is representative of the deeper hurdles that the eurozone has to face up to at some point. The crisis, insofar as it is a crisis of collapsing banks and insolvent sovereigns, may end sooner or later; but the question of who actually runs Europe, and whether democracy can ever be allowed to make the "wrong" choices in the continent, looks further from being answered than ever before.

Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

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Former Irish premier John Bruton on Brexit: "Britain should pay for our border checks"

The former Taoiseach says Brexit has been interpreted as "a profoundly unfriendly act"

At Kapıkule, on the Turkish border with Bulgaria, the queue of lorries awaiting clearance to enter European Union territory can extend as long as 17km. Despite Turkey’s customs union for goods with the bloc, hauliers can spend up to 30 hours clearing a series of demanding administrative hoops. This is the nightmare keeping former Irish premier John Bruton up at night. Only this time, it's the post-Brexit border between Northern Ireland and the Republic, and it's much, much worse.   

Bruton (pictured below), Taoiseach between 1994 and 1997, is an ardent pro-European and was historically so sympathetic to Britain that, while in office, he was pilloried as "John Unionist" by his rivals. But he believes, should she continue her push for a hard Brexit, that Theresa May's promise for a “seamless, frictionless border” is unattainable. 

"A good example of the sort of thing that might arise is what’s happening on the Turkish-Bulgarian border," the former leader of Ireland's centre-right Fine Gael party told me. “The situation would be more severe in Ireland, because the UK proposes to leave the customs union as well."

The outlook for Ireland looks grim – and a world away from the dynamism of the Celtic Tiger days Bruton’s coalition government helped usher in. “There will be all sorts of problems," he said. "Separate permits for truck drivers operating across two jurisdictions, people having to pay for the right to use foreign roads, and a whole range of other issues.” 

Last week, an anti-Brexit protest on the border in Killeen, County Louth, saw mock customs checks bring traffic to a near standstill. But, so far, the discussion around what the future looks like for the 260 border crossings has focused predominantly on its potential effects on Ulster’s fragile peace. Last week Bruton’s successor as Taoiseach, Bertie Ahern, warned “any sort of physical border” would be “bad for the peace process”. 

Bruton does not disagree, and is concerned by what the UK’s withdrawal from the European Convention on Human Rights might mean for the Good Friday Agreement. But he believes the preoccupation with the legacy of violence has distracted British policymakers from the potentially devastating economic impact of Brexit. “I don’t believe that any serious thought was given to the wider impact on the economy of the two islands as a whole," he said. 

The collapse in the pound has already hit Irish exporters, for whom British sales are worth £15bn. Businesses that work across the border could yet face the crippling expense of duplicating their operations after the UK leaves the customs union and single market. This, he says, will “radically disturb” Ireland’s agriculture and food-processing industries – 55 per cent of whose products are sold to the UK. A transitional deal will "anaesthetise" people to the real impact, he says, but when it comes, it will be a more seismic change than many in London are expecting. He even believes it would be “logical” for the UK to cover the Irish government’s costs as it builds new infrastructure and employs new customs officials to deal with the new reality.

Despite his past support for Britain, the government's push for a hard Brexit has clearly tested Bruton's patience. “We’re attempting to unravel more than 40 years of joint work, joint rule-making, to create the largest multinational market in the world," he said. It is not just Bruton who is frustrated. The British decision to "tear that up", he said, "is regarded, particularly by people in Ireland, as a profoundly unfriendly act towards neighbours".

Nor does he think Leave campaigners, among them the former Northern Ireland secretary Theresa Villiers, gave due attention to the issue during the campaign. “The assurances that were given were of the nature of: ‘Well, it’ll be alright on the night!’," he said. "As if the Brexit advocates were in a position to give any assurances on that point.” 

Indeed, some of the more blimpish elements of the British right believe Ireland, wedded to its low corporate tax rates and east-west trade, would sooner follow its neighbour out of the EU than endure the disruption. Recent polling shows they are likely mistaken: some 80 per cent of Irish voters say they would vote to remain in an EU referendum.

Irexit remains a fringe cause and Bruton believes, post-Brexit, Dublin will have no choice but to align itself more closely with the EU27. “The UK is walking away,” he said. “This shift has been imposed upon us by our neighbour. Ireland will have to do the best it can: any EU without Britain is a more difficult EU for Ireland.” 

May, he says, has exacerbated those difficulties. Her appointment of her ally James Brokenshire as secretary of state for Northern Ireland was interpreted as a sign she understood the role’s strategic importance. But Bruton doubts Ireland has figured much in her biggest decisions on Brexit: “I don’t think serious thought was given to this before her conference speech, which insisted on immigration controls and on no jurisdiction for the European Court of Justice. Those two decisions essentially removed the possibility for Ireland and Britain to work together as part of the EEA or customs union – and were not even necessitated by the referendum decision.”

There are several avenues for Britain if it wants to avert the “voluntary injury” it looks set to inflict to Ireland’s economy and its own. One, which Bruton concedes is unlikely, is staying in the single market. He dismisses as “fanciful” the suggestions that Northern Ireland alone could negotiate European Economic Area membership, while a poll on Irish reunification is "only marginally" more likely. 

The other is a variation on the Remoaners’ favourite - a second referendum should Britain look set to crash out on World Trade Organisation terms without a satisfactory deal. “I don’t think a second referendum is going to be accepted by anybody at this stage. It is going to take a number of years,” he said. “I would like to see the negotiation proceed and for the European Union to keep the option of UK membership on 2015 terms on the table. It would be the best available alternative to an agreed outcome.” 

As things stand, however, Bruton is unambiguous. Brexit means the Northern Irish border will change for the worse. “That’s just inherent in the decision the UK electorate was invited to take, and took – or rather, the UK government took in interpreting the referendum.”