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Having scared the pants off Cypriot depositors and almost every other bank creditor in southern Europe, the troika are fumbling about looking for a palatable solution that won't set off an avalanche of withdrawals from every bank in Cyprus when the tills are open again for business, if they ever re-open. The latest idea is to exempt smaller deposits, below €20,000 ($26,531), from the haircut, but it doesn't really solve the fundamental problem – the EU has said loud and clear that not every euro zone deposit is equal. Some are more equal than others.

This has wider ramifications, as Paul Krugman, the economist and New York Times columnist said in his blog: "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!' "

Were that to happen, we would no longer be thinking about small islands in the Mediterranean. Yet, it is worth stepping back and considering what a "haircut" for depositors really means. There is an argument that the troika have given a reality check to a banking system that had simply lost sight of the concept of risk. Just as the sovereign bond crisis discredited the nonsensical belief that all euro zone government credit was of equal stature, we are now facing a similar reevaluation of European banks. Forget about deposit insurance, not all banks are secure – if you deposit your money in Hanky-Panky bank, it is not as safe as Royal Bank and, by the way, you should expect a much higher interest rate to compensate for your exposure to Hanky's lending practices.

Small wonder that the Russian government is in a rage about the Cypriot haircut. The fury may have something to do with personal loss, but we should ask why so many Russians flocked to deposit money in Cyprus. The attraction is partly low taxes but the big incentive is that Cyprus appeared to offer an EU sovereign guarantee at nil cost. In other words, Russians saw Cyprus as a back-door route to a deposit with the European Central Bank. In imposing the haircut, the troika is implicitly challenging whether this can ever make any sense.

When the collective balance sheets of banks are many times the size of the national economy, deposit insurance has to be nonsense. What we need is not better insurance, but better risk pricing. When we hand money over to a bank, we take on part of the risk of that institution's lending and investment activity. Therefore, we need to come to terms with the fundamental equity risk that is inherent in any deposit with a financial institution, and price it accordingly. The troika has acknowledged that banks are not equal, that risk is real and that governments cannot be a backstop. Perhaps in Cyprus, we really have drawn a line in the sand.

Carl Mortished is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/03/24 4:15pm EDT.

SymbolName% changeLast
EUFN-Q
Europe Financials Ishares MSCI ETF
-0.18%22.74

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