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Men sit on a street bench near two unused 24-hour automated teller machines operated by Bank of Cyprus Plc in Nicosia, Cyprus. European policy makers weighed how far to push Cyprus after lawmakers in the Mediterranean nation rejected an unprecedented levy on bank deposits, throwing into limbo a rescue package designed to keep it in the euro.

Simon Dawson/Bloomberg

The parliament of Cyprus was right this week to reject a proposal to confiscate money from modest-sized bank deposits. The idea was a reductio ad absurdum of the euro zone's policy on the sovereign debt of some of its member-countries.

It would be better for the government of Cyprus to default outright on some of its obligations rather than to seize part of the savings of the proverbial widows and orphans, as well as retirees or those approaching retirement – while purporting to levy a tax. This is especially true in a country that has deposit insurance for up to €100,000, in order to protect small savers.

Until a few years ago, Cyprus – which is really the ethnically Greek section of Cyprus, the Turkish section being a de facto protectorate of Turkey – had a fiscal surplus, but its close relationship to Greece resulted in a downturn when Greece fell into a severe recession. The government's debt in itself is still manageable, but Cypriot banks have become shaky because of their loans to Greece.

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Meanwhile, the banks of Cyprus had made themselves attractive to very large foreign depositors, most notably from Russia, with favourable interest rates on their deposits and low taxation. These foreign deposits make the financial sector much larger than the rest of the Cypriot economy. All this has invited some suspicions of money-laundering, though there is nothing necessarily corrupt about small countries that have a very large financial sector.

If extraordinary measures need to be taken to rescue Cypriot banks, then there may well be a case for imposing special levies – even in some sense retroactive taxes – on non-resident depositors who have benefited from these banks' policies.

Like every other country, however, Cyprus has its small depositors. They do not understand banking theory; consequently, they do not think of themselves as their bank's lenders or creditors. The very large depositors, like a corporation's bond-holders, are the ones who understand losses and know that there are always risks.

Cyprus is now seeking loans from Russia, but it is hard to see why the Russian government would facilitate offshore havens from its own tax-collectors. The euro zone has to cope with its own mess – without plundering widows and orphans.

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