World markets roiled as radical Cyprus bailout deal stalls

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A small bailout in a small state has roiled the global financial markets and triggered a political backlash as far away as Russia.

The bailout of Cyprus, one of the smallest members of the euro zone, was stalled Monday morning over reports that the minority Cypriot government lacked the support to pass the proposed €10-billion ($13-billion U.S.) bailout package, which is to impose a "haircut" on bank depositors.

None of the euro zone's sovereign and bank bailouts, from Ireland to Greece, has insisted that bank depositors finance part of the bailout bill. The prospect of rich and poor bank customers losing up to 9.9 per cent of their deposits triggered near panic in Cyprus.

Bank customers, some of who called the bank raid "daylight robbery," were lining up to withdraw cash from cash machines, many of which had run out of euros, and the Cyprus state broadcaster CYBC reported that a man drove a bulldozer into a bank branch in Limassol, the island's financial centre, to protest the levy.

In Moscow, Russian president Vladimir Putin called the levy "unfair, unprofessional and dangerous." Cyprus is one of the biggest offshore banking centres for wealthy Russians and Cyprus is the source of most of the foreign investment in Russia. Various reports said that Russians had stuffed between €20-billion and €26-billion in Cypriot banks.

In Europe, the renewed threat of crisis contagion sent the major European stock indices down, along with the euro. Bond yields in struggling euro zone countries rose sharply.

Greek 10-year bond yields rose 62 basis points (100 basis points equals 1 percentage point). Portuguese yields were up 20 basis points, Spain's 10 and Italy's 8. Fears that Italy faces a renewed crisis were especially acute because the country lacks a government after an inconclusive election last month. Italian bond yields are up 28 basis points in one month, to 4.67per cent.

In Cyprus, president Nicos Anastasiades defended the bailout, arguing that bankrupt banks and a deep recession, or worse, were the alternative. He also said that the bank deposit levy "avoids taking other tough measures such as wage and pension cuts that were put on the negotiations table."

The reasons behind the decision to go after depositors to finance the bailout were never made clear. It appears that, minus the deposit levy, the euro zone leaders feared opening themselves to accusations that they were protecting Russian millionaires and billionaires in a banking system known for money laundering.

In a note, Guy Foster, head of portfolio strategy at Londons's Brewin Dolphin, said "the widespread belief that a meaningful pool of the deposits in Cypriot banks comprises proceeds from Russian money laundering made the idea of bailing out the Cypriot banks particularly unappealing."

But the bailout, which does not demand sacrifices from sovereign bondholders, violates the principle that deposits up to €100,000 are to be covered by the European Union deposit scheme. Savers with deposits of less than that amount are to take a 6.75 per cent hit; those with deposits higher than that amount are to lose 9.9 per cent.

The bailout bill would rise to about €16-billion from €10-billion if the levy on depositors were not imposed.

On Monday, as the vote to approve the package was delayed until Tuesday, and possibly later in the week, negotiations were under way to reduce the burden on small depositors. One proposal would see the levy fall to 3 per cent on deposits of less than €100,000 and increase it to 15 per cent on deposits of €500,000 or more. But the Cypriot government appears just as worried about going after the rich as the poor. If the wealthy are forced into a higher levy, Cyprus could lose its status as a successful offshore banking centre.

In Germany, finance minister Wolfgang Schaeuble said that his government did not care if the levy split were changed as long as the overall €5.8-billion target – the amount to come from depositors – were achieved.