Angela Merkel is having sleepless nights over the bailout of an insolvent Mediterranean state. This time, the German chancellor is not worried about Greece or Spain. The headache is over tiny Cyprus, which has requested €10-billion in aid to keep its rickety banking system afloat. It's a small sum compared to the mountain of German euros underwriting Greece but an investigation by Bundesnachrichtendienst (BND), the German foreign intelligence agency, found that the main beneficiaries of a Cyprus rescue are likely to be Russian oligarchs and money-launderers.
According to Spiegel, the German news magazine, which has seen the BND report, Cypriot banks are home to $26-billion (U.S.) in deposits by Russian investors, money which it claims is flight capital which has been parked by oligarchs in the East Mediterranean tax haven to keep it out of the clutches of the Russian tax authorities.
Cyprus has for decades been a haven of choice for Russians who flock to its capital, known affectionately as "Limmasolgrad" in search of sun, sand and shell companies. A low corporate tax rate of 10 per cent and light regulation is helpful for Russians seeking the safety of offshore ownership and an easy route into the euro zone. So popular is the Cypriot brass plate company that the Russian deposits now dwarf the entire economy of Cyprus, worth some €18 billion.
The Cypriot government protests its innocence, says its abides by EU laws on money laundering and refutes the Spiegel accusation. But there is no doubt that Chancellor Merkel faces a political problem if she turns a blind eye and writes a German cheque. It is one thing to bail out improvident and foolish Greeks. It is quite another thing to ask German taxpayers to underwrite the deposits of the Russian mafia.
So, negotiations between Cyprus, the European Commission, the European Central Bank and the IMF are on hold. A bailout from European Stability Mechanism Funds will probably hinge on Cypriot acceptance, not only of severe budget cuts but a busybody EU task force to ensure its compliance with money-laundering rules and an increase in the country's low corporate tax rates.
The risk is that Cyprus turns its back on Brussels, quits the euro and asks Moscow for help – the Russian government has already provided Cyprus with a €2.5-billion loan. However, for the clients of Cypriot banks, the country's haven status within the euro zone is part of the attraction.
Cyprus protests that Ireland, that other fringe euro zone state with a banking problem, was offered a bailout without being forced to raise its 12 per cent corporate tax rate. However, there is little sign that Russian oligarchs have taken up residence in Dublin. Perhaps it has something to do with the weather.