A couple important points might be getting lost amid all the hand-wringing about who will pay for the troubles of Cyprus’s banks: There’s a big difference between insured and uninsured depositors, and there’s no good reason why the latter shouldn’t lose more than 10 percent of their savings.

The Cypriot government’s plan to levy a 9.9-percent tax on uninsured deposits has met with a vitriolic response in Russia and the U.K., whose citizens and companies have favored Cyprus as an offshore haven for their money. Russian Prime Minister Dmitri Medvedev deemed the move “confiscatory.” Billionaire Mikhail Prokhorov went so far as to call it an assault on “the foundations of Western civilization, the sanctity of private property.”

Actually, in the recent history of Western civilization, it’s common practice for uninsured depositors to suffer losses when a bank goes bust. In cases where the government must get involved, forcing losses on such creditors — who, after all, should have known they were taking a risk — is necessary to protect insured depositors and minimize the cost of that protection to taxpayers.

In the U.S., for example, the Federal Deposit Insurance Corp. frequently imposes losses when it steps in to take over insolvent banks. From 2007 through 2011, uninsured depositors at 32 banks suffered an average haircut of 67 percent, according to a recent paper by two FDIC economists. European countries, too, have bailed-in uninsured depositors. In 2011, for example, state administrators in Denmark forced depositors to share losses when they took over the insolvent Amagerbanken A/S.

As the editors of Bloomberg View have written, the disastrous part of Cyprus’s plan is the imposition of losses on insured deposits — that is, on balances of less than 100,000 euros. The breach of trust could lead people to question the value of insurance throughout the euro area. It’s also patently unfair. Insured depositors presumably accepted a lower interest rate in return for safety. Other creditors, by contrast, knowingly entrusted their money to banks with junk ratings.

It would be well within reason, and within historical precedent, for Cyprus to raise its full 5.8-billion-euro share of its bailout package by imposing much steeper losses on uninsured depositors and bondholders. Concerns that the move could destroy the island nation’s reputation as an offshore haven are misplaced. The damage is already done: Foreign depositors will start pulling cash as soon as the banks reopen. If the government doesn’t do the right thing now, the money will be gone.


Leave a Reply