DEPOSIT INSURANCE (2)

The strength of the reaction against the E.U.'s proposed bailout of Cyprus has taken the authorities by surprise. Protests against the levy on deposits by local Cypriots, and objections from Vladimir Putin (in support of Russian depositors), were to be expected. But the idea was trashed by luminaries such as the Economist; stock markets fell on the news. As a result, the vote on the levy by the Cyprian Parliament, which was supposed to have taken place today, has been postponed. Officials are talking about the possibility of amending the terms.

Banking essentially depends on a bit of a confidence trick. Savers deposit their money on the assumption that it can be withdrawn tomorrow; banks then lend that money out for periods much longer than those promised by savers. The trick comes in persuading those depositors both that they can withdraw their money if they want to (a persuasion that is made easier if the deposits are guaranteed by the Government); and that they don't need to (if they all did at the same time, then the bank would go bust). The levy in the bailout plan attacks both of these elements. First, depositors can't withdraw their money; or, at least, not all of it, since the Government has nicked some of it. Secondly, it puts a large hole in the idea that they don't need to withdraw it; what was guaranteed is, er, not.

In other words, the proposed bailout of Cyprus' banks has blown a big hole in the idea of banking per se. Which is why, despite the fact that Cyprus only represents 0.2% of the E.U. area's GDP, those protests matter. If they do this to Cypriot depositors, what will they do to depositors elsewhere? E.U. leaders are scrambling for a good answer to that question; there isn't one.

Walter Blotscher