Evan Soltas
Mar 18, 2013

The Lesson from Cyprus

In another Bloomberg post, I weigh in on the evolving situation in Cyprus with an argument for E.C.B. deposit insurance and banking union:

The Cypriot confiscation of insured deposits should teach the euro area a lesson: European Union-wide deposit insurance ultimately backed by the European Central Bank can't come too soon.

Cyprus, a small island nation in the Eastern Mediterranean that had become an offshore banking haven, is imposing a one-time levy on bank depositors to defray the cost of a coordinated European bailout. The details aren't settled and are still being negotiated by the Cypriot parliament. The initial plan was that all deposits of less than 100,000 euros ($129,330) would be hit with a 6.75 percent levy. Deposits above that would face a 9.9 percent cut. Depositors were to be given equity in banks and natural-gas bonds as compensation.

The main lesson here is that the responsibility for deposit insurance should lie with the currency issuer.

Deposit guarantees, like the integrity of sovereign debts, ultimately depend on the ability of governments to issue currency. If a central bank’s capacity to provide emergency liquidity and reserves to banks is constrained -- as it is for the national central banks in the ECB system -- then so is the credibility of its deposit insurance. In the case of a severe banking panic, central banks need the power to create money to satisfy the surge in demand for currency.