News Analysis: Calculating Impact of Cyprus’s Bank Bailout

The magnitude of the losses, disclosed late Friday and confirmed Saturday by Cypriot officials, has provoked concern that depositors in second-tier euro zone banks in Slovenia and Italy might withdraw their savings from those institutions.

It has also raised fears that countries like Malta and Luxembourg, which like Cyprus have banking sectors many times bigger than their economies, might soon find it harder to gain access to international bond markets.

One relevant lesson might lie not elsewhere in the euro zone but in the carcass of a Los Angeles-based savings and loan institution, IndyMac Bancorp, that failed five years ago and required a bailout. IndyMac was about the size of the Bank of Cyprus, and its depositors ended up taking nearly as big a loss — 50 percent on deposits above the levels insured by the Federal Deposit Insurance Corporation. Rather than causing a panic and a bank run elsewhere, IndyMac’s debacle proved to be a largely contained disaster with little fallout.

“Just as you did not see mass panic and deposit runs in the U.S. after IndyMac, what happened in Cyprus is not going to spill over into Europe,” said Jacob Funk Kirkegaard, a specialist in banking and government debt at the Peterson Institute for International Economics in Washington.

IndyMac needed rescuing because, like the Cypriot bank, it placed a large bet just before one of the biggest recent credit disasters. For IndyMac, the calamity was the collapse of the subprime mortgage market in the United States. For the Bank of Cyprus, it was the collapse of Greek government bonds, in which it and other Cypriot banks had invested heavily, seeking an adequate return on the billions of euros of deposits that had inflated their balance sheets.

“How unique is Cyprus? Pretty unique actually,” Mr. Kirkegaard wrote in a research note.

He pointed out that compared with other countries with huge banking systems relative to their economies — notably Malta, at about eight times gross domestic product, and Luxembourg at more than 22 times G.D.P. — Cypriot banks had much lower levels of equity to cushion against failing assets. What is more, it is the subsidiaries of foreign banks, which have little or no exposure to the local economies, that make up the bulk of the Maltese and Luxembourg banking systems.

By comparison, many of the Cypriot banking assets that grew to be seven times the size of the country’s economy consisted of corporate, construction and mortgage loans to the Cypriot and Greek economies, which tied the health of these banks directly to those sagging economies.

As proponents of the Cypriot losses argue, just as it was fair that the large depositors that bankrolled IndyMac’s subprime excesses in 2008 pay the cost for the bank’s failure, so it is right that Cypriot savers — the largest of whom were Russian billionaires chasing high-yielding deposits — suffer a similar fate.

“There were stories of pain, too, at IndyMac, but in the U.S., we paid little attention to it,” Mr. Kirkegaard said. “This will impose a lot of pain on Cypriot society, but the outcome will not be that much different.”

IndyMac, when it was rescued by American regulators in July 2008, had become the ninth-largest originator of mortgage loans in the United States, relying largely on large, uninsured deposits to finance a lending spree in some of the riskiest areas of the housing market.

And while the American government backed savers with deposits of less than $100,000, those with more deposited at IndyMac were required to accept a loss of 50 percent when it declared bankruptcy. (The federal government helped prevent a broader panic by later raising the deposit insurance threshold to the current $250,000.)

As the Cypriot government begins investigating the misadventures of the Bank of Cyprus and the second-largest, Laiki, bankers and lawyers in Nicosia have begun to argue that the disastrous venture by the Bank of Cyprus into Greek bonds could well have been avoided.

Local bankers say the bank had more or less sold out of its Greek bond position by early 2010 as Greece’s problems became evident.

Article source: http://www.nytimes.com/2013/04/01/business/global/calculating-impact-of-cypruss-bank-bailout.html?partner=rss&emc=rss