Guest Post: The Cyprus Deal And The Unraveling Of Fractional-Reserve Banking

Tyler Durden's picture

Authored by Joseph Salerno, originally posted at The Circle Bastiat blog,

The “Cyprus deal” as it has been widely referred to in the media may mark the next to last act in the the slow motion collapse of fractional-reserve banking that began with the implosion of the savings-and-loan industry in the U.S. in the late 1980s. This trend continued with the currency crises in Russia, Mexico, East Asia and Argentina in the 1990s in which fractional-reserve banking played a decisive role. The unraveling of fractional-reserve banking became visible even to the average depositor during the financial meltdown of 2008 that ignited bank runs on some of the largest and most venerable financial institutions in the world. The final collapse was only averted by the multi-trillion dollar bailout of U.S. and foreign banks by the Federal Reserve.

Even more than the unprecedented financial crisis of 2008, however, recent events in Cyprus may have struck the mortal blow to fractional-reserve banking. For fractional reserve banking can only exist for as long as the depositors have complete confidence that regardless of the financial woes that befall the bank entrusted with their “deposits,” they will always be able to withdraw them on demand at par in currency, the ultimate cash of any banking system. Ever since World War Two governmental deposit insurance, backed up by the money-creating powers of the central bank, was seen as the unshakable guarantee that warranted such confidence. In effect, fractional-reserve banking was perceived as 100-percent banking by depositors, who acted as if their money was always “in the bank” thanks to the ability of central banks to conjure up money out of thin air (or in cyberspace). Perversely the various crises involving fractional-reserve banking that struck time and again since the late 1980s only reinforced this belief among depositors, because troubled banks and thrift institutions were always bailed out with alacrity–especially the largest and least stable.

Thus arose the “too-big-to-fail doctrine.” Under this doctrine, uninsured bank depositors and bondholders were generally made whole when large banks failed, because it was widely understood that the confidence in the entire banking system was a frail and evanescent thing that would break and completely dissipate as a result of the failure of even a single large institution.

Getting back to the Cyprus deal, admittedly it is hardly ideal from a free-market point of view. The solution in accord with free markets would not involve restricting deposit withdrawals, imposing fascistic capital controls on domestic residents and foreign investors, and dragooning taxpayers in the rest of the Eurozone into contributing to the bailout to the tune of 10 billion euros. Nonetheless, the deal does convey a salutary message to bank depositors and creditors the world over. It does so by forcing previously untouchable senior bondholders and uninsured depositors in the Cypriot banks to bear part of the cost of the bailout. The bondholders of the two largest banks will be wiped out and it is reported that large depositors (i.e. those holding uninsured accounts exceeding 100,000 euros) at the Laiki Bank may also be completely wiped out, losing up to 4.2 billion euros, while large depositors at the Bank of Cyprus will lose between 30 and 60 percent of their deposits. Small depositors in both banks, who hold insured accounts of up to 100,000 euros, would retain the full value of their deposits.

The happy result will be that depositors, both insured and uninsured, in Europe and throughout the world will become much more cautious or even suspicious in dealing with fractional-reserve banks. They will be poised to grab their money and run at the slightest sign or rumor of instability. This will induce banks to radically alter the sources of the funds they raise to finance loans and investments, moving away from deposit and toward equity and bond financing. As was reported yesterday, this is already expected by many analysts:

One potential spillover from yesterday’s agreement is the knock-on effects for bank funding, analysts said. Banks typically fund themselves with some combination of deposits, equity, senior and subordinate notes and covered bonds, which are backed by a pool of high-quality assets that stay on the lender’s balance sheet.


The consequences of the Cyprus bailout could be that banks will be more likely to use contingent convertible bonds — known as CoCos — to raise money as their ability to encumber assets by issuing covered bonds reaches regulatory limits, said Chris Bowie at Ignis Asset Management Ltd. in London.


“We’d expect to see some deposit flight and a shift in funding towards a combination of covered bonds, real equity and quasi-equity,” said Bowie, who is head of credit portfolio management at Ignis, which oversees about $110 billion.

If this indeed occurs it will be a significant move toward a free-market financial system in which the radical mismatching of the maturities of assets and liabilities in the case of demand deposits is eliminated once and for all. A few more banking crises in the Eurozone– especially one in which insured depositors are made to participate in the so-called “bail-in”–will likely cause the faith in government deposit insurance to completely evaporate and with it confidence in fractional-reserve banking system.

There may then naturally arise on the market a system in which equity, bonds, and genuine time deposits that cannot be redeemed before maturity become the exclusive sources of finance for bank loans and investments. Demand deposits, whether checkable or not, would be segregated in actual deposit banks which maintain 100 percent reserves and provide a range of payments systems from ATMs to debit cards. While this conjecture may we overly optimistic, we are certainly a good deal closer to such an outcome today than we were before the “Cyprus deal” was struck.

Of course we would be closer still if there were no bailout and the full brunt of the bank failures were borne solely by the creditors and depositors of the failed banks rather than partly by taxpayers. The latter solution would have completely and definitively exposed the true nature of fractional-reserve banking for all to see.

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hedgeless_horseman's picture



the world will become much more cautious or even suspicious in dealing with fractional-reserve banks.

Nope.  99% of people cannot fathom what the ECB's 1% reserve ratio means.

MrX's picture

history will repeat itself in grand fashion:

hedgeless_horseman's picture



I would love to videotape myself standing outside of a bank in any European country and asking the depositors to explain to me what the ECB's 1% Reserve Ratio means to them as a depositor.  

Project Mayhem homework assignment!

You may be shot as a terrorist before you can speak to ten.

Careless Whisper's picture

The Careless Whisper Evening Stock Chart Review & Threadjacking

Anyone notice that CVX XOM and COP all took a nose-dive during the last 15 minutes of trading, on heavy Volume? While BP didn't budge at all. Is Goldman planning a pre-market downgrade mañana on the international oil sector? Is Middle-East peace about to breakout? Anyone???


hedgeless_horseman's picture



I asked a BP Wind Energy guy how much energy it takes to build, install, and maintain a wind turbine.  

He said energy?  

I said yes, energy?

He said they have no idea.  All they care about is that they were able to finance the costs of the turbines over 20 years.

I asked do the wind turbines even have a 20 year life?  

He said they don't know, and they don't care, because the bank financed them for 20 years.


JPM Hater001's picture

Love your wholesaler...they are taught never to question the coolaid.

Poor fools

auric1234's picture

I was a salesman in a former life. I once asked what to respond if a client asked a specific question. They told me that when this happens I should avoid that sort of client altogether because it's not worth my time.

Salesmen are taught to sell, not to understand what they're selling.


damage's picture

I somehow doubt Cyprus' problem is a banking system which actually allows for loans to be made.

Where does the bank's money for making loans come from if they can't loan out deposits? How would there be any credit? If banks were supposed to be warehouses then why not just get a safety deposit box and fill it with cash? How do you expect to be paid interest on your savings account if they don't loan money out?

How come Canada's banking system pre-1935 was overall quite stable when they had fractional reserve? In 1930 while over one third of US banks failed, zero banks failed in Canada. We both had fractional reserve. The only difference was there was no central bank in Canada.

Banks can't get away with loaning more than their excess reserves without a central bank supporting them.  Because otherwise they'd go out of business within days because of the clearing debt.

flacon's picture

Corporations should "borrow money" from the market, not from a bank. Corp should issue stock and ask people to bid for the stock and raise capital that way. There should be a bidding process for individuals to "borrow money" on the free market as well. Want a loan for a house, then find investors who will loan you the money.


There should be no bailouts. A bank should CHARGE a monthly fee to warehouse the paper money that they keep safe. Around here in Canada there are banks with huge safes with the doors wide open and nothing in the safe. Amazing! And they call these buildings "BANKS"?! 


Also, money should not beget money. Interest usury was banned in ancient times because it was known to defraud the system. 

damage's picture

So just some random investors are going to loan you money so you can buy a house? Sure, buddy.


Of course there should be no bailouts, never said there should be.


So loaning money for a price is evil? Are you sure you're not a socialist?

BobPaulson's picture

Dude, interest comes from opportunity cost, not Satan. You need zero growth to eliminate interest, that's called sustainability. That's also why the environmental movement is at odds with our entire system until we figure out how to grow the economy without growing our footprint. I haven't heard a good answer to this yet.

Theosebes Goodfellow's picture

Ah damage, you've hit the nail on the proverbial head! The crime is not fractional reserve banking. The crime, (kudos to Keith Weiner), is duration-mismatch.

zhandax's picture

No, Austin, the crime is stealing the fuckin money, no matter how you do it or how long it takes.

css1971's picture


Fractional Reserve IS duration mismatch.

orez65's picture

I asked a retired CEO of an electric power company why they use wind power.

His answer: "... because if we don't use wind power we loose our operating license ..."

Wind power is a scam.



noless's picture

Even horse assisted grain wheels? What about entropy reduction intake/exhaust fan generators on automobiles?

Why waste the pressure? Chrisake, build an electronic pressure release/generator combo, all comes out the ass end anyway, at the very least power the local sensor bank.

css1971's picture

Entropy always increases. It never reduces.

BobPaulson's picture

It can decrease locally in a subsystem contained in a system with net increase.

CheapBastard's picture



< I asked a retired CEO of an electric power company why they use wind power.

His answer: "... because if we don't use wind power I don't have a job ..." >

BobPaulson's picture

That graph showing solar thermal so low really surprised me.

css1971's picture

BP don't make em, they wouldn't know shit.

Siemens do. I also see a lot of Vestas around here as well.

bigyimmy007's picture

Thanks for the link.

I had no idea Europe was leveraged that much. Jfc...100 to 1 ratio, that's just mind-bogglingly batshit insane, as if 10 to 1 wasn't bad enough.

BobPaulson's picture

You should come to Canada. Thre ratio is 0%. You can't make this shit up man.

Chupacabra-322's picture

@ MrX,

History will teach us it was all based on The Global Criminal Cabal (Bankster?Intelligence) Crime Syndicate Fraud. 

A Model based on Debt Enslavement.  Fasicsm.  Complete Full Spectrum World Dominance.  Via a Global "Chicago School of Economics" Para Police State Authoritarian Totalitarian Neo Feudalistic Tryanny. 

Were just the Debt Slaves, Divided & Conquered. 


bigyimmy007's picture

It's so much easier to enslave minds than bodies.

The Heart's picture

Hello Mr X, thank you for the video. Sorta makes one tear up seeing this kind of human behavior and knowing that this kind of mayhem could have been avoided if the cops that hurt Rodney had been better trained, more patient, and had allowed him to just go to jail without the incident that sparked these riots.

As far as it repeating again, better read up on this wicked weaponry that is just the tip of the iceberg when it comes to this kind of evil harmful weapons. The confrontations in the future will be horrendous. Check this out.:

What is sad to realize is, the American people have paid for their own destruction at the hands of the new world gestapo that is going to replace the military some day.

But even worse than all this that is coming, is the continued torture and killing off of these innocent goat herders in Guantanamo that were captured to use as objects of blame for the horrors of 9/11. Heck, everybody knows that isreal and certain corrupted elements in the American leadership sponsored and executed 9/11. That is no big secret. Only the details are. These poor innocent people from Afghanistan could never ever have the possibility of orchestrating such a massive event like 9/11 was. Anyone who believes these tortured innocents in gitmo had anything to do with 9/11 is just plain ol stupid, and lives in a degree of denial and ignorance unparalleled on this planet. It is just to farking unreal to believe this horror actually goes on day after day still, while so many know the prisoners there had absolutely nothing to do with 9/11. The bankster puppet bushite neocons had to have a group to blame the 9/11 attacks on, and to direct the public's attention away from the real inconsistencies and criminals that caused the 9/11 murderous attacks on America to start off the profits for war campaign. How long will the WORLD stand by and watch this evil go on? The only real reason they do not let them out is because of the horrid tales they would tell about how the Americans, and prolly others, have tortured them and done things that are so against the Geneva convention, it would make a mockery of the realness of this document, or it's actual effectiveness in modern times.

Dear good folks, please DO something, or anything at all for these innocent people who are now slowly dying, rather than to live on in this continued indefinite detention and daily suffering. Think about it; how many of you reading this could stand the mental and physical torture at gitmo, while KNOWING you are completely innocent? Could you endure the tortuous conditions at gitmo for almost ten years with no one coming to help you or free you?? Everyone on board is now being petitioned to do something to SAVE these people's lives. Follow your Heart.





TeMpTeK's picture

Anyone who leaves 1 million cash in an account that is only insured for 100K is a buffoon. Not to mention the warning signs over the last 4 years of EU financial Mayhem in every newspaper... The fool and his money is now parted....

prains's picture

it's almost impossible to start false wars without fractional reserve banking so the only industry still left in the hands of americans will not be curtailed under any circumstances, as long as war makes money for the 1% then fractional reserve banking is all we have.

Edward Fiatski's picture

Uh... does it mean, that banks can only lend out 1% of total deposits? Sounds reasonble.




Radical Marijuana's picture

Yes, hedgless_horseman, I completely agree with your estimate of about 99% of the people not being able to fathom that the ECB "reduced the reserve ratio, which was 2%, to 1% as of the reserve maintenance period, starting on 18 January 2012."

However, I feel it is important to emphasize that is because the People DO NOT WANT TO UNDERSTAND.

In the Canadian context, I have been working on THAT problem directly for about three decades, through the political contribution tax credit. My activities included a couple of court cases against the Canadian government regarding the laws controlling the funding of politics, which spanned about fifteen of those thirty years. Here are links to my continuing current work on those topics, in the Canadian context:

Since I actually have discussed these issues face to face with tens of thousands of people, from all walks of life, for a few decades, and I made a serious effort, during my court cases, to track down every authority on these topics that I could find in the library, I believe that I am relatively qualified to concur with your statement, hedgless_horseman.

In fact, more than 99% of the general population in most of the world always act like Zombie Sheeple, who do not want to understand the monetary and taxation systems that control their lives! Perhaps some small percentage could literally be unable to understand anything, however, most of the people could understand, IF they wanted to. The crucial point is that they DO NOT WANT TO UNDERSTAND! That is superficially a completely irrational attitude, but still, those ARE the real social facts!

Inside the context of THOSE SOCIAL FACTS, and SOCIAL HABITS, "The Unraveling Of Fractional-Reserve Banking" may reasonably be expected to become an opportunity to replace it with something worse. ... While I agree with the article above regarding what it says, I do NOT agree that the outcomes will necessarily be in any ways better.

It would take a prodigious series of political miracles for the vast majority of the Zombie Sheeple to do anything else than allow the next system of organized lies, backed by coercion, run by the next set of ruling classes, to develop to become even worse than the fractional reserve banking system was. After the current pyramid scheme collapses, the most probable projections are for another one, even worse, to be implemented in its place, because 99% of the people will continue to not want to know anything about that, and not want to do anything about that.

It is almost impossible to understate how bad things already are, and even more impossible to understate how much worse they are probably going to get. Indeed, I would emphasize that by asserting that money is always backed by murder, and that the runaway insanities of the monetary and taxation systems surround deeper runaway insanities regarding the murder systems and death controls, which again, the overwhelming majority of people do not want to understand, and do not want to do anything about, except continue to participate within those systems as Zombie Sheeple, who act like political idiots.

After working directly on these problems for several decades, I am currently convinced that 99% of the people will continue acting like brain dead political idiots, because they have been conditioned to want to be like that. The tiny fraction of 1% that made and maintained that system of social habits have every possible advantage to keep things like that.

Of course, I probably will continue to waste my time to attempt to change that social situation. However, in reality, I have been defeated, or rather reduced to an apparently permanent stalemate situation. That is basically why I spin my wheels in the mud by bothering to post some of my kind of bla, bla, blah on the Zero Hedge Web site. At least here, with this select audience, there is some tiny fraction of the 1% of the people who actually want to understand how the monetary and taxation systems really work.

It continues to be quite sublimely paradoxical that almost everybody worries about their money, and how to make it, and how to spend it, BUT almost nobody wants to understand the SOURCE of that money, nor the MEANING OF THAT SOURCE! Therefore, we are living inside of a fractional reserve banking system that 99% of the people do not understand, and do not want to understand, and do not want to do anything to change it. Therefore, we are a long way from having enough of the people care enough to learn about that, and want to do something about that. We are nowhere close to the kind of social tipping point where, say, 10% knew and cared, instead of less than 1%.

Personally, I like to day dream about some future when 5% of the people really cared, and another 20% supported them, in order to have the political will to change the fractional reserve system. However, these days, that seems to be quite a ridiculous day dream to entertain. Instead, we are on a runaway path towards the current systems collapsing into chaos, followed by more genocidal wars, along with democidal martial law. Meanwhile, on that path, it looks like 99% of the population will continue to want to understand nothing about that, and do nothing to effectively change that!

By far the most probable REAL future is that the vast majority of the people will continue acting like Zombie Sheeple, and after they have been fleeced to exhaustion, they, and their lambs, will be massively slaughtered off. However, that probably will not make any difference, because they will continue to want to ignore that, and do nothing about that. ... I have not enjoyed learning about that, and have attempted to change that, ... but that is that!

walküre's picture

Very cool.

At least here, with this select audience, there is some tiny fraction of the 1% of the people who actually want to understand how the monetary and taxation systems really work.

If there was a Dancing With The Stars Zerohedge Edition we might get our message across. Maybe the sheeple would need to see us perform a dance in order to captivate their attention span of a fly.

In reality though, the hammer will come down everywhere including in Canada. Few are prepared. Being prepared means to tune out all the noise and propraganda and live almost a stealth life. Always looking from the outside in and being watchful, careful and informed about every step the elite takes.

John_Coltrane's picture

I'm guessing that a signficant fraction of ZH readers have read Griffiths tome, "the creature from Jeckyl Island" and thus understand very well the nature and history of money, banking, fractional reserve banking and most importantly what sound money is.   Our money system is backed by debt and only debt and that is its fundamental flaw.  Though the average citizen would stare is blank silence if you pointed out the stunning truth that if we pay down all our debt we destroy all our money.  Its a truly insane system!  Sound money is backed by real finite commodities like gold, oil, food stores etc. which require work to create and thus follow the laws of thermodynamics and physics.  Such money is sound/finite for this reason.  We've never really had such a system.  Though one can use a lot of words, to describe our system, Griffiths summarized it best as the "the name of the game is bailout and its instument of enslavement is debt".  The government is the debt addict and the FED and treasury its debt pusher.  This pusher/addict relation is why the government always grows larger.  There is no competition in such a system organized as a cartel like the FED.  There is no possibility of creative destruction and rebirth-and thus such a system is doomed to fail.  We ZHers are just frustrated that it seems to take so long to do so.

fallst's picture

No, its "backed-up" with Federal Income Tax, also created in 1913.


Radical Marijuana's picture

Yes, fallst, taxation, and legal tender laws, back up fiat money.  However, WHAT backs up the government's powers to rob, which we call "taxation?"  The answer is that murder backs up money. If you resist being robbed by the government, then their enforcers may kill you with impunity. The government uses it revenue to pay for enforcement, to gain more revenue, and so, basically, the government is another entropic pump.

In that context, governments, as organized systems of lies, operating organized robberies, are self-organizing and self-justifying. They are simply the best organized local territorial gangsters, and they tend to be directed by the best organized biggest gangsters, the banksters.

Generally speaking most people do not want to face the basic facts regarding thermodynamics, and information theory, including the people who developed those theories, in ways which turned their meaning backwards. That was like the way that "money" was inverted. Money used to mean gold and silver. Dollars used to mean an amount of silver. However, all of that was systematically inverted. (Which reflects, on a deeper philosophical level, how we have inverted the meaning of the concept of entropy.)

However, there is another deeper problem, too, with the idea that money could be backed by commodities, and therefore, somehow become more honest money, or sound money. That problem is that the possession of private property can not exist, and has no meaning, outside of some system of public violence. Therefore, owning gold or silver returns to the basic reality that money is backed by murder.

In my view, the only "solutions" are to continue to muddle through the madness that human realities are always organized systems of lies, operating organized robberies, while attempting to organize resistance in ways which will enable there to be a better set of checks and balances, so that the human ecology and political economy may work better, for longer. ... BUT ... at the present time, the established systems are runaways, and most of the previous checks and balances are being systematically destroyed.

Furthermore, I would again emphasize that thinking that invoking the conservation of matter, in the form of commodities like gold and silver, which cannot be made out of nothing, is now too superficial a solution to the runaway entropic pump, energy system problems that our globalized civilization is experiencing. We have a HUGE PROBLEM that what exists NOW is a global electronic fiat money fraud, backed by atomic bombs. The REAL combined money/murder systems have been amplified to astronomical sizes, by technology, and thereby have become utterly insane.

The ONLY real solutions are new murder systems, to back up new money systems, since the debt controls depend on the death controls. HOW to do that after weapons of mass destruction have been developed has no know answer, at the present time. The first generation that has grown up with that emerging problem is still alive today. We are cruising on the inertia of past social habits, to continue to operate the force backed frauds which were made and maintained during history. BUT, BUT, BUT, amplifying those with powers trillions of times bigger (which as suddenly happened within current life times) is a problem which me have managed to mostly ignore ... although it keeps on getting BIGGER!

Thus, the deeper problem with the monetary system is HOW to back it up with a murder system, AFTER the development of weapons of mass destruction. ??? ???

BobPaulson's picture

You don't even need a commodity based system to cut out the banks' role in creating it by loans. If the government was owned by the people and not the banking families, they would just print the money and give it to themselves. This would still dilute the currency, but avoid all our debt insanity designed to reinforce that the state is beholden to rich cartels. We are suckers in a debt prison worshiping the jailer.

hansg's picture

99% of people cannot make any kind of meaningful change to the ECB's 1% reserve ratio either.

NemoDeNovo's picture

Oh how I'd Love this to be true, but I ain't betting the Farm...Yet

bank guy in Brussels's picture

Well, it looks like Slovenia is going down for sure now ... Because the government there just said everything was fine and not to worry:

« The new prime minister Alenka Bratusek told the Slovene parliament on Wednesday that the fears are overblown. “Our banking system is stable and safe. Comparisons with Cyprus aren’t valid. Deposits are safe and the government is guaranteeing them.” »

Kirk2NCC1701's picture

Riddle me this: How do you differentiate between genuine banking problems and an artificially created one? If the CB media start the " a Leper too" rumor, they can systematically target any peripheral bank/country.

All the while the most suspect countries with shitty Debt/GDP are getting media 'cover' (protection). That's right Belgium and UK, I'm talking about you!

John_Coltrane's picture

I would look at two factors just as I would and did in selecting a bank for my savings.

1)The ratio of loans to deposits (you want this to be low), certainly below 1.

2)The fraction of non-performing loans (NPLs)

For example, the BIS as of 2011 revealed that in cyprus over 29% of all loans were NPLs.  By comparision in Luxembourg, another overbanked country the NPLs are only 0.3% of assets!  See why you want your capital in Luxembourg!  Those bankers follow the important rule, don't loan money to people who can't pay it back.

(My credit union has only 0.1% NPLs which just might be related to the fact they carry all mortgages on their books, insist on 20% down and a documented good income.)  If other banks had such standards the 2008 bust would never have occurred, nor the housing boom that led up to it.  No skin in the game means people don't give a shit.



css1971's picture

Under fractional reserve, there is no difference.

If confidence is lost in the institutions, they are by definition, toast. When you are levered 50:1, the tiniest loss is massively magnified.

Racer's picture

Bring on the Emperor has no clothes day! I want a good giggle at his microscopic member.

Black Markets's picture

OK if it's so easy to start a bank run post-Cyprus... I will buy an ice cream for the first person on this thread to precipitate the collapse of a multinational financial institute via a bank run.


Cdad's picture

Well...if they have not run already, it may well be too late for Eurpeans.  Don't be surprised if, over a three day weekend for example, capital controls are simply announced.  Inter bank lending within Europe was already showing signs of stress...about one month ago.

Again, the beginning of the story is not lines at cash machines...that's the end of the story.  As we just saw in Cyprus via the "Russian Oligarch loophole", the real bank run is electronic.  So good luck waiting to act if your catalyst is lines at a bank somewhere, buddy.

Karlus's picture

One ice creme please

dick cheneys ghost's picture

Thats right Cdad and Im guessing that the ECB saw that 'electronic bank run' happening in real time, just like Hank Paulson did before he asked congress for $700 Billion large