Can't get enough of Cyprus? Then here is yet another post-post-mortem from Goldman's Jernej Omahen, once more trying to put some very silvery lining on this particular mushroom cloud, and providing some useful facts in the process.
Cyprus deposit tax: a depositor “bail-in” – and/or – a wealth tax
A bail-in instrument – or (just) a wealth tax?
As part of its rescue package, Cyprus introduced a one-off tax on deposits. This “tax” can be viewed as both (1) a depositor bail-in, and/or (2) a wealth tax. Cyprus aims to capture €5.8 bn of tax revenue in this way, which compares to the total bailout package of €10 bn. In absolute terms, the amounts are low; regardless, the market focus on potential read-across will be high, in our view.
Two components of contagion potential …
The Cypriot tax is certain to prompt depositors in GIIPS banks to assess two issues: (1) the probability of savings participating in bank cleanups (“bail-in”) and (2) perceiving their savings as a potential base for a “wealth tax”.
In our view, the “bail-in” risk is unlikely to rattle periphery depositors at this point – after all, Cyprus is late in addressing its bank issues. Elsewhere on the periphery, depositor perception of banks has improved; inflows have materialized. Perceiving deposits as a base for potential taxation, however, is new. And scope/duration of its negative impact hard to gauge, in our view.
… an uncomfortable precedent, for the LT
The tax on depositors is setting a precedent, which is likely to have an impact beyond the immediate term, in our view. Resilience of, in particular, retail deposits was an important element of stability during crisis peaks (e.g., Spain). Post the Cyprus precedent, however, it is
reasonable to expect that the deposit volatility in stressed sovereigns could rise, for two reasons: firstly, perceived risk of deposit bail-in will have increased; secondly (independent of failing bank issues), perceiving savings as a potential tax-base – for wealth taxes – is new.
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Summary of weekend events in Cyprus: tax on deposits
- Over the weekend, Cyprus and Troika agreed on a rescue package with the following key points:
- €10 bn total rescue package.
- A tax on deposits, expected to yield €5.8 bn, which has the following characteristics:
- 6.7% tax on deposit amounts < €100,000.
- 9.9% tax on deposit amounts > €100,000.
- Deposit amounts are recorded as of Friday close (March 15) and apply to all deposits in Cypriot Banks in Cyprus (across currencies, type of customer account). They do not apply to customer deposits of Cypriot banks held outside of Cyprus (the two large Cypriot banks both have a presence in the UK, for example).
- Cypriot bank operations in Greece will be taken over by Greek banks, at no cost to the Greek tax payer. This is important as the large Cypriot banks operate a substantial portion of group assets in Greece.
- In exchange for the tax, the impacted depositors will be granted shares in the Cypriot banks.
- Tax changes, where (1) the corporate tax rises to 12.5% from 10% and the income from deposits to be taxed at 20-25%.
- Bail-in of junior debt is expected to take place, however overall impact is limited by a low balance of outstanding securities.
- Commitment to downsize local banking sector towards EU average size (in relation to GDP) by 2018.
- A privatization programme which is expected to contribute €1.4 bn.
- Russia will participate, but to a small extent (exact amount / type unclear).
Cyprus deposit tax: a “bail-in” and/or a wealth tax
As part of its rescue package, Cyprus introduced a one-off tax on deposits over the weekend. This “tax” can be viewed as both (1) a depositor bail-in, and/or (2) a wealth tax. Cyprus aims to capture €5.8 bn of tax revenue in this way, which compares to the total bailout package of €10 bn. In absolute terms, the amounts are low; regardless, the market focus on potential read-across will be high, in our view.
This type of depositor contribution is unprecedented in the European financial crisis to date, with previous bail-outs avoiding impairing any part of the bank’s capital structure, outside of shareholder equity and – in the case of Spain – select preference share holders.
Impact on Cypriot banking system: a transformational event
Cyprus had a stable deposit picture, throughout the crisis. The ECB and Cyprus CB data suggest that deposits grew throughout the crisis period. Total deposits (retail, corporate and other) record a first meaningful outflow only in January 2013. It is likely that the deposit picture has subsequently deteriorated – that data is not yet publicly available.
This – relative – deposit stability will be thoroughly shaken by the introduction of the deposit tax, in our view. It raises €5.8 bn, thus, in itself, reducing the deposit stock by 8.5%. In our view it is unlikely to stop there. The disproportionate impact of this tax on high net worth depositors (most of them foreign) and increased taxes on deposit income clearly reduce the attractiveness of Cyprus, as a bank location, for foreign depositors. They, we estimate, represent some 30% of total deposits in the system. A sharp rebalancing – via outflow of FX deposits – could therefore continue for a while, thoroughly impacting the Cypriot banking system. The deposit outflow gap will need to be filled by the only source of funding available to Cypriot banks – the ECB funds. The ECB has reassured the market that liquidity for Cypriot banks will be made available as necessary.
But Cyprus is small and banks not interconnected. Even if we assume a bank run of immense proportions – say of 50% of all Cypriot deposits – the burden of emergency liquidity assistance would amount to an incremental €34 bn – substantially less than 1% of total current ECB facility usage, for example.
Two channels for depositor sentiment contagion: fear of bail-in, fear of taxation on savings
Cypriot deposit tax is certain to require depositors in GIIPS banks to assess two issues: (1) the probability of savings being used for bank clean-ups (“bail-in”) and (2) perceiving their savings as a potential base for a “wealth tax”.
In our view, the “bail-in” risk is unlikely to rattle periphery depositors at this point – after all, Cyprus is late in addressing its bank issues. Elsewhere on the periphery, especially in Spain and Ireland, depositor risk perception of banks has improved; deposit inflows have materialized. Perceiving deposits as a base for potential taxation, however, is new; the scope/duration of its impact hard to gauge.
We consider the following points:
Cyprus is small, and its banking system unique. Stand alone, the risks are low. Cyprus has, in absolute terms, a small banking system and we expect no direct knock-on impacts to other parts of the Eurozone financial institutions. It is also reasonable to argue that the Cypriot banking system is unique due to (i) high portion of foreign depositors and (ii) high BA/GDP. A read-across into other peripheral banking systems, on those two metrics, is very weak.
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Contagion. Despite Cyprus being small, and arguably unique, a depositor in a peripheral bank is likely to ask the obvious question: how likely is a deposit tax for me? The answer to this question, we believe, will differ, depending on the peripheral country where it is asked. But it should, in essence, boil down to two issues: (1) how likely are savings to be bailed-in in any future bank rescues; (2) how likely are savings to emerge as a tax-base for any future wealth taxes?
- Greece: the read-across is not clear cut, in our view. There is an argument to be made that risk-aware depositors have already moved their deposits away from Greek banks, leaving solely the “sticky” residual in the banks. However, close ties between the two countries, as well as deposit flow to Cyprus during Greek crisis peaks, could form an argument for a restart in deposit outflows, in our view. Perceiving deposits as a potential tax-base could add to the volatility.
- Ireland: we see limited scope for a strong read-across in Ireland. The banking system suffered greatly in 2010, but has since been stress-tested and recapitalized. Deposit flows have also turned positive. It is unlikely, in our view, that an Irish depositor would fear yet another bank bail-out.
- Italy: unlike Ireland and Spain, Italy did not require a bank bail-out. That said, the NPL formation for the system is accelerating, and problems at specific institutions (e.g., the 3rd largest bank) have recently received meaningful media attention. Additionally, Italian depositors had experienced a deposit tax in the early 90’s. The potential for some “sentiment” read-across therefore exists. But as said, we still expect it to be modest.
- Portugal: Similar to Ireland, the depositors should largely perceive the terms of Portugal’s bail-out as very unlikely to be altered at this stage. The banking system has been recapitalized and is undergoing planned downsizing. That said, deposit flows in Portugal have remained under pressure, with an outflow of around 10% over the last 12 months.
- Spain: similar to Ireland, a depositor is also likely to interpret the Cyprus deposit tax as something that could have happened in 2012 – but didn’t, in our view. Post the (external) stress-tested and considerable recapitalization in 2012, deposit flows have turned positive, suggesting confidence has returned.
However, the last leg of Bankia recapitalization, which involves conversion of preference share holders (mostly retail) into common equity holders, will take place over the course of March. From a timing perspective, this substantial transaction is likely to coincide with the Cyprus crisis, potentially invoking unwelcome parallels.
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Cyprus: a steady deposit picture – until end of January 2013
Cyprus had a stable deposit picture, throughout the crisis. The ECB and Cyprus CB data suggest that deposits grew throughout the crisis period. Total deposits (retail, corporate and other) record a first meaningful outflow only in January 2013. It is likely that the deposit picture has subsequently deteriorated – that data is not yet publicly available.
This – relative – deposit stability will be thoroughly shaken by the introduction of the deposit tax. It raises €5.8 bn, thus, in itself, reducing the deposit stock by 8.5%. In our view the process of deposit reduction is unlikely to stop there. The disproportionate impact of this tax on high net worth depositors (a large part of them foreign) and increased taxes on deposit income clearly reduces the attractiveness of Cyprus for foreign depositors. They, we estimate, represent some 30% of total deposits in the system. A sharp rebalancing – via outflow of FX deposits – could therefore continue for a while, thoroughly impacting the Cypriot banking system. The deposit outflow gap will need to be filled by the only source of funding available to Cypriot banks – the ECB funds.
We re-calculate the estimated €5.8 bn captured by the “deposit tax” as follows:
- € deposits. The Cypriot banking system reported €-denominated deposits of €48 bn (as per Jan-13). This amount is reported both by the Cypriot central bank as well as the ECB.
- FX deposits. To this, we add €20.2 bn of FX deposits, which are predominantely US$ deposits (86%), with a much smaller contribution from GBP (6%) deposits. The FX deposits represent some 30% of the deposit total, which is unusually high, in the context of Eurozone banks. In our view, the individual deposit amounts here are likley higher and therefore impacted by the higher (9.9%) tax rate.
- Total deposit stock stood at €68 bn (end January). Dynamically, Cyprus had a healthy deposit evolution throught the crisis. Deposits grew from €52 bn in 2007 to €69.6 bn in 2012 (+33%). In our view, most of the increase is due to Greek deposits seeking a “safe haven” during the peak crisis period in Greece. The first major deposit outflow was recorded in January, when deposits fell by almost €2 bn. That said, we do not have data from end January to date – the clear expectation is that additional deposit outflow materialised during this period.
- 2/3 of deposit tax contributed by the > €100,000 deposit amounts. For the purposes of this calculation, we assume that the last reported deposit figures remained static. The tax is said to have resulted in €5.8 bn of revenue, implying an average tax rate of 8.5%. On the basis of the two tax rates, we estimate that €1.94 bn of deposits is raised from deposit amounts < €100,000 and €3.86 bn from deposit amounts > €100,000. In other words, 67% of the deposit tax revenue is paid from the high net worth depositors.
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