There are many lessons and implications from the Cypriot crisis (we list 25 here). Among the most important is that conditionality is back, energetically, which is very important when considering the circumstances under which other, bigger, countries might access ESM or OMT. We believe, like BNP's James Mortimer-Lee, that the market has been too complacent, seeing OMT and “whatever it takes” as unconditional – that’s wrong. A second lesson is that a harsher line is being taken by the core. This partly reflects more effective firewalls, so that core countries are more willing to “burn” the private sector, where doing so does not represent a serious systemic risk. Cyprus may not be a template, but we have seen enough to glimpse what the new pan eurozone bank resolution system could look like. Risk for certain classes of stakeholders in banks has risen. We are a long way from seeing the eurozone crisis resolved.
Via Paul Mortimer-Lee, BNP Paribas,
There are many lessons to be learned from the Cyprus bailout, and plenty of implications for how things may develop in the future. We list 25 here, but there are more.
Lesson 1: Do not underestimate the ability of the eurozone to do the right thing – after all the alternatives are exhausted;
Lesson 2: Eleventh hour deals can often lead to mistakes and have unintended consequences. The decision to haircut depositors under EUR 100k was a pothole the Troika fell into. It questioned the integrity of the EUR 100k deposit guarantee;
Lesson 3: The disappearance of Mario Monti from the scene has reduced the influence the South has on decisions about the future of the euro;
Lesson 4: There appears to be bailout fatigue in Germany, the Netherlands and Finland. Mrs Merkel is prepared to be tougher ahead of the election than many thought;
Lesson 5: The new Chair of the Eurogroup, Mr Dijsselbloem, seems to be a hardliner compared with his predecessor, Mr Junker from Luxembourg;
Lesson 6: Mr Dijsselbloem can sometimes be too outspoken and not sufficiently diplomatic. Beware future gaffes;
Lesson 7: The ECB is prepared to use the ultimate weapon – “no more money for your banks”. This is not exactly ejecting a country from the eurozone, but would amount to making it very difficult for it to stay in;
Lesson 8: Such a threat has profound political implications and is above even Draghi’s pay grade, so must have the backing of Mrs Merkel and others;
Lesson 9: When a problem is not seen to be systemic, there will be reluctance in Germany and like-minded countries to use taxpayers’ money to solve it. Cost/benefit balancing will ensure each case really is “unique”;
Lesson 10: This puts private interests at greater risk in absorbing the financial pain, or at least the first tranche of it, especially in small non-systemic countries;
Lesson 11: “They” (the Troika) will seek to use private money where they can to limit the size of public sector involvement. While each case is unique, the principles are the same. In Greece, government bondholders took the pain; in Cyprus large depositors. Each case is “unique” but there may well be further “unique cases”, each different in its own special way;
Lesson 12: When it comes to resolving banks’ difficulties there is a hierarchy of who will take the pain: shareholders first, then junior bondholders, then senior bondholders, then large depositors, then the state, then foreign taxpayers;
Lesson 13: How much pain the private sector will take depends on whether or not a problem is seen as “systemic” or not. The less systemic it is, the more private interests will suffer;
Lesson 14: Some countries see firewalls as adequate. So they are now prepared to “burn” stakeholders who were previously protected;
Lesson 15: The probability of direct bank recapitalisation by the European Stability Mechanism (ESM) has gone down;
Lesson 16: Moral hazard has been reduced;
Lesson 17: We crossed a Rubicon of sorts when capital controls were introduced in Cyprus. A Cypriot bank euro is not freely exchangeable with German bank euro. The euro area became more fragmented;
Lesson 18: It may be more difficult to remove capital controls than expected;
Lesson 19: A precedent for the use of capital controls has been set that can speed up capital flight in a crisis, raising the probability of their subsequent re-use;
Lesson 20: It would be surprising if larger depositors were not making defensive moves out of weak banks and banking systems. Watch the scale of ECB MROs and ELA operations;
Lesson 21: The Cypriot economy will see a major recession;
Lesson 22: The Cypriot programme will, consequently, prove to be too optimistic, there will have to be another;
Lesson 23: While Draghi has bought time, the fundamental problems in the eurozone are a long way from being solved, and can come back to haunt markets;
Lesson 24: Do not expect Russia to take the loss with a feeble protest – there will be consequences;
Lesson 25: Conditionality is very important to the core countries. There is no such thing as a conditions-free bailout. There are no blank cheques and no free access to Outright Monetary Transactions (OMT) or ESM. There is no such thing as a free lunch (unless not having a free lunch threatens the system).