Cyprus Ultimatum Threatens Banking System

How soon things change. No sooner had Europe appeared to settle down, promising better conditions for a slowing Australian economy and lower costs of funding on international wholesale markets, when the chaos kicks off again.

Cyprus has dominated international headlines this week, after an unprecedented move to impose a one-off tax on savings worth up to 10%. Banks were closed as people rushed to withdraw money, and are to remain closed until next Tuesday.

Ultimatum

Cypriot politicians voted unanimously against the levy, imposed by the European Commission in conjunction with the International Monetary Fund. The island has already upset the Russians, who were alarmed to discover that 10% might go missing from the billions in Cypriot accounts.

But now, they’re pleading for help from the Russians, after the European Central Bank issued Cyprus an ultimatum.

The island has until Monday to find €5.8 billion or the ECB will cut off the emergency funds that are keeping the island’s banks afloat. This would almost inevitably see Cyprus drop out of the Eurozone.

And concerns will not rest there. Following the onset of the financial crisis, confidence in European banks has been established through the fundamental principle that all retail deposits are protected up to €100,000 in the event that of a bank collapses.

However, by imposing a levy as a preventative measure – the funds go towards a bailout package by the International Monetary Fund – this circumvents these principles and uproots confidence in the safety of deposits in any weakened Eurozone state.

It would hardly be surprising if savers in Greece, Italy and Spain considered the safety of their funds, following a snapshot demand that has put the Cypriot financial system in jeopardy.

And all this serves to do is reprise the uncertainty in global markets, forcing costs up and sentiment down.

We’d almost been allowed to forget about the crucial issue of solvency; now we might never be able to forget it again.

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