Cyprus Reaches Bailout Deal

Late last night, an agreement was made in Cyprus to prevent a financial collapse.  The EU will provide a 10 billion euro financing package in exchange for haircuts on large depositors and losses for bank bondholders.  Capital controls will also be put into place, effectively limiting the amount of money bank customers can move at any one time and preventing what would likely be a mass exodus of deposits.  Overall market activity has been surprisingly muted over the past week, with investors seemingly looking past the Cypriot turmoil, possibly due to the small size of the Cypriot economy or because of confidence in the monetary easing programs in place at the world’s major central banks.  We would argue that a dangerous precedent has been set, whereby bank depositors are by no means safe from losses if a financial institution runs into trouble.  The initial bailout plan went so far as to haircut insured depositors as well, but this has since been removed.  During the next sovereign debt crisis, deposit flight from risky institutions could take place, leaving weak banks even weaker and causing ripple effects throughout global financial markets.  While this kind of event may not take place immediately, data will likely emerge over the next few weeks and months on how southern European banks are weathering what could be an impending storm.