Cyprus reached a EUR 10bn bailout deal with international creditors early Monday, thus averting a financial collapse and possible eurozone exit, which would have been the case if ECB suspended its support. ECB said it would cut off emergency liquidity assistance to Cyprus’s banking system on Monday if the government failed to reach a bailout agreement. Unlike the original deal from a week ago, the new agreement spares bank accounts below the EU-insured limit of EUR 100,000 and envisages that only large deposits in two largest banks will suffer losses. The deal imposes steep losses on uninsured depositors - possibly up to 40% - at Bank of Cyprus, the country’s largest bank, which will take over the viable assets of Cyprus Popular Bank (Laiki Bank), the second largest. Importantly, the deal does not need the approval of the Cypriot parliament because losses on large depositors will be imposed through bank restructuring, not a tax levy, and the parliament has already passed laws on bank restructuring last week.
The agreement aims to significantly reduce the size of Cypriot banks, likely putting an end to the country's status as offshore tax haven. Taking into account that the Cyprus's financial sector accounts for about half of the economic activity, the country is likely to suffer a sharp deepening of the current recession, with a possible GDP decline of around 8-10% this year.
We view as positive dismissing of the original plan of a bank levy that was supposed to tax the guaranteed deposits under EUR 100,000. However, as underlined by Moody’s rating agency early today, the idea, while abandoned, may already have dangerous consequences, raising the risk of deposit outflows and increased bank funding costs throughout the euro area.
Stocks gained and the euro rose on the news that Cyprus reached bailout agreement, with Euro Stoxx 50 up 1.2% and EUR-USD at around 1.30 as of 9:45 a.m. CET.