Cyprus bank customers asked to help bail out banks

A sign which reads 'Hands off Cyprus' is plastered on an electricity pole outside the pariament building in the Cypriot capital Nicosia on March 18, 2013.

The eurozone crisis -- after several months in hibernation -- roared back to life today. The euro fell. Gold rose. Bank shares tanked.

All this, thanks to a bailout plan for the small island nation of Cyprus. A plan designed to calm markets and smoothe investor worries... but it had the opposite effect.

That's because restructuring bank debt in Cyprus means depositors have to share the burden.

This is the first time since the euro crisis began that depositors have been asked to bail out the banks where they save. Not the bondholders or the equity investors. Anyone with cash in a  bank account in Cyprus could now lose up to 10 percent of it, as a one-off tax.

“That sends a scary message to all other Europeans,” says analyst Louise Cooper. “It says that your savings are not necessarily safe in a bank. What this risks is bank runs."

But the Germans, in particular, insisted that depositors take a haircut. They say up to half the cash swilling around the Cypriot banking system comes from wealthy Russians. Why should German taxpayers bail them out? Rupert Ruparel of the Open Europe think tank says there’s been a paradigm shift in Europe’s debt crisis.

“Germany is no longer willing to put unlimited bailout cash on the line," Ruparel says. “They weren’t willing to put money on the line to bail out these Russian depositors.”

And economist Andrew Hilton says the Germans have a point.

“They feel that Cyprus had become a sort of money-laundering machine for dodgy Russian money, and that Cyprus must pay," says Hilton.

But Cyprus can only be pushed so far by its European partners. The country's bank liabilities are more than seven times the size of its economy. It could easily default and crash out of the eurozone, with unpredictable consequences. The Cypriot parliament votes tomorrow on the bailout plan.

About the author

Stephen Beard is the European bureau chief and provides daily coverage of Europe’s business and economic developments for the entire Marketplace portfolio.

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