With or Without Bailout, Cypriots Lose Trust in Banks

March 25, 2013 NICOSIA, Cyprus — With her wedding day three months away, Despina Charalambous is desperate to gain access to her savings, which have been frozen at the Bank of Cyprus for more than a week. She plans to take out all her money once the banks reopen, even though the new bailout plan for her country supposedly guarantees the safety of her deposits.

“I have lost my trust in Bank of Cyprus and banks in general,” Ms. Charalambous, 33, a biologist, said. She was still bitter that just last week the country’s president was ready to skim money even from small savers like her to help secure a 10 billion euro, or $12.9 billion, lifeline to the nation’s outsize banking industry.

Multiply Ms. Charalambous’s concerns by tens of thousands of account holders in Cyprus, and it becomes apparent why many people here and abroad have a sneaking suspicion that European leaders, in scrambling to cobble together yet another solution on Sunday night to the Cyprus crisis, have come up with little more than a Band-Aid for what is likely to remain a gnawing wound.

Stocks were down broadly in Europe on Monday, after the head of the Eurogroup, Jeroen Dijsselbloem, suggested that the idea of skimming savers’ accounts to bail out banks could be considered a “template” for other countries. The borrowing costs of the financially shaky Spain and Italy surged upward as the markets digested the Cyprus news — and the broader implications for the euro currency union.

While depositors with less than 100,000 euros in their accounts will be untouched, people with more money will take losses in a first for euro zone bailouts. More broadly, this is the first time a euro zone country is planning to block depositors from taking their money out of financial institutions in large amounts and moving it elsewhere.

In recent decades, such measures, known as capital controls, have typically been confined to emerging countries, like Argentina, or authoritarian states like Iran. Now Cyprus, a longtime haven for rich people from around the world, is struggling to figure out how to prevent them from going elsewhere.

“For the first time, we have capital controls in the euro zone,” said Nicolas Véron, a senior fellow at Bruegel, a policy research group in Brussels, and a visiting fellow at the Peterson Institute for International Economics in Washington. “The next time there is a crisis somewhere else in the world, people will think of what happened in Cyprus and will try to get their money out much faster. These are the new rules of the game.”

Even many ordinary savers like Ms. Charalambous will have to wait a little longer for their cash. Despite promises since last week that the country’s banks would reopen on Tuesday, the government late on Monday ordered all of them, including the Bank of Cyprus and Laiki Bank — the nation’s largest financial institutions, with most of the accounts on the island — to stay shut through at least Thursday. And automated cash withdrawals will be limited to 100 euros a day.

Under the terms of the bailout, Laiki will be restructured, with its guaranteed deposits transferred to the Bank of Cyprus.

Local bankers conceded that the country was ill-prepared to deal with carrying out capital controls. It had not, for example, determined what types of controls to put in place — whether restricting local transfers, or forcibly extending the maturity of term deposits, or even in extreme cases closing bank accounts.

Bankers and lawyers still working on the bailout deal on Monday said a decision had not been reached on whether Cypriots with deposits under 100,000 euros would be able to walk into their local branches and transfer their deposits to another, safer bank on the island.

“They definitely will not be able to send their money overseas,” said a person involved in the discussions who spoke anonymously because the person was not authorized to speak publicly. “But with regard to transferring them to another local bank, that has not been decided.”

No wonder Ms. Charalambous is edgy. “You just get the sense that they don’t know what they are doing,” she said.

Banking experts say trust, once lost, is not easily regained. In the case of Cyprus, the deep desire by Germany and the International Monetary Fund to make those who took advantage of the system pay a share of Europe’s latest bailout may have long-term consequences not just for Cyprus but across the euro area.

“Burden sharing is fine,” said Adrian Blundell-Wignall, the top financial economist at the Organization for Economic Cooperation and Development and a member of the Financial Stability Board. “But if you make people nervous about their deposits, you are playing with fire.”

While analysts hailed Europe’s decision to wind up Laiki Bank by transferring its poorly performing assets to a so-called bad bank and the better-performing ones to the Bank of Cyprus, it was far from clear how Cypriots would regard their largest bank when it did reopen its doors.

The Bank of Cyprus reflected the ambition of this small island — like Iceland before it — to become a global financial player by attracting deposits from all over the world.

But at its root, wealthy Russians and other foreigners aside, this century-old institution is a local one — handling the short-term deposits, credit cards and working capital needs of Cyprus’s 850,000 citizens with branches on practically every street corner in Nicosia and even in the most remote fishing village. If the concerns voiced by Ms. Charalambous and many other Cypriots over the last 10 days are an indication, the bond of trust between the bank and its clients may already be irreparably damaged.

The uncertainty has also wreaked havoc with thousands of businesses of all sizes that had kept large accounts at the Bank of Cyprus and Laiki Bank.

“We’re talking about the two biggest banks that supply the financing in this country,” said Vasilis Zertalis, chief executive of Prospectacy, a financial services consulting firm that helps companies set up shop in Cyprus. With the banks’ prolonged closure, Mr. Zertalis said, “many of those companies are going to go out of business right away.”

Since last weekend, when President Nicos Anastasiades first floated the idea of confiscating a portion of bank deposits, Mr. Zertalis’s phone has been ringing nonstop with clients looking for a way out. “We’re just trying to keep our clients operational,” he said.

On Monday, he was frantically searching for a solution for one of his clients with a half-million-euro overdraft at Laiki — which, like the Bank of Cyprus and other financial institutions here, took large losses on its holdings of Greek debt and lost piles of money lending to businesses, now bankrupt, in Greece.

The client, a midsize electronics retailer that imports PlayStations, Xboxes and video games, must pay its suppliers by the end of the month — this Friday — for products it already imported to Cyprus. But the importer will not be able to collect payments from customers until the end of April. Mr. Zertalis has sought financing from abroad, and he has been working to get an extension from his client’s suppliers.

“If you deal with a multinational in New York and you are a small player, they don’t care” that Cyprus banks are having a problem, he said. “You’re just an account that’s now become a headache for them.”

As the banking sector shrinks, Cyprus’s service-oriented economy will shrink with it.

Mr. Zertalis says his e-mail account has been flooded with offers from banks in Switzerland, Germany, Luxembourg and the Netherlands saying he can open accounts there within an hour should he choose another location to guard his clients’ money.

“They are targeting Cyprus,” he said. “We are going to see hard times coming here. This is only the beginning.”