"Zypern - Warum die Märkte aufgeregt sind"

"As part of the €10bn ‘bailout’ secured by the Cypriot government this weekend, special taxes are being applied to depositors - with the split as to how this tax burden will be felt by large and small depositors not yet known. While the Cypriot economy is among the smallest in the Eurozone, measuring only 7% of the size of Greece, these developments contain two principles that are agitating financial markets.

First, the introduction of deposit bail-in and work-around of deposit-guarantee insurance into the Eurozone crisis response toolkit. While this is of broad interest, its significance is entirely political. The iniquity of exempting large and sophisticated government bond holders and senior bank bondholders from the bail-in, and instead designing it as a tax on depositors in such a way that deposit guarantees would not be triggered will lead to further erosion of trust between governments and their people. This is likely to contribute to the rise of anti-European politics across the European south. And the only thing that can defeat the European project is electoral anti-Europeanism.

Second, and of greater importance to financial markets in the short-term, is the question as to whether small depositor taxation will bring contagion and depositor flight to other peripheral countries. The ECB’s Outright Monetary Transactions (OMT) programme was designed to give the central bank the toolkit to deal with the prospect of cross-border capital flight, although Draghi at his last press conference made the mistake of revealing that the legal documents required to operate OMT are still not in place. Assuming that these legal documents can be hastily assembled, the ECB is in a position of absolute power to prevent any bank runs from destroying the Eurozone’s financial system. But the political costs of OMT activation are still significant and the amount of financial stress that a government will be willing to take before signing up to a EU programme is not clear.

So, while the ECB has the toolkit to offset any deposit flight and limit the financial fallout, the political ramifications will likely echo for years to come."