For Cyprus, Painful Medicine to Swallow in Order to Avoid Collapse

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This story is based on a radio interview. Listen to the full interview.

Audio Transcript:

Marco Werman: I'm Marco Werman. This is The World. It's been a crazy week for bank customers in Cyprus. But the good news today is that a banking collapse on the Mediterranean island has been avoided. The bad news? The new $13 billion bailout deal with the European Union involves significant pain for Cypriots. A major bank will be shut down, another will be restructured, and anybody with more than 100,000 euros in those banks is going to help pay for the deal. Stavros Zenios is a professor of finance at the University of Cyprus in Nicosia. He gives us the broad strokes of this new plan.

Stavros Zenios: The basic outline is that the bank depositors will be bailed in. One of the banks, the second biggest bank of the country, Laiki Popular Bank, will go into resolution, which means all of the secure deposits, up to an amount of 100,000 euros they will be transferred to Bank of Cyprus and they are secure. Anything over that amount will be frozen until the bank's assets are sold, and people gradually will get back their money. So basically this is a controlled bankruptcy. For Bank of Cyprus, the major bank on the island, this bank will be recapitalized, but depositors over the 100,000 limit will get a haircut. At this point it is not clear how big the haircut will be, there are talks of about 30 percent.

Werman: Yeah, you say step in the right direction, but what is a haircut, really, when you're talking Cyprus' two biggest banks. This is more like a permanent wave.

Zenios: Well, they will get one-time cut on their deposits. It is a big impact on the country's economy. The uncertainty and the turmoil has essentially dealt a very strong blow to the country's offshore business, especially financial services, from which there is concern that it will take a very long time for the country to recover. So the Euro group has addressed the banking problem, but in the meantime the economy and the stability of the country has been dealt a very strong blow.

Werman: I mean, the headline sounds like this is going to be a loss for some account holders, and with Cyprus' two leading banks a target of this, how are people with healthy deposits reacting?

Zenios: Well, the situation on the ground here is synonymous. People say this is the same like the experience we had in 1974 with the war. It's still too early to understand the implications of this decision. For example, gradually realized that the bank that's going into resolution, which will create unemployment problems, also it had his pension fund in this very same bank, which we see when the bank goes into resolution, they will not get their money back, or it will be a long time until they get their money back.

Werman: Are you saying that pensions for a lot of people are going to dry up as well?

Zenios: The pensions that were invested in Popular Bank, they will be frozen until the bank is resolved, and nobody knows how long this process will take.

Werman: And if banks don't resolve their problems, that means people who have pensions won't ever get them?

Zenios: Anything over EUR 100,000, the answer is yes, people will never get them. This is now the implications of this decision, what does this really mean for the real economy. We had two banks that were all the banking activity of the country, so we understand when one of them is going into resolution, and these banks had eight times the GDP of the country in terms of liabilities.

Werman: So what's been the reaction from the street, people who don't have that much money?

Zenios: Well, people who don't have that much money, they are worried now about unemployment. Unemployment in Cyprus had been the highest we had since the establishment of the republic. It's over, it's about 12 percent. Usually we have three to four percent unemployment. Now, with this big blow to the financial services sector, that was 25 percent of the economic activity of the country, this has another negative impasse on the job creation. So there's a lot of uncertainty. The country's going through uncharted territory. We came very close to the cliff of dropping out of the euro. So even if we manage to pull back from this disastrous event, the situation is not pretty.

Werman: Stavros Zenios, professor of finance at the University of Cyprus in Nicosia. Good to speak with you. Thanks.

Zenios: Thank you very much. Have a good day.