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Cyprus: 'Monetary unions die because of bank runs'

The European authorities have increased the risk of a break-up in the euro with the raid on deposits in Cyprus, warns Paul Donovan of UBS.

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by Paul Donovan on Mar 18, 2013 at 11:04

Cyprus: 'Monetary unions die because of bank runs'

Paul Donovan (pictured), senior economist at UBS, the Swiss bank, is well known for his ascerbic daily podcasts on financial markets. Here we publish the transcript of his comment on the dangers posed by the bailout of Cyprus.

Politicians fail to see the bigger picture

'The economists of UBS have been emphatic that the euro will not break up. The costs of break up are horrendous, not just economically but also socially and politically. The benefits of a breakup are few if any.

'Hitherto the euro area has lurched from crisis to crisis without increasing the risk of a break in any of its solutions.

'The terms over the bailout of Cyrpus over the weekend have increased the risk of breakup of the euro. We still do not see the euro breaking up and the increase in the risk is still very small.

'The politicians in the euro area seem not to have properly comprehended the bigger picture. Either that or there’s some kind of dramatic alternative gesture that they’re going to unveil.

'The terms of the bailout are well known but the critical issue is what is characterised officially as a wealth tax and effectively a raid on all bank deposits in Cyprus.

'The euro in a Cypriot bank is not worth the same as a euro in a German, a French or even a Greek bank right now because depending on the size of the deposit, a tax, which means a haircut of 6.75% or 9.99% will be levied.

'The very great risk is that if there is even a hint of a wobble in the banking system elsewhere in the euro area depositors will fear that similar rules will apply.

'Even a 10% chance of losing 10% of one’s bank deposit is likely to create a panic.

'While Cyprus might be characterised as a special case there have been so many special cases across the euro that political reassurances in this regard will not have much worth.

'Why would one risk holding a bank deposit in a banking system even with insurance and guarantees if one thinks the banking system is vulnerable?

'There are two critical points to emphasise.

'First, every peacetime monetary union break-up of the 20th century was characterised first by depositor flight and bank runs.

'Monetary unions die because of bank runs.

'That phrase should be whispered in to the ear of every European finance minister every day, three times a day until the fact becomes lodged in their brains.

'Second, people dislike losing money more than they like making it. That is to say the anger at being denied 100 euros one is owed is less than the anger one feels at having 100 euros one already owns subsequently taken away.

'This is why the fear of a bank deposit raid causes a disproportionate effect on investors.'

To hear today's podcast by Paul Donovan go to the UBS website and follow the link.

For more on the impact of events in Cyprus read our market report and Q&A 'why does the Cyprus bailout matter?'

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10 comments so far. Why not have your say?

They have just created what will probably be the biggest run on Banks in history... Wonder which other european countries will follow suit.

It will be interesting to know how much the banks are going to lose, as no money, means no interest being made, no interest being made means no bank!!!

For the banks to do this, takes some coordination to suddenly freeze thousands of accounts. Having lived in Cyprus, coruption is there, and I wonder how many of the top account holders got a heads up it was happening and had the chance to remove the funds...

If it was me I would be happier it is happening today, then in 2 days time, when its pay day....

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We need newer smaller banks being set up, who have no links to the previous bloated, fraudulent banks who continue to squander money on bonuses even though they are not actually doing much in the way of business (lending to business) as opposed to recklessly purchasing, selling contaminated products to each other.

We should give up on all current banks as they all are infected by parasites or leeches, sucking the life blood from ordinary people.

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@ Rose, agree.

The problem is to run a bank, you need certain credentials, qualifications and experience as per regulation.... The only people who have these are the current bankers..... We need someone to set up a bank, hire one of these people then sit on them to ensure everything is above board!!

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In terms of its size relative to the rest of Europe Cyprus' banling sector at 8 times GDP is unique, Spain Italy etc dont come remotely close so it is unlikely to have amterial or prolonged impact on the Eurozone. There is alot of vested interest in milking this for what it is worth as many "professionals" have been sitting on the sidelines seeing their performance relative to their peers get worse. The ones making most of the noise are those that have been all along urging investors to stay long bonds. we have El Erian spouting armageddon I am waitng for Roubini and Soros. the 2 and 20 crowd are deperate to stem fund outflows so they will look to milk this for what it is worth. You have to feel sorry for te Russian politicians,oligarchs and other assorted "entreprenuers" who kept on putting their money into Cyprus, in the full knowledge that it was looking for a bailout. You could not make it up

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Who would want to make it up? It is here and @ rose states quite well that some alternative, trustworthy, system is needed. Seems strange to find this on a financial comment, perhaps? 50% to transparent charity will make the world a happier place, especially for the gifter.

Now, about this cooperative ethical transparent bank....names in the hat, please.

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I took all my money out this morning. I will not leave a penny more than I have to in a bank, British or otherwise. The socialists are finally getting their way...

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I think another question is, (Cyprus situation aside, although 100% agree it's a disgrace), why would anyone want their money in the bank just now anyway, other than the minimum amount for cash flow purposes.

We're being asked to deposit money and central banks deflate the buying power of that money by having inflation running above ridiculously low rates and engaging in 'currency wars'.

Low rates which cause and will repeatedly cause (whilst the love affair with cheap credit is encouraged) economic bubbles and the subsequent problems they create.

Worse still, as with Cyprus, those that are bingeing on cheap credit are not the ones that are paying the high price of such 'false consumerist', destructive policies.

It's not the sign of a civilised, democratic society. Mind you, the EU concept isn't exactly in line with that either.

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Well just like to say, looks like I was right after todays news, seems loads were tipped off!!!

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To Roger Savage-excellent comment. Just what I think. Except for the security angle there is zero reason to keep money in ANY bank-no interest, underlying threats etc.,

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Paul Eden

Mar 19, 2013 at 19:55

Very good article. Well explained, particularly the part that people will react disproportionately to having their money taken away from them. And if that is so, then people in other countries will be wary of those responsible for such money grabbing.

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