Why Cyprus Is a Special Case

The Cyprus bailout deal is a big improvement over the first botched attempt. It doesn’t repeat the error of breaching the guarantee on bank deposits up to 100,000 euros. Instead, it restructures the two biggest banks and forces their creditors, including large depositors, to take huge losses.

Yet the euro area’s leaders must do a lot more to convince Europeans and the markets that they have drawn the right lessons from this debacle. They need to say clearly why Cyprus is an exception and commit to integrating the euro area further so that it’s less vulnerable to such crises. They’re failing on both points.

The head of the euro area group of finance ministers, Jeroen Dijsselbloem, appeared to draw all the wrong conclusions in a March 25 interview, after the new deal was struck. He suggested that the Cyprus pact offered a new template for resolving the debt crisis.

Under this new model, the burden of repairing banks would shift from taxpayers to private creditors. Specifically, Dijsselbloem said he hoped the new approach meant that the 500-billion-euro European Stability Mechanism would never be used to directly recapitalize banks.

Policy Whiplash

Leaders from the wealthier northern-tier countries, including Germany, Finland and the Netherlands (Dijsselbloem is Dutch) advocate such an approach because it would avoid further transfers from north to south. This would be fine if it were possible. It isn’t -- not if the euro area is to remain intact.

Upon hearing Dijsselbloem’s remarks, any bondholder or depositor in a weak Spanish or Italian bank would be inclined to run, leading banks in those countries to collapse. Thankfully, he quickly recanted in a short statement, which said Cyprus is not a model.

Such fumbling is another example of the whiplash euro-area leaders have been causing. Is there, or isn’t there, a guarantee on deposits below 100,000 euros, for example? Just a week ago, the so-called troika of euro area creditors -- the European Commission, the European Central Bank and the International Monetary Fund -- said there wasn’t: They agreed to a deal in which the Cypriot government would take 6.75 percent from all deposits below the threshold.

The latest Cyprus bailout is peppered with commitments to the “principle” of a deposit guarantee. So which version of euro-area intentions should depositors in Spain believe?

National leaders and the IMF should state clearly why Cyprus is different. Unlike Spain, Portugal or Ireland, Cypriot banks are in trouble because they’ve attracted waves of hot money from abroad, in particular Russia. Cypriot banks have assets eight times bigger than the nation’s gross domestic product. It’s wrong to ask taxpayers, whether in Cyprus or Germany, to guarantee such investments. The banks’ owners should have to take any losses, and the banks should be reduced to a more sustainable size.

Luxembourg (a euro-area member with an even higher ratio of bank assets to GDP than Cyprus) should face similar treatment if it gets in trouble -- but not Spain or Italy. This needs to be spelled out clearly and consistently.

Deposit Insurance

Dijsselbloem and others need to be equally clear that they’ve learned their lesson from the debacle over deposit guarantees. It isn’t enough to state support for a “principle” that governments can honor or not. The region needs a common deposit insurance policy as part of the banking union that the EU is contemplating.

The lesson of Cyprus isn’t that Germany and the northern creditors have finally gotten their way and can leave it to the private sector to pay for the next crisis, whether in Greece, Slovenia or some other country. The lesson is that Cyprus really is different, and that more than ever the euro area needs the institutions that a single-currency system demands. The EU must pool its risks and accept some level of fiscal transfers.

Action, realistically, will have to wait until after the German elections in September. But in the meantime the EU should at least avoid sowing confusion -- or, worse, committing itself to ideas that will doom the euro.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.