Streetwise Professor

March 25, 2013

Is the Badinov Bank Good Enough?

Filed under: Economics,Financial Crisis II,Politics,Russia — The Professor @ 2:49 pm

Although Medvedev fulminated at the injustice of the Badinov Bank solution, subsequent Russian reaction has been more accepting: the man who matters-Putin, not Medvedev-“has decided to support it.”

Perhaps Putin is just bowing to reality.  I’m more interested in whether the deal makes economic sense, especially as compared to the levy scheme that went down in flames.

The fundamental fact is that the two big Cypriot banks are insolvent.  Assets are less than liabilities.  The resulting loss must be borne by someone or someones, specifically:

  1. Equity holders. (Ha!)
  2. Bondholders.
  3. Unsecured depositors.
  4. Secured (guaranteed) depositors.
  5. Taxpayers.
  6. Extraterrestrials.

With all due deference to Krugman, let’s rule out (6).  With respect to (5): (a) Cypriot taxpayers-uhm, Cyprus is bankrupt (which is why it needs 10 billion euros in bailout funds), so Cypriot taxpayers aren’t a realistic alternative, and (b) bowing to political pressure and an impending election, Merkel has ruled out German taxpayers.

So that means that the loss must be borne by those with claims on the insolvent banks.  The proper way to do it is to work through those claimants in order of seniority from junior (equity) to senior (insured deposits).  That’s what has been done now.  That’s the right way to do it.  It’s what should have been done at the outset, given the economic and political realities.

The problem with the solution that went down in flames is that it violated the priority of claims.  Apparently in an attempt to appease the Russians, Cyprus’s president Nicos Anastasiades decided to reduce the losses imposed on uninsured depositors-who include many Russians-by imposing losses on insured depositors, most of whom are the countrymen he was actually elected to represent. Moreover, the levy was imposed equally across claims on Cypriot banks, regardless of the severity of their insolvency.  This was also highly objectionable, because it meant that depositors at banks that were truly egregious in their risk taking were treated identically to those who were less egregious.  Under that rule, no depositor has any incentive to avoid especially risky and reckless banks, or to monitor bank riskiness.

The Badinov Bank alternative is therefore defensible on rule-of-law grounds, whereas the levy alternative was not: moreover, the Badinov bank alternative is economically more sensible, especially in terms of giving depositors better incentives.

The irony, of course, is that Russia would have been better under the Anastasiades alternative.  Russian depositors at the Popular Bank of Cyprus will be especially hammered under the Badinov bank alternative, because that was the baddest bank of them all.  Whereas they were looking at a 10 percent loss under the levy scheme, they are now looking at losses upwards of 30 percent.

Oh well.  That’s the way the seniority cookie crumbles.  And that’s how it should be.  Let the crumbs fall where they may.

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  1. SWP, do we know that major Russian accounts were at Laiki Bank? And Laiki has an 80%-owned Russian subsidiary who’s accounts wont be affected.

    Is it possible that we are being led to believe that Russian money will be hard hit, but not be the case? (I don’t think it’s likely but there is a chance)

    Comment by colleen — March 25, 2013 @ 7:29 pm

  2. Apparently in an attempt to appease the Russians, Cyprus’s president Nicos Anastasiades decided to reduce the losses imposed on uninsured depositors-who include many Russians-by imposing losses on insured depositors, most of whom are the countrymen he was actually elected to represent.

    No, he was “appeasing” the Cypriot business community, who are his natural constituents (he is center-right) and bank primarily with the two insolvent banks. The old plan was actually far worse for Russian depositors in Cyprus.

    Comment by S/O — March 25, 2013 @ 9:56 pm

  3. The old plan was actually far worse for Russian depositors in Cyprus.

    Says who and based on what exactly?

    Comment by peter — March 26, 2013 @ 7:33 am

  4. “No one knows exactly how much money has left Cyprus’ banks, or where it has gone. The two banks at the center of the crisis – Cyprus Popular Bank, also known as Laiki, and Bank of Cyprus – have units in London which remained open throughout the week and placed no limits on withdrawals. Bank of Cyprus also owns 80 percent of Russia’s Uniastrum Bank, which put no restrictions on withdrawals in Russia. Russians were among Cypriot banks’ largest depositors.

    While ordinary Cypriots queued at ATM machines to withdraw a few hundred euros as credit card transactions stopped, other depositors used an array of techniques to access their money. ”

    Comment by Oleg — March 26, 2013 @ 8:43 am

  5. Peter asks, “Says who and based on what exactly?”


    Deposits: Just 10 percent of Bank of Cyprus’s 27.8 billion euros of deposits are in units outside the euro zone. The Russian and UK units of Bank of Cyprus hold a roughly equal amount, at 1.2 billion euros. Deposits in Cyprus account for 66 percent of the bank’s deposits, and deposits in Greece account for 23 percent. The figures are dated end-September 2012 and published in the bank’s third quarter accounts.

    While there are claims that a much larger percentage is “ultimately owned by Russian beneficiaries”, they are just that – claims. And others who claim to have acquaintances in the know deny that.

    Comment by S/O — March 26, 2013 @ 8:48 pm

  6. … claims that a much larger percentage…

    Much larger than what? Can you read at all? The quote you posted says nothing whatsoever about the nature of the BoC’s local deposits.

    And others who claim to have acquaintances in the know…

    You cannot be serious.

    Comment by peter — March 27, 2013 @ 6:03 am

  7. 1-4, I understand, but why 5. Certainly the ET’s should fork over – look at their shameless abscondin with Skittles – any thing with such bad taste deserves anything we can get from them.

    Comment by Sotos — March 29, 2013 @ 9:07 am

  8. The effects of Cyprus, and how stolen money gets cycled to Cyprus, and then re-cycled as “Foreign Direct Investment”

    from FT:

    Russian and Ukrainian businesses, it said, “appear to be using Cyprus for their financial transactions to pay for imports and to receive payments for exports for tax optimisation reasons.

    When the money comes back to Russia/Ukraine, it shows up as FDI inflows on the capital account, rather than as export earnings on the current account.”

    This would explain why “tiny Cyprus” is Ukraine’s main source of investment, accounting for some 30 per cent of FDI.

    From Capital Economics: The introduction of capital controls in Cyprus risks disrupting these flows, which may ultimately affect business activity and hit vital capital inflows.

    Summing up, Capital Economics said: The upshot of all this is that although the direct impact from the levy on deposits in Cyprus on the Ukrainian economy is likely to be limited, wider vulnerabilities mean that the Cypriot crisis may still be enough to tip Ukraine into a financial crisis of its own.

    Without an IMF deal in place, Ukraine is extremely exposed if the Cypriot bailout triggers a fresh spike in financial market tensions.

    On the ground in Kiev, the Cyprus crisis ripples are not sparking panic just yet, but they are being felt.

    Comment by elmer — March 31, 2013 @ 7:49 am

  9. List of companies that withdrew their money based on inside info:

    Cyprus bailout inside info? 132 companies pull out over $900mn in deposits
    Written by Admin on April 2, 2013 in News – No comments

    One hundred and thirty-two companies reportedly had inside knowledge of Cyprus’ impending levy tax as they withdrew deposits worth US$916 million in the run-up to the bailout deal.

    The companies withdrew their savings in the two week period
    (between March 1 to March 15) leading up to the rescue deal that
    enforced heavy losses on wealthy depositors in Cypriot banks,
    according to Greek newspaper

    Comment by elmer — April 2, 2013 @ 7:26 am

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