A rush of money out of Cyprus would shift more financing responsibility to the European Central Bank, which provides about 10 billion euros of emergency loans to the country’s lenders. After 30 billion euros, the ECB would have to lower its standards for the collateral it demands from Cypriot banks, Panigirtzoglou said. With deposit flight and rising loan losses in Cyprus and Greece, the ECB could lose money on the funds it lends. Even capital controls won’t stop the drain, some say.
“Banks will become even more dependent on ECB liquidity because deposits will be largely drained,” UBS AG Chairman Axel Weber, a former ECB board member, said on Bloomberg TV today.
The island’s lenders have been closed since a plan by the European Union to force losses on depositors in exchange for a 10 billion-euro bailout touched off a political upheaval. Parliament rejected the deal, which would have taxed all bank accounts, including those under the 100,000-euro deposit- insurance limit. A new agreement shuts Cyprus Popular Bank Pcl, the nation’s second-largest lender. Uninsured depositors of that institution and the Bank of Cyprus Plc, the biggest, will share losses, while insured deposits in all the banks are spared.
When Iceland imposed capital controls after a property bubble burst and its banks collapsed, political leaders said they would be temporary, too.
Financial firms, with assets 11 times the national economy at the peak, were too big to save. So Iceland let them fail, splitting them into good and bad banks. Bondholders bore most of the losses. Iceland’s krona dropped by more than half.
Restrictions on the movement of capital out of the country were intended to stabilize the currency. They mostly related to the conversion of the krona to other currencies and targeted legacy foreign investments in the nation’s securities.
Even with such a limited reach, the Icelandic capital controls have had a negative impact on the economy, according to Pall Hardarson, president of Nasdaq OMX Group Inc.’s Iceland unit. They’ve discouraged outsiders from investing and made it harder for Icelandic companies to sell bonds overseas, he said. After doubling every year for five years, foreign direct investment in the island collapsed in 2008 and has remained about 25% below the pre-crisis level.
“Ultimately we need to create confidence in the economy, and with these controls it’s hard to do so,” said Hardarson. “Officially they only apply to legacy investments, but nevertheless they send a signal that things aren’t the way they’re supposed to be.”
Krona-denominated bonds left from the boom era cannot be converted to foreign currency when they mature. The proceeds need to be reinvested in krona assets. That has created two foreign-exchange rates for the island’s currency -- an official one traded domestically and one offshore.