From Cyprus to Frankfurt.

Dear SAP Banking community members,

As we discussed some weeks ago, effects of Palliative Care are over and turmoil is back in the Financial Markets.

http://sapbank.blogspot.co.uk/2013/02/liquidity-and-palliative-care.html

We could discuss about Cyprus for hours, if it’s right or wrong to force hair-cuts in deposits below 100.000 EUR and their impact in trust.

Trust is a critical asset of the financial system, once is broken there’s no glue which fix it up. If deposits and current accounts, the most liquid asset in a Bank are not safe, preventing panic and a subsequent banking run is very difficult.

And then, what’s happened here; have the leaders of the Troika (Eurozone, IMF and European Central Bank) become insane?

At the same time that Cyprus people were demonstrating in front of their parliament and Cyprus banks, Mrs. Christine Lagarde; Managing Director, International Monetary Fund was given an important speech in the Frankfurt Finance Summit. And without mentioning Cyprus, she gave some hints of what was happening, and more important, what’s going to happen in the future.

http://www.imf.org/external/np/speeches/2013/031913.htm

On her speech, Mrs. Lagarde made clear that the Financial System has huge undercapitalization issues, and fixing them is not a priority, but the priority.

Theoretically, capitalization would improve with economic growth, but economic growth is not here and is not expected soon.

Consequently, there’s only one alternative, we have to reduce debt with write-offs, this is happening in Cyprus and very soon it will happen everywhere.

We could argue why depositors have to pay the bill before junior or senior debt holders; and the reason is Cyprus is a very special case.

Cyprus is one of the main tax heavens in the Eurozone, and 42% of the Deposits in Cyprus banks are over 500.000 Euros.

Tax heavens have been very useful for building the current mega-bubble of debt, but the exit strategy of this crisis is efficient capital management; consequently, from now on bubbles are bad. That’s the second important point of Mrs. Lagarde speech. Hard regulation for everybody; including shadow banking (and tax heavens).

The question is, why charging deposits with a new extraordinary capital tax and not writing-off other assets, like Cyprus debt? There’re two important reasons for that;

First; the main volume of Cyprus banks liabilities are deposits of foreign investors. World’s leaders want to give a lesson that tax heavens are over and this is a good way to do it.

Second; a very important part of Cyprus debt is hold by Greece banks. By solving Cyprus crisis we will worse German’s banks solvency problem. Sorry, my mistake, I meant Greece problem (or maybe not).

Of course we will face risks of panic and bank run in Italy and Spain, but this can be solved by a temporary liquidity injection and, in the worst case scenario, capital controls.

It’s probably unfair, but that’s not the point. The point is it will work; and Mrs. Lagarde knows very well.

Looking forward to read your opinions.

K. Regards.