Confidence In Cyprus Banks Falters As Government Proposes Deposit Tax

Cyprus is facing a run on its banks after the government proposed taxing bank deposits. The government has put off a vote on the plan in a bid to calm things down. Banks are set to re-open on Thursday after a bank holiday was declared on Monday.

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This is ALL THINGS CONSIDERED from NPR News. I'm Melissa Block.

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And I'm Robert Siegel. It is just a small island south of Turkey, but Cyprus is affecting markets around the world. The country is struggling to contain a financial crisis. Banks there will be closed until Thursday, at the earliest. This is after the Cypriot government agreed over the weekend to a deeply unpopular tax on bank deposits to bail out its banks. Today, the turmoil in Cyprus sent stock prices around the world tumbling and it sent European leaders scrambling to reassess the tax plan. NPR's Jim Zarroli has more on what the troubles in Cyprus mean for other countries.

JIM ZARROLI, BYLINE: Cyprus is a tiny country of just 800,000 people and yet, it has managed to turn itself into one of Europe's major financial players. For years, it has offered investors a private, discreet place to put their money and as a result, its banks grew fat with foreign deposits, especially from Russia. Mohamed el-Erian is the CEO of the investment firm PIMCO.

MOHAMED EL-ERIAN: This is an offshore center that's very large relative to the size of the economy. Of course, it brings benefits in terms of earnings, but it also brought risk.

ZARROLI: With so much foreign money coming in, Cypriot banks needed a place to invest. Nicolas Veron, of the Peterson Institute for International Economics and the European think tank Bruegel, says a lot of that money got invested in Greece. Veron says Cyprus has longstanding cultural ties to Greece, so it made a certain amount of sense and yet, the decision would cost the banks dearly.

NICOLAS VERON: And where Greek bonds were restructured a year ago and that meant considerable losses for Cypriot banks and it massively destabilized this offshore financial center.

ZARROLI: Today, Cyprus' two largest banks are $17 billion in the hole. For nearly a year, the government has been talking to European officials about getting a bailout. Veron says, for a long time, Cyprus' left-leaning government was reluctant to take the kind of austerity measures that Europe demanded and the talks went nowhere.

VERON: Basically, the consensus after the Greek debt restructuring was to say, well, there's no way we can negotiate with this government in Cyprus, so let's wait until there is a new government.

ZARROLI: Then in February, a new president was elected and the talks intensified. Over the weekend, the new government agreed to levy a tax on all bank deposits. The proposal has proved deeply unpopular and tonight came reports that European officials are thinking about modifying it so that it only applies to customers with large deposits. Support is also eroding in Cyprus' parliament.

Mohamed El-Erian says if the plan is rejected altogether, the government is left without any good options.

EL-ERIAN: If they don't approve it, one of the banks collapses immediately. If that bank collapses, there a chance that the other bank will collapse. If the ECB does not come to the rescue of these banks, depositors will lose all their money.

ZARROLI: El-Erian says that could lead to enormous instability and even force Cyprus out of the Eurozone. And yet, Nicolas Veron says the proposed tax on deposits raises problems of its own. Veron says the notion that a bank can reach into its customers' accounts and seize money to pay for its bad investment decisions sets a very disturbing precedent.

VERON: There was a very strongly embedded trust, at least in the developed world, a deposit was safe asset, safely in the bank, would not be expropriated and especially small deposits were absolutely rock solid. There was no way you could lose money on this sort of asset. And obviously, now this is no longer the case.

ZARROLI: The danger, he says, is that this will further erode people's confidence in their banks. If banks in Cyprus can take such a step, customers throughout Europe and beyond could begin to wonder whether their own deposits are safe. Over the next few days, Cypriot officials will be looking for a way to salvage the bailout plan without undermining Europe's financial system. Jim Zarroli, NPR News, New York.

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