The Cyprus Bail-In: When Eurozone Depositors Paid for the Banks 2013

A Friday Night in Brussels

At a little after two in the morning on Saturday 16 March 2013, in a windowless conference room on the fifth floor of the Justus Lipsius building in Brussels, the finance ministers of the eurozone signed the most controversial sentence they had ever put on paper. The communiqué they released said the Republic of Cyprus would receive a EUR 10 billion adjustment programme, and that to fill the EUR 17.5 billion financing gap the country itself would have to find EUR 7 billion — most of it through a "stability levy" applied to every deposit held in every Cypriot bank, including the insured ones under EUR 100,000. The levy was set at 6.75 percent on balances below the deposit-guarantee ceiling and 9.9 percent above it. Cypriot banks would not open on Monday. By Sunday afternoon the ATMs had been emptied in queues that wound around the cathedral square in Nicosia and the old harbour in Limassol.

"This is a one-off measure," said Jeroen Dijsselbloem, the new Dutch chair of the Eurogroup, at the closing press conference. "It is the only way to ensure the immediate stabilisation of the financial sector." The sentence held for ninety-six hours. On Tuesday 19 March the Cypriot House of Representatives voted thirty-six to zero against the deal, with nineteen abstentions — not one government deputy was willing to vote for what the country's tabloids by then were calling "the European theft". By the following Monday a redesigned programme had emerged that protected every insured euro and shifted the entire burden onto large depositors at two banks. It was the first eurozone resolution in which uninsured bank customers, not taxpayers, paid the bill, and it set the template that every subsequent eurozone bank failure would follow.

How a Banking Sector Got to Eight Times GDP

To understand why Cyprus needed a bail-in at all you have to look at the size of what was being resolved. Cyprus had joined the European Union in May 2004 and the euro in January 2008. In the four years that followed, deposits in the Cypriot banking system grew from EUR 38 billion to EUR 72 billion, with the consolidated balance sheet of all Cypriot monetary financial institutions ballooning from roughly four times GDP at accession to a peak of more than eight times GDP at the end of 2009. By any cross-country measure, only Iceland in 2007 — discussed at length in our piece on the Icelandic banking collapse and the limits of central-bank lender-of-last-resort — had run a more extreme bank-to-GDP ratio in recent memory.

Three forces pushed the curve up. First, Cyprus offered the lowest corporate tax rate in the euro area at 10 percent, combined with bilateral tax treaties left over from the Soviet era — most importantly with the Russian Federation — that made the island the cheapest legal route for round-tripping Russian capital into euro-denominated assets. By the end of 2012, roughly EUR 21 billion of the EUR 68 billion of non-bank deposits held in the two largest Cypriot banks belonged to non-residents, the bulk of them Russian. Second, the Cypriot banking law treated deposits as a senior obligation alongside other senior unsecured debt, with no statutory preference — a design choice that made depositors legally equivalent to bondholders for resolution purposes, a point that mattered once the bail-in was on the table. Third, Cypriot banks had been allowed to invest the imported deposits across borders, and they had concentrated their euro-area sovereign exposure in the highest-yielding paper available — Greek government bonds.

By mid-2011, Bank of Cyprus and Cyprus Popular Bank — known by its Greek name Laiki — together held roughly EUR 5.8 billion in Greek government bonds at book value, equivalent to about one-third of Cyprus's GDP. When the Greek private-sector involvement haircut was agreed in March 2012, of which we treat the politics in our piece on the Greek debt crisis and the eurozone sovereign-debt rupture, the realised losses came to roughly EUR 4.5 billion across the two banks, or about 25 percent of Cypriot GDP, in a single accounting period. Laiki had also been operating an EUR 9.5 billion Emergency Liquidity Assistance line from the Central Bank of Cyprus throughout 2012, secured against collateral that the ECB Governing Council, in a 21 March 2013 letter from Mario Draghi to Cypriot Finance Minister Michalis Sarris, deemed sufficient only until the Monday following — a position the IMF subsequently described as the decisive procedural pressure on the parliament (IMF, 2013).

The First Deal and Its Three-Day Collapse

The Friday-night package of 16 March was, in the testimony of officials who were present, designed in the conference-room corridor rather than on paper. President Nicos Anastasiades, who had been in office only twenty-eight days, had flown in with the explicit instruction from his coalition partner to protect Russian non-resident depositors above all other constituencies — a request that was incompatible with both the German Finance Ministry's view that those depositors should bear most of the loss and the IMF's view that the deposit-guarantee ceiling was inviolable. The compromise that emerged blurred both objectives. By taxing every euro of deposit including those under the EUR 100,000 ceiling, the levy raised the EUR 5.8 billion target while only mildly diluting the share borne by large balances. The Russian foreign minister Sergei Lavrov, briefed at six in the morning Moscow time, called it "unfair, unprofessional and dangerous". Within twelve hours President Vladimir Putin had called Chancellor Angela Merkel.

The bank-run risk was the immediate problem. Cypriot banks had been due to open for normal business on Tuesday 19 March; the government had declared a public holiday on Monday 18 March to extend the weekend, and an emergency law tabled on Sunday afternoon froze withdrawals beyond EUR 100 per day per ATM card. The queues outside the ATMs in Nicosia that Saturday were photographed by every wire service in Europe. Athanasios Orphanides, the former Governor of the Central Bank of Cyprus who had been replaced by the incoming government less than three weeks earlier, gave an interview to the Financial Times on the Monday morning describing the deal as "a fatal mistake" and warning that "if depositors in Spain or Italy lose confidence, the euro itself will be at stake" — a quote that ran on the front page of every European newspaper that afternoon (Demetriades, 2017).

The parliament met at six in the evening of Tuesday 19 March. The vote was thirty-six to zero against, with all nineteen DISY government deputies abstaining rather than voting against their own president. The communist AKEL party, the centrist DIKO, the socialist EDEK and the Greens all voted no. Within an hour the Eurogroup was back on conference call, with Draghi and the IMF's Christine Lagarde joining from Frankfurt and Washington. The German Finance Minister Wolfgang Schauble, asked by reporters in the corridor whether Cyprus might be allowed to leave the euro, replied only that "the EUR 10 billion is still on the table — what is on the Cypriot side is now a matter for the Cypriots".

The Second Deal and the Resolution Mechanism

What emerged in the early hours of Monday 25 March 2013 was a structurally different package built around two propositions. First, every insured deposit under EUR 100,000 would be protected in full — the deposit-guarantee directive would not be touched. Second, the entire burden would fall on the two banks at the heart of the crisis, with their large depositors converted into shareholders or wiped out altogether, and the rest of the Cypriot banking system left untouched. Cyprus Popular Bank — Laiki — was placed into resolution, its insured deposits and good loans transferred to Bank of Cyprus as a "good bank", and its remaining shell, holding the bad loans, the equity, the subordinated debt and the uninsured deposits, wound down. Senior bondholders at Laiki were extinguished outright. Uninsured depositors at Laiki lost the entire balance above EUR 100,000, with no equity conversion offered — a near-total wipeout estimated at roughly EUR 4.2 billion of pre-resolution claims.

At Bank of Cyprus the mechanics were softer but still drastic. Uninsured deposits above EUR 100,000 were divided into three tranches. The first 37.5 percent slice, later raised to 47.5 percent in the operational decree of 29 March, was converted into Class A equity at a nominal price of EUR 1 per share, recapitalising the bank to a target Common Equity Tier 1 ratio of 9 percent. A second slice of 22.5 percent was held in a temporary escrow that could be drawn upon if the recapitalisation came up short, with the residual returned in two later tranches once the audit by PIMCO was finalised. The remaining 30 percent was locked into time deposits of six and twelve months, frozen at zero interest. Insured deposits were untouched. Senior unsecured bondholders, of which there were roughly EUR 200 million outstanding, were also converted to equity at the same terms. Subordinated debt was extinguished. The pre-existing equity was reduced to a notional residual.

Capital controls — the first imposed on a member of a monetary union since the euro began — accompanied the deal. The decree of 27 March set a daily cash-withdrawal limit of EUR 300 per person per day, banned overseas cheque clearing, capped credit-card transactions abroad at EUR 5,000 per month, and required ministerial approval for transfers above EUR 200,000. The controls were tightened in April after early evasion through corporate accounts and only fully lifted in April 2015, almost exactly two years after they had been imposed.

The Real Economy in the Bail-In's Wake

The combined cost of the two operations was in the order of EUR 8 billion of depositor and bondholder losses, against an EUR 10 billion troika package and roughly EUR 1 billion of state contributions. The Cypriot economy contracted by 5.9 percent in 2013 and a further 1.4 percent in 2014 — a peak-to-trough drop of about 10 percent over three years — somewhat less severe than the troika baseline of minus 13 percent, but enough to produce a sustained period of double-digit unemployment that did not return below 8 percent until 2019. Bank of Cyprus, recapitalised by its former large depositors, returned to the London stock exchange in early 2017 and posted its first full-year profit in 2018. Russian-origin deposits, which had peaked at roughly EUR 21 billion in 2012, had fallen below EUR 5 billion by 2018 and were close to zero in real terms by 2024 following sanctions imposed after the invasion of Ukraine.

The Cypriot banking sector itself shrank in line with the chart above — from a balance sheet of more than eight times GDP at the peak in 2009 to a little above four times by the end of 2014, and below three times by 2020. The non-resident deposit model that had defined Cypriot banking for two decades did not survive. The country reoriented its current account around tourism, professional services and, increasingly, technology.

A Template Codified

The Cypriot bail-in had been improvised in three weekends. The European Commission proposal for a Bank Recovery and Resolution Directive had been on the table since June 2012, but Cyprus moved it from a draft drifting through trilogue into a piece of legislation member states could no longer afford not to pass. The BRRD adopted in May 2014 and transposed by 1 January 2015 codified the bail-in waterfall that Cyprus had improvised, with one significant tightening — a minimum bail-in of 8 percent of total liabilities and own funds before any public money could be drawn (European Commission, 2014). The Single Resolution Mechanism Regulation followed in July 2014, the Single Resolution Board took up its powers on 1 January 2016, and the architecture was ready in time for the first major test of the new regime — the resolution of Banco Espirito Santo of Portugal in August 2014, in which subordinated bondholders took the loss while senior creditors and depositors were transferred to a bridge bank.

Two further resolutions followed the same path. The orderly winding-down of Italy's Banca delle Marche, Banca Etruria, CariChieti and CariFerrara in November 2015 imposed losses on subordinated bondholders — many of them retail savers who had been mis-sold the securities — and triggered the Italian political crisis that delayed the Monte dei Paschi resolution for a further eighteen months. The Banco Popular Espanol resolution of 6 June 2017 — Europe's first full BRRD-style resolution of a major bank, sold to Banco Santander for EUR 1 — wiped out shareholders and subordinated bondholders to the tune of EUR 3.3 billion in a single overnight intervention, and was the proof case that the Cyprus template could be applied to a bank ten times larger without contagion.

The reading that crystallised in the policy community was that depositor losses are politically survivable only when they are clearly bounded by the EUR 100,000 guarantee ceiling — a lesson learned, expensively, from the original 16 March deal that had tried to violate it. The Northern Rock queue of September 2007 (treated in the Northern Rock bank run and the loss of British faith in the deposit guarantee) and the entire 2008 cycle covered in our piece on the 2008 global financial crisis had taught the Western policymaking class that an unprotected guarantee ceiling is worse than no ceiling at all. The Friday-night Brussels compromise had violated that lesson; the Monday-morning replacement restored it, at the price of a brutal but bounded loss for those above the line.

What Stayed in Nicosia

The man who had insisted in March 2013 that depositor bail-in would be a one-off — Jeroen Dijsselbloem — gave an interview to Reuters and the Financial Times on 25 March that contradicted the script. Asked whether the Cyprus model could become a template for the rest of the eurozone, he said: "If we want to have a healthy, sound financial sector, the only way is to say, look, there where you take the risks, you must deal with them" (Reuters, 2013). The remark caused European bank shares to fall by 2 to 4 percent within the hour and forced a clarification from his office by the end of the afternoon. Within a year the BRRD had embedded his unguarded sentence in EU law.

In the Bank of Cyprus annual general meeting of 25 March 2024, eleven years to the day after the second deal, the company's deputy chairman read out the closing share price — EUR 4.32, against a notional conversion price of EUR 1.00 in 2013. The cumulative dividend paid since the bank's return to profit in 2018 was EUR 1.05. A converted depositor who had held all of the equity allocated in 2013 had recovered, in present value, somewhere between 70 and 80 percent of the original haircut — closer to par than anyone in the Friday-night room had thought possible. The deposit that had been converted into a share, eleven years and one capital control regime later, had become a stock with a market in London and a yield, paid quarterly, in euros.