You Cannot Engage In Commerce Without Liquidity

As I predicted here, accepting the transfer of the 9B of Laiki ELA to Bank of Cyprus would be disastrous. The disaster has now appeared.   The latest Central Bank plan has the following to say about the large (>100K euro) depositors of the Bank of Cyprus:

(1) Loans outstanding to the bank netted against deposits.  Congratulations, you have now paid off your loans!   If you still have more than 100K of deposits, go to step 2

(2) 37.5% of amount >100K is converted to Bank of Cyprus equity senior to the existing equity.   In other words, we can consider this to be a 0.

(3) 22.5% of the amount >100K will be frozen for 90 days until a valuation of Bank of Cyprus assets is made, after which a decision will be made as to if it should be haircut or not.   In other words, you can consider this to be preferred stock, series A.    Note that I am not sure how one assesses bank assets when you simultaneously withdraw all liquidity from the system.   About 20% of Bank of Cyprus loans were non-performing two weeks ago.   It is hard to imagine that 100% of them won't be non-performing in 30 days from now.   If you are one of the very fortunate people to have some liquidity right now in Cyprus, would your first thought be to use it to make your loan payments???

(4) 40% will be frozen for an indefinite period (claimed to be short, but let's get serious) and will be returned to you when bank results merit it.    There is a word for financial instruments with this payoff schedule and it is called preferred stock, series B.   It is certainly not a checking account!

So, in the best-case scenario, this is a 37.5% haircut.   In the worst case scenario, this is a 100% haircut.

My more immediate concern however is liquidity.   In ALL scenarios it is a 100% liquidity haircut.   You will not be able to access a single euro above 100K on Tuesday morning.    Laiki and Bank of Cyprus are the two money center banks in Cyprus and the core of the local payment infrastructure, used very heavily by local businesses for their operating, payroll and working capital accounts.

The Cyprus market could probably operate (with a lot of random, unfair pain) with the Laiki acccounts being lost.    It seems inconceivable to me that the market can operate with both Laiki and Bank of Cyprus being frozen.   They must be the bankers for 70% of Cyprus firms.  Hundreds of firms will miss payroll, not be able to pay suppliers, etc in this scenario.   I am really at a loss as to what is going on.   It is like taking a century of knowledge about how banking supervision is supposed to work and throwing it out of the window.

I hope this is the Central Bank of Cyprus off in outer space as it has been several times last week  (e.g. they wanted to open the banks without capital controls) and some adult supervision will enter the picture, otherwise this is going to be a very, um, interesting few weeks.    If these restrictions last for, say, a month, there is a large likelihood Cyprus is back on the CYP, whether they want to or not.

Posted on March 31, 2013 and filed under Cyprus.