Coutts, the UK private bank, takes a look at the bank crisis in Cyprus and the controversy over a proposed levy on savers' deposits, and what this means for the euro.

Editor’s note: Below
are comments on the controversial bank bailout deal for Cyprus, which
takes such processes into uncharted waters by imposing a levy on savers, which
has alarmed financial markets (the euro fell in the exchanges on Monday
morning). Here are comments from Norman Villamin, chief investment officer, Europe, at Coutts. The remarks are taken from the regular
“Coutts Wealth Watch” commentary sent out by the bank.

The controversial bank bailout deal for Cyprus is
unprecedented in that it penalises savers. The images of frantic customers
queuing outside branches, desperate to withdraw their hard-earned savings,
highlights the precarious position the eurozone still finds itself in.

What has happened?

Cypriot authorities, together with the European Union, the
European Central Bank and the International Monetary Fund agreed on a €10 billion
($12.95 billion) funding programme intended to stabilise the local banking
system. In a clear break with recent policy trends, the plan passes a
significant part of the cost on to savers, while also bailing in junior
bondholders (forcing them to exchange their bonds for bank equity).

Under the deal, approximately €6 billion will be raised
through a 9.9 per cent levy imposed on customer deposits of more than €100,000
and a 6.75 per cent levy on deposits under that sum.

Is it a done deal?

Not yet. The deal has caused uproar and many savers have
tried to withdraw their savings. The Cypriot government is discussing the
possibility of changing the levy to 3 per cent for deposits below €100,000, and
to 12.5 per cent for above.

The move to take a percentage of deposits, which could raise
almost €6 billion, must be ratified by parliament, where no party has a
majority. If it fails to do so, President Nikos Anastasiades has warned that Cyprus's two
largest banks will collapse. Under the original deal, depositors will receive
bank equity as compensation. The Russian government and International Monetary
Fund have yet to agree to make contributions to the programme.

Why was the Cypriot
deal structured so differently?

The size of the banking recapitalisation needed in Cyprus is much
larger than elsewhere - so a bail-out by bringing the liabilities onto the
government balance sheet was not possible given the country’s sovereign debt
burden.

With only about €4 billion of senior bank debt outstanding,
forcing senior debt holders to take a haircut would not be enough. Given the
bank’s relatively weak anti-money laundering framework and high number of
non-resident depositors, there was also relatively little appetite to directly
bail them out.

Will there be a run
on Cypriot banks?

The likelihood of a bank run seems limited. It has been
suggested the government may ring-fence Cyprus’s largest banks - Bank of
Cyprus and Laiki Bank. Further deposit outflows from the periphery would,
however, be a further drag on growth and confidence following the Italian
elections. The current situation in Cyprus does serve to highlight the
increasing risk to bond holders and depositors in peripheral countries.

Where does it leave
investors and other bank savers?

It leaves investors highly dependent on local compensation
schemes and emphasises the absence of progress on a pan-European banking
framework and deposit insurance scheme - which would have more credibly
addressed concerns. With the battle lines clearly drawn - to the detriment of
junior bond holders - we continue to have a preference for senior bank debt in
the eurozone’s periphery.

Our concerns do not extend to core EU members - where bank
capitalisation has been much-improved and regulatory frameworks considerably
strengthened.