Markets drop amid euro-crisis fears over Cyprus bailout

BERLIN — Fears of renewed economic crisis in Europe flared Monday as officials took the unprecedented step of targeting bank deposits in Cyprus to help rescue the country’s ailing financial system.

The proposal to tax all bank deposits, which requires approval by Cyprus’s parliament, led depositors to empty ATMs over the weekend and raised questions about whether the precedent could upset Europe’s banking system more broadly. By taxing all deposits, even those covered by government deposit insurance, the plan slaps at an important presumption of modern banking — that small accounts in publicly insured institutions are safe.

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Cypriots protest E.U. bailout proposal: The plan to tax all bank deposits sparked a bank run on the troubled island and renewed fears of economic crisis in Europe.

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The proposal upset world markets, led Cyprus to keep its banks shuttered until Thursday while its parliament debates the deposit tax, and prompted an angry backlash from Russian President Vladi­mir Putin. Russians have tens of billions of dollars at risk in the island nation — some of it representing legitimate investment, some of it laundered from illegal enterprises, some of it an effort to avoid Russia’s own political uncertainties.

Putin called the tax “unfair, unprofessional and dangerous” — unusually sharp opposition by a major power to a bailout program vetted by European leaders and the International Monetary Fund.

European officials endorsed the plan at a weekend meeting, and IMF managing director Christine Lagarde said it “appropriately allocates” the costs of bailing out Cypriot banks.

The situation in Cyprus is a potent reminder of how the political economy of the euro zone remains volatile. Though many analysts feel the worst of Europe’s crisis has passed, the prospect of a nation being forced from the currency union remains a possibility and carries an uncertain set of risks.

The United States has little direct exposure to Cyprus. A statement from the U.S. Treasury Department said officials were watching the situation closely and urged “that Cyprus and its Euro area partners work to resolve the situation in a way that is responsible and fair and ensures financial stability.”

World markets dropped modestly Monday and the euro fell against the dollar, but analysts said the real costs may come later if depositors in struggling countries such as Spain and Italy question whether their money is safe in their banks.

Options are few

Bank depositors have been spared in the euro zone’s other bailouts, though other classes of asset holders and investors have suffered officially sanctioned losses — including owners of Greek government bonds, and bank stockholders in Ireland and Spain. Outside the euro zone, foreign depositors were wiped out in Iceland’s 2008 banking crash.

Jacob Funk Kirkegaard, an analyst at the Peterson Institute for International Economics, noted that Cyprus, the IMF and other international creditors had few options. The country’s banking problems are so deep that the Cypriot government could not afford the loans needed to fix them. And within Cyprus’s banks, deposits are the only pool of money large enough to raise the $7.5 billion international lenders want Cyprus to contribute to a roughly $20 billion total bailout.