How did Cypriots respond to the 2013 banking crisis?

Almost exactly five years ago, Cypriot bank depositors found themselves in a pickle:

Germany is adamant that the banking system in Cyprus must be shrunk to half its present size and Cyprus’s two largest banks restructured as part of any rescue plan…Senior EU leaders, including Olli Rehn, the commission’s economic chief, and Mr Dijsselbloem had originally expressed reservations about the plan out of fear it would lay waste to the island’s economy, which is heavily reliant on financial services. But officials involved in closed-door discussions said many who were resistant now believe massive capital flight is assured, making the Iceland solution more palatable.

–“Pressure mounts on Cyprus”, March 21 2013

Under the outlines of the deal, depositors with accounts worth less than €100,000 would not be touched. But those above those levels in Laiki Bank, the second largest and most troubled financial institution, would be severely cut, the officials said. The losses on large deposits in Bank of Cyprus, which will survive as a much smaller entity, have yet to be decided, but could be as high as 40 per cent.

–“EU ministers approve Cyprus bailout deal”, March 24 2013

Cyprus is to become the first eurozone country ever to apply capital controls – with limits on credit card transactions, daily withdrawals, money transfers abroad and the cashing of cheques – intended to prevent a vast outflow of euros when its banks open on Thursday. Under drastic measures that some analysts say are incompatible with monetary union, depositors would be able to withdraw no more than €300 in cash each day, said people familiar with the move. Transfers of more than €5,000 would require permission from the central bank.

–“Cyprus imposes severe capital controls”, March 27 2013

Recent research by Martin Brown, Ioanna Evangelou, and Helmut Stix analysed how these traumatic experiences affected behaviour. They interviewed 807 Cypriot households with at least €5,000 in bank deposits at the beginning of 2014.

Their main finding is that the bail-in encouraged Cypriot savers to hold less wealth in bank accounts:

This ~25 per cent decline in domestic bank deposits was not just the effect of the government’s confiscation. It was also a reallocation by savers away from an untrustworthy banking system into physical currency:

In the short-term, this shift was driven only by savers who had lost money on things that were supposed to be safe. Bank shareholders lost money as well, but the survey data from Brown et al found that shareholders did not increase their holdings of cash if they had avoided any haircut on deposits or bonds:

The type of financial loss incurred by households strongly affects their immediate change in money holdings…Households which are subject to a bail-in react much more strongly than households which are subject to losses on bank equity. However, the type of assets bailed-in, i.e. (uninsured) deposits or (subordinated) bonds, seems hardly relevant for subsequent household behaviour. These findings suggest that a loss in confidence of banks as a creditor leads to a significant reallocation of money holdings. By contrast, the negative wealth effect of a financial loss — which is also incurred by the holders of bank equity — does not per se seem to trigger such behaviour.

Everyone in Cyprus saw what happened to large depositors, but only those who personally experienced losses felt compelled to adjust their savings allocations.

Things look different when Cypriots were asked about their longer-term plans. Almost one quarter of households surveyed were still willing to hold bank deposits in Cyprus above the deposit insurance threshold, while another third said they would hold no bank deposits whatsoever. Surprisingly, there was no relationship between these preferences and the experience of a bank bail-in:

While a bail-in of deposits or bonds strongly affects short-term changes in money holdings, the incurrence of a bail-in appears to have much less influence on the longer-term confidence of households in the banking sector…Households which experienced a bail-in of deposits are less confident in holding uninsured deposits at a bank than households which experienced no loss, an equity loss, or a bail-in of bonds. However, the difference between bailed-in depositors and those without a financial loss (10 percentage points) is modest compared to the overall low level of confidence. Likewise, we find only minor differences in confidence towards the deposit insurance scheme between bailed-in households and those households which did not experience a financial loss.

The researchers conclude that “policies to limit the use of cash as a means of payment and wealth storage may seriously constrain the asset allocation of households”. Or, put another way, the combination of a cashless society and regular deposit haircuts could be a recipe for economic catastrophe.

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