Fairness and Reflexivity in the Cyprus Bail-In

Abstract

The Cyprus debt crisis provides some unique lessons. By the time an assistance program was agreed with the Troika of international lenders, the problem had become so complex that a depositor bail-in was implemented to safeguard financial stability. The bail-in was an ad hoc solution applied for the first time in the eurozone but is now the blueprint for dealing with future banking crises. This paper examines the events for the eighteen-month period before the two eurogroup meetings on Cyprus in March 2013, and the resolution and restructuring of the two systemic banks of the country with depositor bail-in. We show how delays in dealing with the crisis exacerbated the problem but also how the tools brought in to solve the problem had significant unintended consequences that fit the reflexivity principle. Available evidence questions the validity of confidential studies guiding the policy decisions on depositor haircut and supports the argument that the bail-in, as implemented in Cyprus, violated international principles of fairness. We use the analysis to draw some lessons on the use of bail-in for future crises.

Keywords: financial crisis, banking crisis, depositor bail-in, risk management, neglected risks, eurozone, Cyprus, Greece

JEL Classification: E32, E44, E63, F32, F34, G33