Just when Europe looked like it was stabilizing and would no longer muck up global growth, they unveil a scheme that has surprised depositors across the world. Cyprus, a tiny economy, has a banking system on the verge of collapse, like Greece, Portugal, and Ireland before it. Before the EU will agree to give the country a $13 billion bailout needed to keep the banks afloat, it has attached a new and unprecedented requirement. Deposits in Cypriot banks will face a one-time tax to help defray the bailout costs. Deposits of more than 100,000 Euros will face a levy of 9.9% while those under 100,000 Euros will face a levy of 6.75%. In all the previous European bailouts, bondholers and shareholders were forced to take the cut while taxpayers helped to foot the bill. Imagine waking up and finding out that your savings account had been reduced by 10% overnight.
Cyprus does have a deposit guarantee through the central bank but it is worth little if the entire financial system has collapsed and the country has no money. Should Europe pay off depositors? Probably. But this underscores the fact that the deposit guarantee is only as good as the country that backs it. It also underscores why a country with only several large banks can collapse the entire system if they get into trouble.
FDIC and NCUA deposit insurance in the United States appears to be solid. No depositor, including in the Great Depression and the Financial Collapse in 2008, has ever lost a penny of FDIC insured money. But it could still happen one day. That's why BestCashCow provides an indicator of bank health and safety on each bank's page (example: Brookline Bank). A safe bank doesn't mean lower rates either. Our research has shown that banks that are in better financial condition, generally offer better rates. Depositors can have their cake and eat it also.
The EU is already backtracking on the Cyprus deposit levy idea, so we'll see where it goes. While Cyrpus is a small country with limited direct impact on other nations, it could spook depositors in other countries. That's why the bailout has attracted so much international attention. If savers in Italy, Spain, Ireland or any other country with bank problems perceive that deposit money could be in jeapordy, they could pull the money and either put it under their mattress or in a safer country. Such a bank run would only magnify the financial problems in those countries.