In January 2012 Standard and Poor's downgraded its long-term credit rating for the Republic of Cyprus from BBB to BB+ citing it's opinion of the effect on Cyprus of deepening political, financial, and monetary problems within the eurozone, with which Cyprus is closely integrated.
The downgrade also reflected the view of Cypriot financial institutions' significant exposure to Greece, which was believed to further exacerbate Cyprus' existing external vulnerabilities.
Savers in Ireland should note that this downgrade was equivalent to moving from where Ireland is currently rated, down just two notches.
Roll the clock on a little over a year and S&P's concerns appear to have been realised with the Cypriot banking system now requiring a bailout of some €10-12 billion, and in a new twist in the ongoing saga, the government has been forced to consider imposing burden sharing upon ALL depositors.
The proposal on the table is that those with deposits below €100k in a bank will be “taxed” at 6.75%; those with deposits above €100k will be “taxed” at 9.9%, contributing approximately €6bn to the bank bailout in total.
This proposal overrides existing depositor insurance schemes. Although most of us have been assuming that no matter what, deposits up to €100,000 are protected under an EU-wide deposit protection scheme, instead savers will receive equity in their respective banks by way of compensation.The shortfall of €4-6 billion will have to come from the ECB/IMF.
This highlights, at a time when Ireland is about to end the Eligible Liabilities Guarantee, the very real risks faced by savers in deposit institutions subject to "guarantees" which is that the guarantee is really only as good as the ultimate backing of the country issuing it. In the case of Ireland this means a Sovereign State rated just two notches above Cyprus.
It seems reasonable to assume that anyone with over €100k in deposits with a single banking group should expect to bear some risk in the event of a collapse of a bank. As we know, this has already happened in Ireland with certain structured products issued by Anglo Irish Bank having already defaulted.
However, the key insight from Cyprus is that a precedent has now been created in terms of the socialisation of losses across bank deposits and now not even €100,000 can be viewed as "certain".
We have argued consistently for the last 5 years that risk and expected returns are related. If an Irish bank is paying above the market rate of interest for deposits, then this has to be seen as some manifestation of risk.
We recommend that cash and fixed interest investments should have an average AA+ credit rating and this now rules out virtually every single institution operating in the Republic of Ireland with even RaboBank now "only" rated AA.
With interest rates so low on bank deposits, it seems possible that savers will now be more willing to consider alternatives and most, without a clearly thought out plan, will be prey for the financial services sales machine.
Before you leap out of the frying pan and into the fire think about what you need your money to do for you, and consider working with a financial planner who has your best interests at heart rather than a commission based sales person who will tell you what you want to hear.
