No one wants to bail out Cyprus because it is “Greece with dodgy banks,” one third Russian depositors, a tax haven, corrupt, and the banking system is measured at eight times the size of the real economy. Even a pro-bailout politician may not wish to soil the name of bailouts by handling this case. The Germans are balking.
But if depositors take losses in Cyprus, what kind of precedent does this set?
One risky scenario is that it sets off a run on some of the weaker eurozone banks.
A better case scenario is that the market distinguishes Cyprus from the other cases (all of them? some of them?) in the eurozone and European Union. But that too involves a trick. Let’s say the market can distinguish Cyprus from Spain. Can the market also distinguish Greece from Spain? Is it good to break the expectation of “we’re all in this together,” even when doing so is justified?
A systemically costless fail of credit obligations in Cyprus is itself risky. It leads people to start wondering what else might be a systemically costless fail and testing that boundary. (“If we let Greece go, maybe they’ll know we are still committed to Spain…”) Which means a Cyprus fail might be systemically costly in the first place.