Right now, the two largest banks in Cyprus are dangerously close to a meltdown. If they fail, depositors could end up losing virtually all of their money. That's because, the banking system of Cyprus absolutely dwarfs the GDP of that small island nation.
Cyprus is known all over the world as a major offshore tax haven, and wealthy Russians and wealthy Europeans have been pouring massive amounts of money into the banking system over the last several decades. What's more those bank deposits are supposed to be insured, but the truth is that there is no way that the government of Cyprus could ever come up with enough money to cover the massive losses that we are potentially looking at.
This is a case where the banking system of a nation has gotten so large and so rotten that the national government, without a central bank to create its own money, is absolutely powerless to stop a collapse from happening. If those banks fail, depositors may end up getting 50 percent of their money or they may end up getting nothing.
No one outside the banks know how bad the damage is yet. And considering the fact that many of the largest corporations and many of the wealthiest individuals in Europe have huge mountains of cash stashed in Cyprus, the fallout from a banking collapse could potentially be absolutely catastrophic.
So Cyprus needs to come up with some money from somewhere in order to keep that from happening. Basically, there are three options at this point...
1) Even though the bank account confiscation tax was voted down today, there is talk that it could come back in another form. This is really the only place inside of Cyprus where enough money can be raised to bail out the banks.
2) Cyprus could go back and beg the IMF and the EU for money, but the IMF and the EU have already said that they want depositors to share in the pain.
3) Cyprus could get the money that they need from the Russians. This will be discussed in more detail later.
4) They could leave the Euro and replace the deposits with a new currency created by a central bank...but that would most likely see a devaluing of the new currency by international traders..it would recover however.
A lot of people will see the headlines proclaiming that Cyprus has voted against the wealth tax and think that everything is going to be okay now, but that is very far from the truth. The reality is that this is only the first move in a very complicated chess game. The problems for Cyprus have just begun. When the banks of Cyprus reopen in a few days, there is going to be a stampede of people trying to pull their money out of the banks.
In fact, this was starting to happen even before the "bank holiday" was declared. According to press reports http://www.wirralonline.com/news/item/troops-betrayed-in-cyprus-bank-grab-as-russians-seize-%C3%82%C2%A32bn , bank insiders were tipping people off about what was going to happen in the days leading up to the crisis...
But Russian oligarchs and big investors emptied accounts in the days beforehand, prompting claims they were tipped off by bank insiders. A source told The Sun: “It leaked out. Bankers warned their best clients. Government officials warned their friends and relatives.
According to some http://www.businessinsider.com/david-zervos-cyprus-may-turn-into-a-std-situation-2013-3 we could see billions more euros withdrawn from banks in Cyprus once they reopen. There will be mass panic as depositors scramble to reclaim their money before it can be taxed. It may not even matter what Cyprus eventually decides to do about a "wealth tax". The bank run that is about to happen may be enough to bring down the banks of Cyprus all by itself.
And of course people all over southern Europe are watching developments in Cyprus very closely. As Alistair Darling recently noted, if depositors in southern Europe start getting nervous that their bank accounts will be targeted too, they will be likely to start pulling money out of the banks very rapidly. http://www.telegraph.co.uk/finance/financialcrisis/9939443/Darling-Cyprus-savings-raid-could-trigger-bank-runs-across-Europe.html
"They have actually now said to people ‘We will come after your deposits, no matter how small your savings are’ and that seems to me to make it more likely that, if you are a saver in Spain or in Italy, for example, and you have just the sniff of the EU or the IMF coming your way, you will take your money out and you will get a run on the bank"
And if you don't think that this could ever happen anywhere else, you are just being delusional. In fact, the Finance Minister of New Zealand is now proposing that depositors in his nation should be required to "take a haircut" if any banks in his nation fail... http://www.scoop.co.nz/stories/PA1303/S00306/national-planning-cyprus-style-solution-for-new-zealand.htm
The National Government are pushing a Cyprus-style solution to bank failure in New Zealand which will see small depositors lose some of their savings to fund big bank bailouts. What would we all do if we suddenly discovered that you had no money in the bank? Most people just assume that their money will always be there because their bank accounts are "guaranteed" by deposit insurance and by the full faith and credit of the the UK government.
But that is exactly what the people of Cyprus thought too, and look how that turned out. It would be hard to overstate how dangerous the situation in Cyprus is. Yes, their nation is very small but their banking system is absolutely huge, much like the UK. If the banking system of Cyprus fails, it could be a "Lehman Brothers moment" for all of Europe. At this point, the entire European banking system is leveraged 26-1 see explanation here http://www.zerohedge.com/contributed/2013-03-19/could-cyprus-take-down-eu-banking-system , which basically means they do not have the cash to cover bad investments.
Once European banks start to fail they could start falling like dominoes. There is also a very strong possibility that Cyprus could be forced to leave the euro, and if that happens everyone will be wondering who will be next to leave.
So don't think for a second that the crisis in Cyprus is over. The banking meltdown version 3 is just getting started, and the consequences could end up being far more dramatic than any of us could possibly imagine.