Posted on April 17, 2013 by David Laidlaw
Cyprus’s decision to appropriate a percentage of the deposits in its banking system appears to be another example of the dangers of “reaching for yield.” When high-quality money market funds and savings vehicles provide very little return, there is a strong temptation to invest in lower quality institutions to obtain higher interest rates.
Financially secure banks in Germany such as Deutsche Bank typically pay about 0.4% to their depositors for one-year CDs. An article, “Foreign Businesses in Cyprus Grind to a Halt”, in The New York Times dated March 24th reported that the Cypriot banks were paying some depositors 5% interest on their balances. It has also been reported that over $30 billion in Cyprus’s banking system (or about 30% of deposits) was held by Russians.
This suggests that wealthy Russians were speculating that the banks would be bailed out and their deposits protected. However, it appears that the final deal with the European Central Banks calls for uninsured deposits (amounts greater than 100,000 Euro) to lose about 60% of their “investments.” These consequences demonstrate the risks of trying to get higher interest rates than the legitimate market offers.