A Financial Hub's Future: Can Cyprus Retain Its Banking Sector?
Puri, Indira, Harvard International Review
Will the recent Cypriot crisis change the structure of the Cypriot economy? The country's economic strength has, in recent years, stemmed from its banking sector, with bank deposits amounting for over seven times the country's GDP in 2010. In the aftermath of the crisis, however, Cyprus has both imposed a bank levy and increased various taxes to pay back its debt, both moves that could potentially hurt Cyrpus' standing as a financial powerhouse. On the one hand, the bank levy imposed by the Cyprian government on deposits above 100,000 euros and the increase in tax rates may drive depositors to other countries. On the other hand, the Cypriot government claims that the bank levy is a one-time action and will not be repeated; Cyprus' tax rates, even after this increase, will remain one of the lowest in the Euro zone; and other countries are dealing with their own problems, so Cyprus, if not as wonderful a place to deposit funds as it was before the crisis, may remain the best place to deposit funds relative to other options. Assessing whether depositors are likely to flee the country in the long term means assessing whether the bank levy is likely to be a one-time occurrence and determining Cyprus' appeal as a tax haven relative to other potential tax havens. Unfortunately for Cyprus, it seems that the bank levy, even if one time, if likely to drive depositors away from the country, and that the relative appeal of Cyprus as a financial center is likely to diminish following policies implemented during the crisis. In the long term, then, Cyprus is unlikely to have as large a banking sector as it did before the onset of the Cyprian crisis.
Cyprus is the currently the only country in the Euro zone to levy tax on bank deposits, which means depositors can turn to any other country in that region to preserve their funds it depositors believe that Cyprus is likely to impose another bank levy. While the Cyprian government has stated that the levy is a one-time policy, and will not be repeated, foreign depositors have reason to doubt this assurance primarily because Cyprus has offered no reason why this levy is an extraordinary, exceptional policy whose repetition is unlikely. Rather, the country has merely stated that it is in need of funds, and that, because it is in need of funds, it is imposing a bank levy as a means of raising money. If Cyprus' only justification for the use of a bank levy is a dearth of funds, a dearth of funds may well occur in the future, and this same justification could be used to impose yet another levy. …