Coutts, the UK private bank, takes a look at the bank crisis in Cyprus and the controversy over a proposed levy on savers' deposits, and what this means for the euro.

Editor’s note: Below are comments on the controversial bank bailout deal for Cyprus, which takes such processes into uncharted waters by imposing a levy on savers, which has alarmed financial markets (the euro fell in the exchanges on Monday morning). Here are comments from Norman Villamin, chief investment officer, Europe, at Coutts. The remarks are taken from the regular “Coutts Wealth Watch” commentary sent out by the bank.

The controversial bank bailout deal for Cyprus is unprecedented in that it penalises savers. The images of frantic customers queuing outside branches, desperate to withdraw their hard-earned savings, highlights the precarious position the eurozone still finds itself in.

What has happened?

Cypriot authorities, together with the European Union, the European Central Bank and the International Monetary Fund agreed on a €10 billion ($12.95 billion) funding programme intended to stabilise the local banking system. In a clear break with recent policy trends, the plan passes a significant part of the cost on to savers, while also bailing in junior bondholders (forcing them to exchange their bonds for bank equity).

Under the deal, approximately €6 billion will be raised through a 9.9 per cent levy imposed on customer deposits of more than €100,000 and a 6.75 per cent levy on deposits under that sum.

Is it a done deal?

Not yet. The deal has caused uproar and many savers have tried to withdraw their savings. The Cypriot government is discussing the possibility of changing the levy to 3 per cent for deposits below €100,000, and to 12.5 per cent for above.

The move to take a percentage of deposits, which could raise almost €6 billion, must be ratified by parliament, where no party has a majority. If it fails to do so, President Nikos Anastasiades has warned that Cyprus's two largest banks will collapse. Under the original deal, depositors will receive bank equity as compensation. The Russian government and International Monetary Fund have yet to agree to make contributions to the programme.

Why was the Cypriot deal structured so differently?

The size of the banking recapitalisation needed in Cyprus is much larger than elsewhere - so a bail-out by bringing the liabilities onto the government balance sheet was not possible given the country’s sovereign debt burden.

With only about €4 billion of senior bank debt outstanding, forcing senior debt holders to take a haircut would not be enough. Given the bank’s relatively weak anti-money laundering framework and high number of non-resident depositors, there was also relatively little appetite to directly bail them out.

Will there be a run on Cypriot banks?

The likelihood of a bank run seems limited. It has been suggested the government may ring-fence Cyprus’s largest banks - Bank of Cyprus and Laiki Bank. Further deposit outflows from the periphery would, however, be a further drag on growth and confidence following the Italian elections. The current situation in Cyprus does serve to highlight the increasing risk to bond holders and depositors in peripheral countries.

Where does it leave investors and other bank savers?

It leaves investors highly dependent on local compensation schemes and emphasises the absence of progress on a pan-European banking framework and deposit insurance scheme - which would have more credibly addressed concerns. With the battle lines clearly drawn - to the detriment of junior bond holders - we continue to have a preference for senior bank debt in the eurozone’s periphery.

Our concerns do not extend to core EU members - where bank capitalisation has been much-improved and regulatory frameworks considerably strengthened.