Editor’s note: As the Cyprus debt and banking crisis rolls on, there have been comments, such as from the likes of Banque Havilland in London, noting that there have been significant flows out of the Mediterranean island in recent months. (That firm said yesterday it had seen a surge in the number of enquiries from HNW individuals for guidance on where best to hold wealth in the future.)

This is scarcely surprising  – more outflows may happen although much depends on the imposition and effectiveness of any capital controls that the government tries to impose. Meanwhile, at Exclusive Analysis, a firm tracking geopolitical risks of interest to investors and business, its chief global economist Brian Lawson, gives his assessment of the situation.

Currency risk: Greek and German banks are likely to suffer as Cyprus contracts, creating the likelihood of future bail-in in Greece.

With no Russian help forthcoming, and the European Union unwilling to compromise, Cyprus has been forced to yield to EU rescue conditions. Its modified rescue package writes off junior and senior bonds issued by Laiki Bank, the first time senior bondholders lose their capital. It imposes unspecified heavy losses on larger (more than €100,000 ($127,783)) depositors in Laiki. Their deposits will be used to cover losses, with the bank being run down and smaller, guaranteed deposits transferred to Bank of Cyprus. Larger depositors in Bank of Cyprus also face a significant write-down and enforced deposit-for-equity swaps. Affected deposits in both banks are frozen to avoid capital flight. Guaranteed depositors (less than €100,000) and Cyprus´s smaller, more solvent banks have been spared haircuts, reversing the Troika´s prior failure to respect a eurozone bank guarantee scheme.

Despite significant lending to Cyprus as a country, the eurozone banking system has minimal exposure to Cypriot banks. This reduces immediate contagion risk. The latest BIS data showed that banks from reporting countries (which exclude Russia) had $58.4 billion of Cypriot exposures in September 2012. However, lending to Cypriot banks was just $441 million. Instead, $40.7 billion was private sector debt. Unsurprisingly, Greek banks were most exposed, with $16.4 billion, followed by German banks with $7.6 billion. France, Italy, Netherlands and the UK are also among large holders of Greek deposits.

Cyprus now faces severe economic pressures: it has lost its role as a low-tax financial sector haven. Inevitable recession places at least some Cypriot private sector loan exposures at risk within a three-year outlook. Greek banks are already being rescued and are thus unable to cope with potential new losses.

Future losses in Cyprus could force Greece to seek additional rescue funds: this is unlikely to be welcomed by the Troika. As a result, Greek banks could face similar bail-in risks to those imposed on Cyprus (despite claims that Cyprus is a unique case). Elsewhere in the eurozone, the initial involvement of all deposits within the proposed bail-in and the inclusion of senior Laiki debt in the write-off threaten to encourage deposit withdrawal from, as well as to curtail market access for, troubled banks during future eurozone crises.

Capital flight is likely to be exacerbated by comments from Eurogroup President Jerome Dijsselbloem, suggesting depositor and senior bondholder bail-in should become the norm in future. Huge French and German bank exposures to Italy and Spain give these large countries greater leverage: risk is thus potentially highest in smaller countries with lower negotiating capacity, such as Slovenia. Renewed capital flight is likely to produce weaker bank share and bond prices, reduced access to bond markets, and greater reliance on ECB facilities.