Having failed to agree a bank resolution regime more than four years into the Eurozone banking crisis, the EZ authorities have, at the second attempt, come up with a resolution of the Cypriot banks. The haircuts of uninsured bank creditors appear to be 60% and more.
After a bank resolution, the surviving banks are solvent. Naturally, depositors may feel sore, and there could be deposit flight as soon as they re-open, even where the haircuts have been severe enough to make them adequately capitalised again. But not to worry, the central bank is there to deal with irrational deposit flight. It is after all the lender of last resort.
But lo and behold, the Cypriot government has imposed capital controls - even insured deposits not facing a haircut are restricted. But since the written-down assets of the surviving banks are now in excess of their liabilities (they have been resolved) these assets will be money-good at the central bank.
Not so apparently. If the ECB believes that the surviving Cypriot banks are now solvent, why is there any need for restrictions on depositor withdrawals? Is the ECB prohibiting liquidity provision through ELA after a bank resolution to which it has been a party?
Of course the haircuts may, in the eyes of the ECB, be inadequate to ensure solvency. In which case why is the deal not modified further? Capital controls effectively create an inconvertible currency trapped in Cypriot banks, a precedent likely to be remembered when trouble strikes elsewhere. Do re-opening US banks decline to release deposits after the Feds have done their work, for the want of a lender of last resort?