Cyprus shock troubles shaky banking system

FRANKFURT, Germany – This week’s deal to rescue Cyprus and its banks from financial collapse has renewed fears about Europe’s shaky financial system and where trouble might next appear.

Many banks across Europe have been struggling for more than three years as losses on government bonds and bad loans piled up. Some governments, meanwhile, have taken on more debt trying to prop up their lenders to the point where they have needed bailing out themselves.

In Cyprus’s case, its banking sector became much bigger than the country’s government could afford to rescue – seven times the size of the country’s economy. When the banks were hit by large losses and Cyprus could not afford to bail it out on its own, the country turned to the other 16 European Union countries that use the euro.

Rather than making Europe’s taxpayers foot the entire bill for bad banking, Cyprus and the other eurozone countries agreed to make the banks’ bondholders and big depositors contribute to the rescue.

One bank, Laiki, is to be split up, with its nonperforming loans and toxic assets going into a “bad bank.” The healthy side will be absorbed into the Bank of Cyprus. Savers with more 100,000 euros in both Bank of Cyprus and Laiki will face big losses – possibly as much as 80 cents on the euro.

Daniel Gros, director of the Centre for European Policy Studies in Brussels, said the Cyprus deal “could be a strategic change.”

Depositors and investors have taken note of the Cyprus deal and are warily looking around at other countries where the financial sector appears too big or too unstable. The STOXX Europe 600 Banks index have fallen 7 percent since a first bailout deal, later rejected, was reached March 16.

Even some of the more financially disciplined countries in the eurozone can raise concerns: The Netherlands had to take over SNS Reaal, the country’s fourth-largest bank, after it suffered heavy losses. And in Germany there are banks under pressure from competition and losses on bad loans. However, most of the countries that are gaining scrutiny in the aftermath of the Cyprus bailout do not have economies on the same scale as the eurozone’s financial leaders.