The announcement that a levy (another word for expropriation) would be imposed on deposits at Cypriot banks in order to help finance the country’s bailout package must be one of the most bizarre and incomprehensible decisions ever taken by the Eurogroup early on Saturday morning. What on earth were they thinking?

The eurozone crisis is far from over

Back in 2008, when the financial crisis exploded on to the scene, eurozone finance ministers acted quickly to try and preserve some semblance of confidence in the areas banking system.

“The Council of the European Union agreed on October 7, 2008, that it is a priority to restore confidence and proper functioning of the financial sector. It committed to take all necessary measures to protect the deposits of individual savers...”

This statement formed part of the proposal to amend the directive of the European Parliament and of the Council amending Directive 94/19/EC on Deposit Guarantee Schemes. So, on the one hand, the EU says it is committed to take all necessary measures to protect deposits of individual savers, on the other it imposes expropriation of depositors’ money by saying that Cyrpiot’s situation is unique.

Well well, haven’t we heard all of that before? Greece was special, Cyprus is unique. And it is clear that this type of private sector involvement has widespread support. Jeroen Dijsselbloem, the Dutch Finance Minister who is president of the Euro Group, said: “As it is a contribution to the financial stability of Cyprus, it seems just to ask a contribution of all deposit holders.”

International Monetary Fund managing director Christine Lagarde issued this statement following the Eurogroup meeting: “I welcome the agreement reached today to address Cyprus’ economic challenges. The IMF has always said that we would support a solution that is sustainable, that is fully financed, and that appropriately allocates the burden sharing. I believe that the agreed package meets these three objectives...”

So this is the IMF’s view of appropriately allocating burden-sharing. In other words, deposits are to be seen as dispensable forms of bank funding. And what about that depositor compensation scheme that we so dearly love. Well, in the interests of general financial stability the scheme is being ignored, with the levy structured in such a way that it does not trigger any of the schemes provisions. Thus, the credibility of such schemes is being seriously questioned.

The Cypriot situation may indeed be unique for these reasons: it has a high level of Russian money, weak money laundering standards, a very large banking sector compared to total GDP (the banking sector problems stem from the Greek debt restructuring) and in the words of the Cypriot Government, the alternatives are much worse. That a bailout was required was undisputed. Back in June 2012, the Cypriot Government made such a request. And the fact that banks had little senior bonds in issue exacerbated the problem since a Greek-style haircut would not provide sufficient funds. Additionally the banks need recapitalisation (they are about to run out of cash) and haircuts do not provide new cash. Junior bondholders are also being impacted. Still, the combined impact of involving senior and junior debt holders would not have been sufficient – though at least it would have respected the concept of the collateral status of such instruments. Thus the involvement of depositors’ cash was a question of the maths.

Even if this were the case, then why not target just the larger deposits rather than target also those deposits below the €100,000 mark – the entry level where the EU has stipulated that the deposit compensation scheme kicks in. The decision, therefore, to include such deposits sows a seed of doubt on the strength of the deposit compensation schemes that are in place. This doubt may now lead depositors to move their cash to safer havens. It is not unreasonable to think that if the authorities are not willing to save such a small nation, what chances are there to save the larger ones.

While at the time of writing the position remains very fluid, the outcome seems even less certain. Cypriot parliamentary approval is required and may not be achieved. The scenario of a rejection to the proposal in Parliament is more dramatic given it could lead to a failure of the banking system in Cyprus and an exit of the euro. Whatever the outcome, there are some serious lessons that need to be taken from this. The principle that deposits below €100,000 are safe is chief among these. Failure to respect at least this basic principle will lead to a resurgence of financial contagion and the possibility of bank runs, especially in the periphery. The eurozone crisis is far from over.

David Curmi is managing director of Curmi and Partners Ltd.