The eurozone offered a support package of € 10 billion to Cyprus on the condition of a contribution from Cypriot savers. Cyprus rejected these conditions and the support.

The European conditions were ill received in European countries as well. In other countries, bank holdings up to € 100,000 are fully guaranteed. Asking something different of Cypriot savers would be a breach of trust in the eurozone banks and might have a knock-on effect on banks in other countries. Savings, however, do come with risks as well. Before the financial crisis hit in 2008, deposits were guaranteed at much lower levels. Why would Cypriot deposits above € 100,000 be protected at all?

The main sentiment in Europe, however, seems to be that Cypriot banks are safe havens for illicit Russian capital exports and it is (politically) unthinkable that European money would be used to bail out Russian ‘villains’. They needed to be bailed in, hence the tax.

Sensing this sentiment, the Russian Prime Minister Medvedev considers the European support plan to be an assault on Russian interests. He demands to know whether the Russian money in Cyprus is indeed illicit, as that would also hurt Russia’s interests. He has a point. To levy savings may be an easy way to bail in Russian ‘villains’ in the financial crisis, though it is a legally dubious way of doing so.

A difficult, but legally sounder, way for Cyprus to go in this respect would be to consider a banking purge equivalent to reforms after wars, such as for instance the monetary reform of 1945 in the Netherlands. To recreate a functioning monetary system and to wipe out black market earnings, on September 26 1945 all existing money was declared void overnight and all bank accounts were blocked. Everyone received 10 guilders to tide them over for a week, after which time a gradual release of deposits was engineered. The release of these deposits, as well as the exchange of old denominations into new ones, was conditional upon the legal origin of these funds. Ill-gotten money could not be turned into new tender, while the gradual process ensured that a sound system was set up.

A banking purge in Cyprus would ensure the identification and safeguarding of ‘honest’ money and satisfy Medvedev’s request to scrutinize the legality of Russian deposits in Cyprus. If these turn out to be illegal or cannot be traced, there is no harm in declaring them void and thus improving Cyprus’ bank balances. An interesting legal question would then be whether Russia can exercise a claim on these deposits. If they are legitimate, banks remain in dire straits and Cyprus in deep trouble. But a purge would allow for a clean-up of the banking sector. Some banks may prove to be sustainable, with or without an additional capital injection. Others may go bankrupt, in which case - in line with other European countries - their customers will find their savings up to € 100,000 guaranteed by the Cypriot government. Again, an interesting legal question is then whether this guarantee, ultimately paid for by Cypriot or European tax payers, would extend to non-Cypriot or non-European depositors.