Cypriot bailout and use of market mechanism is commendable

ADVERTISEMENT
Now banks can open without a panic and massive withdrawal of funds. Financial and government leaders have shown good leadership and they should be commended for a solution which is one step better than the American bailouts in 2008.

In any banking crisis, the government should shore up the system so the global economy can function. Misjudgments by banks continue to have dire consequences as evident by the recent situation in Cyprus. The need for yet another bailout indicates risks inherent in global financial markets are either not recognized or not priced properly and therefore not covered adequately by the banks and governments.

When these risks materialized in Cyprus, the Eurozone elected to put a squeeze on the public in the form of a proposed bailout that included a levy on depositors instead of holding bank management and shareholders responsible for their mistakes. Banks should be asked to have these groups provide more capital to absorb book losses. Alternatively, the European Union should shore up the banking system.

Asking the general public to absorb losses turned out to be impractical and unfair to the depositors. If banks can’t absorb losses, then the government should use public resources, as in the U.S., like general taxes, deficit financing, and central bank assistance, to fix the problem.

Kaushik is a professor of Finance at Pace University’s Lubin School of Business in New York.