Cyprus avoids a bad haircut, but pays a price for shady finance

The dark side of sunny Cyprus: money laundering and lax enforcement of tax law has made the country a hotspot for wealthy Russians.

In a surprise move that shocked investors and commentators alike, the Republic of Cyprus announced plans last weekend to impose a levy on bank deposits.

However, Cyprus’ prime minister, Nicos Anastasiades, had warned on Tuesday that parliamentarians were likely to reject the levy. Overnight, the levy was rejected resoundingly: not one parliamentarian voted in favour of the controversial haircut. Cyprus had planned to raise €5.8 billion ($AUD6.78 billion) from a one-off levy on bank deposits. Deposits of €100,000 or more would incur a 9.9% penalty, while smaller depositors would face a 6.75% tithe.

The €5.8 billion levy was expected to raise is a part-contribution to the €10 billion sovereign bail-out plan hatched by the IMF and the EU Commission. Corporate taxes in Cyprus are currently at 10%, although hikes are on the table.

Dirty laundry

The fact is that Cyprus is money-laundering central. Wealthy Russians aren’t parking their rubles there because they find the climate hospitable. This Mediterranean version of the British Virgin Islands is a EU tax haven (click here for an illuminating list) meant to provide banking secrecy and financial confidentiality in handy, super-yacht proximity to the filthy rich’s pied-à-terre in Cannes, Côte d’Azur and Monaco. (Disclosure: I have been on Microsoft co-founder Paul Allen’s mega-yacht. Paul Allen isn’t actually aware of this. Yet.)

Do not believe the apologists when they state that Cyprus is “fully-compliant” with EU anti-money-laundering (AML) directives and supervised by the ECB. The EU only reached agreement on common bank supervisory arrangements in December 2012.

The ECB also supervises the Bank of Greece, which, in turn, supervises Greek private banks. As Der Spiegel reported recently, neither the Bank of Greece nor the ECB seemed to notice that around 2,000 Greek citizens, many of who appear to earn minuscule incomes, transferred around €52 million to HSBC’s Swiss arm between 2009 and 2011.

It was only in 2010 when future IMF chief, Christine Lagarde, who was then France’s finance minister, handed the Greek government a list of Swiss bank accounts held by Greek citizens. The Greek tax office didn’t appear keen to follow it up.

How does this relate to Cyprus? Remember, the ECB supervises the Bank of Cyprus as well — with a telescope to the blind eye.

For those with long memories, you will recall the Bank of Credit and Commerce International (BCCI), a cesspit of drug-running, terrorist financing, money laundering and arms trafficking. Headquartered in Luxembourg and supervised, ostensibly, by the Bank of England, its tentacles delved deep – allegedly – into the Carter and Reagan administrations.

The point here is that national central banks cannot be trusted to either exercise competent supervision or undertake adequate prudential monitoring. Irrespective of its provenance, provided capital flows in, neither governments nor central banks are particularly concerned about dodgy dosh. After all, dirty money smells just as good as clean, crisp euro notes.

My beautiful laundrette

In case you’re interested in laundering the lazy few million rubles you have burning a hole in your pocket, here’s the three-stage process:

Placement: placing illicit profits into the formal financial sector, or illegally transferring funds out of the country. Like Russia, for instance.

Layering: dividing or separating funds from their original source by employing a number of transactions – for example, through corporate vehicles established in off-shore financial centres. Like Cyprus, for instance.

Integration: placing laundered funds back into the formal economy. Like Russia, for instance.

Suddenly, Russian President Vladimir Putin is concerning himself with the affairs of a tiny island nation in the Mediterranean. Why? Well, one might assume that the Russian Federation is justifiably concerned by a deposits tax where around €40 billion of the €70 billion on deposit in Cypriot banks is owned by Russian banks and corporations. According to financial watchdog Global Financial Integrity, Russia has invested almost €200 billion in Cyprus, with capital outflows from Cyprus back to Russia totalling close to €130 billion.

Last Monday, Putin went further, describing the levy as “unfair and dangerous”. Russian finance minister, Mikhail Prokhorov, presumably in an attempt to show he is a classicist, argued that the EU was opening up a “Pandora’s box” and “had set a real financial mine under the idea of a single Europe”.

I’d be rather worried too, if my ill-gotten Pandora’s box of mafiya, narcotics and sex-trafficking money wound up in the consolidated revenues column of the IMF.

Throughout the ‘90s, Russia was cited by the G7’s Financial Action Task Force (FATF) as one of the most problematic money-laundering territories, as noted by the 1997–98 FATF-IX report. Consequently, the Russian Federation enacted a number of pieces of legislation designed to combat money laundering, such as the 2001 Law on Action to Combat the Laundering of Proceeds from Crime, which brought Russia closer to the legislative standards adopted by the FATF and in the EU’s Second Money Laundering Directive. In other words, just enough to silence the squawking geese in Brussels.

The problem is, once Russian laws started homing in on organised crime and corruption, Moscow simply sent the problem offshore. Once Cyprus entered the EU in 2004 and adopted the euro in 2008, the ghost in the machine was unleashed.

But it beggars belief that a tidy proportion of dirty Russian rubles aren’t being laundered into clean rubles and euros by Cyprus’s banks. And it’s not as if German finance minister Wolfgang Schaueble and Eurogroup chairman Jean-Claude Juncker have been particularly subtle about the connection between Russo-Cypriot bilateral investment.

That is what the combined EU-IMF Cyprus deposits tax is all about: hitting up the legitimately wealthy, as well as those with ill-gotten gains, to repay Cyprus’ debts. Taking a leaf out of the US Internal Revenue Service’s 1930s playbook, which saw Al Capone arrested on tax evasion, the EU and IMF are striking at money launderers’ most vulnerable assets: their official deposits.

Zero option

The problem was that the less-than-wealthy Cypriot, from pensioners to paraplegics, from the unemployed to first-home savers, could have been hit with a one-off 6.75% levy. Unsurprisingly, Cyprus’ parliament rejected this measure, eliminating the tax on depositors with less than €20,000 in the bank.

However, one can fully understand why Cyprus’ government originally planned to hit depositors across the board: what about splitting up bank accounts by placing smaller sums (i.e., less than €20,000) in false or fictitious names? This is unlawful throughout the Eurozone, but it’s not difficult to accomplish and is routine in many countries.

Interestingly, the Europeans appear divided over the plan to Eat the Rich. Schaeuble claims the decision to levy the tax came jointly from the government of Cyprus, the ECB and the EU Commission, while noting that Germany would have supported the bank deposit guarantee guarantee on small accounts held by savers. In other words, Schaeuble is pointing the finger squarely at Brussels and Frankfurt.

What other option did Cyprus have? Would Cypriots have preferred across-the-board tax rises of indeterminate duration? Or a one-off levy? Is it not reasonable that the main beneficiaries of Cyprus’ generous – nay, lax – financial intermediary service industries bear the brunt of the costs associated with maintaining this offshore tax haven?

First, the bail-out plans proffered to Ireland, Greece, Portugal and Spain involved some steep personal and corporate tax hikes to boost revenues and cut fiscal deficits. In January this year, Greece raised the corporate tax rate to 26%, while increasing the top-tier personal income tax rate to 42%, starting at a comparatively-low €42,000.

Second, 90% of Cyprus’ bank deposits will remain intact. Its status as a tax haven is assured, as it is the only means by which it can secure investment and, as a conduit for dirty money transformed into euros that can then be utilised for any legitimate purpose.

Third, the Cyprus deposits tax will be raised almost immediately; there will be uncertainty associated with taxation revenue increases. Many Club Med revenue targets will not be met due to either (i) evasion; (ii) avoidance; (iii) low, zero or negative economic growth; (iv) high unemployment, shrinking the revenue base; or (v) all of the above.

Fear not. Other Euro governments are not about to introduce Cyprus-style deposits taxes, although if the ECB and Commission are trying to induce panics among depositors, they sure are going about it the right way.

And you can take that to the bank.