Cyprus Was Not an Exception

The recent crisis in Cyprus has highlighted the curious and dangerous phenomenon of banking systems that are much bigger than the economies in which they are based. One reason the government of Cyprus struggled to deal with its failing banks was that their assets were seven times as big as the country’s economy.

Cyprus is not the only such country in the euro zone. Luxembourg and Malta, which have established themselves as tax havens serving big global corporations and the superrich, have banking systems that are even larger. Luxembourg’s bank assets are a staggering 22 times its gross domestic product, and Maltese bank assets clock in at eight times the size of its economy.

Leaders of both countries have insisted that they should not be compared with Cyprus and that they expected European leaders to stand behind their governments and banks come what may. Speaking of his banking system, the finance minister of Luxembourg, Luc Frieden, said: “We want to expand it further, not to downsize it.”

Banks in Luxembourg and Malta, many owned by big European and American financial firms, are healthier than those in Cyprus, according to the International Monetary Fund. But the I.M.F. raised concerns about the ability of the countries to properly monitor their banks or support them in a crisis. In other words, the euro zone and the I.M.F. would have to step in to bail them out if they ran into trouble.

In any case, the euro zone needs urgently to finish work on a banking union that would allow the European Central Bank to supervise large banks instead of leaving that task to national policy makers who may be too protective of their banks. Europe should also have a common process to restructure troubled banks, which should reduce the risk of Cyprus-like debacles. A banking union would also give savers more confidence that their insured deposits are truly guaranteed, an assurance that was deeply shaken by what happened in Cyprus.

Thankfully, the crowds were not as big and chaotic as people had feared when banks in Cyprus reopened last week after for two weeks — but only after the country imposed tough capital controls to prevent depositors from fleeing. Europeans may not be as lucky next time.

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