Using public money to shore up ill-liquid banks is the problem.
The Cypriot political class has decided to play for time: not good!
Here’s the good news: what Brussels decided to do was overt, it just didn’t prepare the population to understand what it was doing on their behalf. By floating an idea to tax depositors to pay for recapitalizing failing banks, Brussels was advancing an idea publicly. It was rejected. Normally, Central Banks (think the U.S. Federal Reserve) pound down interest rates to create another spending bubble permitting the investor class to chase higher equity yields; this creates revenue for govmint while it depreciates the currency!
Brussels was doing overtly what the American Central Bank does covertly.
Where did the banking technocrats in Cyprus fail?
They didn’t distinguish between failed and non-failed banks. They tried to protect a political class namely bank creditors, and they never had deposit insurance.
With each crisis comes new divergent models from which the macro-technocrates in Brussels create moral hazard. This dysfunction has a political origin. A banking union is required to create a lasting bulwark against insolvency. The IMF and the European Stability Mechanism have a roll to play here, however, each seems hopelessly futile as an indigenous political class is caught dimwitted.
Here’s the choice: hit depositors or hit European tax-payers.
A plan should incorporate that senior bondholders get wiped out. Uninsured depositors get wiped out. (Putin will declare war!! But do it anyway.) Anyone with deposits under 100k are insured. Fearing bank runs means having the European Central Bank on hand. Specifically, a 7% tax on depositors over 100k would suffice. But a political statement must be made regarding senior bond holders and Russian money laundering. By writing down bank debt, wiping out creditors and preventing bank runs this policy respects creditor/depositor hierarchies and the rule of law.