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Friday, March 29, 2013

Small States Stress Distance from Cyprus

BRUSSELS—Luxembourg and Malta moved to defend their economic models after Cyprus's bailout turned the spotlight on other small euro-zone countries with large financial sectors.

Senior officials from the two countries, both of which have financial sector assets many times the size of economic output, slammed what they called misleading comments from senior European officials suggesting that small countries with huge financial sectors may present a threat to financial stability in the euro zone.

In a statement released early Wednesday, Luxembourg's government said it is "concerned" about recent "comparisons between the business model of international financial sectors in the euro area."

The comments come two days after Cyprus secured a €10 billion ($12.9 billion) European bailout under terms that include winding down its second-largest bank, Cyprus Popular Bank PCL. On Wednesday Cyprus laid out details of aggressive capital controls to curb the flow of money out of the country.

Luxembourg, with a population of just 525,000, has one of the European Union's largest banking sectors on paper, thanks to a tradition of low taxation and comparatively light regulation dating back decades. According to European Central Bank data, the country's banking assets are about 22 times its annual economic output, compared with a multiple of around seven for Cyprus.

The Luxembourg government took particular issue with comments by some officials that have attempted to boil down the essence of Cyprus's problems into a simple question of the size of its banking system, relative to its overall economy. What matters, rather, is the "quality and solidity" of the financial sector and its size in relation to the euro area as a whole, the government said in a statement.

The Luxembourg government said that its financial industry has a "diversified customer base, sophisticated product services, efficient supervisory mechanism and rigorous respect and implementation of international standards add to its uniqueness". By contrast, Cyprus's financial sector was considered to be "structurally unbalanced," it said.

Cyprus's bailout has sparked fresh warnings from policy makers about overreliance on financial sector revenue. In a speech in Moscow last week, European Commission President José Manuel Barroso said the crisis in Cyprus was "the result of an unsustainable financial system" that was a multiple of the country's GDP and "certainly has to adapt."

"Markets are now focusing on potential weaknesses in euro-zone states whose banking sectors very large relative to their economies," said Christian Schulz, an economist at Berenberg Bank in London.

The Cypriot bailout was notable for being the first in the euro zone to impose losses on bank depositors for the first time. The agreement is designed to protect deposits up to €100,000, but will impose severe losses on bigger ones.

Berenberg's Mr. Schulz said that the political signals from the Cyprus bailout are a clear threat to Luxembourg's interests. "That in itself will raise concern with people who have large deposits there," he said.

Still, Luxembourg's banking sector consists largely of subsidiaries and branches of foreign banks, so significant support might be expected from mother banks and, ultimately, the governments of those mother banks, in the event of a crisis. Just 8% of Luxembourg's banking assets are held by domestic banks compared with 71% for Cyprus, according to Mr. Schulz.

That is reflected in the assessment of the three big international credit ratings firms, all of which still rate Luxembourg's government debt at triple-A.

"The Cyprus crisis has had no impact on Luxembourg banks or on client deposits," said Ernst Wilhelm Contzen, the Luxembourg Bankers' Association chairman, in an emailed statement.

"The Luxembourg banking system is one of the soundest and safest in the European Union, with Luxembourg banks having an average solvency ratio of over 17% over the last years" and remains a "haven for investors and depositors at the heart of the Euro-zone," he said.

In an interview published Wednesday, the central bank governor of Malta, another small country with big ambitions to build a financial sector, also dismissed as "misleading" any comparison with Cyprus. The assets of Malta's major banks amount to "just below 300%" of GDP, which by international standards was "within normal limits," Josef Bonnici said in an interview with the Times of Malta. Mr. Bonnici also highlighted the exceptional nature of Cypriot banks' losses on Greek government debt.

"Maltese domestic banks have limited exposure to securities issued by the program countries," Mr. Bonnici said.

Write to Tom Fairless at tom.fairless@dowjones.com

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