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What We Can Learn from the Crisis In Cyprus

Bank Run

Mary Poppins Bank Run

Often we take the ability to access our funds in the bank for granted. But it wasn’t always this way. Throughout history there have been runs on the bank. People fear that they won’t be able to get their money out and all rush to the bank at once to try to get theirs first. After all that is what fractional reserve means, i.e. only a fraction of the people can get their money at any one time. In ancient times before official banking was established people would loan their gold to the local goldsmith and he would give them a depository receipt and they would be able to come back at any time and get their gold back. Then rather than go to the goldsmith every time they wanted to buy something they just started trading the receipts. After a while, the goldsmith figured out that not everyone would ask for their gold at once so he could use some of the gold instead of buying his own. But if his reserves got too low his customers would grow suspicious and then everyone would begin rushing in to claim theirs and he would be lynched.

Classic movies have touched on the theme of runs on the banks. Do you remember the scene in “Mary Poppins” where the little boy causes a bank run? (If not, you can watch it by clicking the first image). Another one was in the Christmas Classic “It’s a wonderful Life” in this case George Bailey was able to prevent the bank run by using his own money and carefully explaining the fractional reserve system. (Click Second image to see it). Incidentally, there are recent real life examples of  banks not having enough cash on hand and doing exactly what George Bailey did to prevent a run.

Wonderful Life Bank Run

It’s a Wonderful Life- Bank Run

In one case the manager did exactly the opposite of what they did in Mary Poppins and pulled all the cash out of the vaults and stacked it behind the tellers where everyone could see it, to instill confidence in the people that there was plenty of money. On the first day, he instructed the tellers to take their time and pay everyone in small bills so they wouldn’t run out of cash. That night he wired for reserves to be brought in and the next day to prevent lines he instructed the tellers to pay everyone with large bills and pay them as quickly as possible so lines would not form. By the third day the possible run was over. That is one advantage of the Federal Reserve System, in a situation like that the banks can borrow from the Federal Reserve and prevent a bank run.

Does that mean that Bank Runs Can’t Happen- Right? Hardly, Ask Argentina or Cyprus.  In today’s article Leif Simon editor of the Offshore Living Letter tells us what lessons we can learn from Cyprus. ~Tim McMahon, editor

Crisis In Cyprus—What You And I Can Learn

By Leif Simon

Cyprus  is dominating the financial news this week. The details of any bailout seem to  change so fast that the media can’t keep up. The suggestion of imposing a  one-time tax on deposits in Cypriot banks hit hard opposition from Cypriots,  although the tax seems to have been targeted at the many Russian account-holders  at banks in this country. Still the mere discussion of such a tax should have  those in the offshore world scrambling.

Meantime,  residents in Cyprus have bigger and more urgent concerns, as banks there have  been closed since last Saturday and lines at ATMs snake around corners.

Talks  of Russia buying out the entire banking system in Cyprus may be largely  rhetoric; regardless, they’re absurd. Regardless, I’d say that the offshore  banking industry in Cyprus is dead no matter what happens from here. As soon as  bank accounts are unfrozen, I expect to see funds fleeing to other  jurisdictions as quickly as wire instructions can be issued. No one will want  to keep money in the country even if no “one-time” tax is imposed (it does now  seem that that subject is dead).

As  the Cypriot government continues to try to find a workable solution to satisfy  EU officials and the IMF, the rest of the world watches. How could something  like this happen? And…if it could happen in Cyprus…where else?

As  you watch, wonder, and ask yourself those worrying questions, I strongly  recommend that you also take some lesson from all of this as to how to  structure your personal affairs.

One  word: Diversification.

It’s  my ongoing mantra. Diversify currencies, economies, banks, and investments. Anyone  who had funds in a Cypriot bank and needed that money this week was out of  luck. Account-holders had no access to wire money out of the country and limited  access to their own money in the country (if they happened to be in the  country), as cash in ATMs has been scarce.

For  some folks this has meant that they have been shut out of access to all the  money they have…period.

On  the other hand, those who kept some money in another country had a back-up.

Note,  though, that, in this crisis case, even those who had money in other countries  couldn’t access it from Cyprus, as, again, ATM disbursements have been limited  and restricted. So let’s add cash on hand to our list of things to be  diversified in.

With  the ubiquity of ATMs and the prevalence of credit card usage around the world,  most of us no longer worry about how much cash we have in our pockets. I used  to travel around the world carrying as much as US$7,000 or US$8,000 in cash. Moving  from one country to the next not sure when I’d see my next ATM or if the hotels  in rural Latin America or Asia would take credit cards, it was the only prudent  thing to do, despite the risks of carrying that much cash around. In addition,  I used always to keep a few hundred dollars of local currency on hand for the  countries I visited most often. This way I didn’t have to worry about arriving  late after currency exchange offices had closed, for example.

Today,  I travel with less than US$100 in my pocket. The first thing I look for at the  airport when I land anywhere is an ATM. Sadly, that wouldn’t have helped me in  Cyprus this week, and I’m planning to bump up my travel cash for future trips. Probably  not to levels pushing the reporting requirements for cash, as I used to carry,  but enough to cover a night or two at a hotel and a couple of days of meals.

Banking diversification is a necessity that I remind you about regularly. Anyone banking offshore should have at least two accounts, each in a different country.  My point is that banking diversification comes in different levels. You want to bank in different jurisdictions…but you also want to bank with different banks. A few years ago,  one of my accounts in Panama was frozen when the bank was taken over by Panama’s  Banking Superintendent. Fortunately, the business associated with that account had  another account at another bank in a different country. The business was able  to continue to operate, to pay bills, and to receive payments from clients. Eventually,  the bank was reopened and all depositors (including me) received the full values  of our accounts. Meantime, however, had all the cash assets of that business been  in the Panama bank, I would have been in a real bind.

Having  accounts with two different banks in Panama would have worked in that case, as  the issue was bank specific. However, the events in Cyprus this week show that  country diversification is necessary, as well. Don’t keep all or most of your  cash or investments in any one bank or in any one country.

Yes,  more accounts mean more bank fees, which start to add up. In the scheme of  things, though, this is a small price to pay for the security of knowing that  you can access at least some of your money all of the time.

Don’t  let what’s going on in Cyprus turn you off from offshore banking. It is indeed an  anomaly (and, hopefully, will remain one). Do learn from this week’s debacle,  though. If you haven’t yet begun the work associated with setting up your  personal offshore infrastructure in a way that protects you from crisis events  like this one…get started right now.

Originally Published under the title  Crisis in Cyprus–What You And I Can Learn

Reprinted by permission of The Offshore Living Letter.

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