Lessons from history: Cyprus 2013 and Iceland 2008 — what they teach about deposit protection

Definition

Two historical crisis episodes — Iceland 2008 and Cyprus 2013 — are often cited in discussions about the limits of deposit protection. Each illustrates a different risk mechanism and a different systemic response. This article describes what happened and how the protection mechanisms behaved; it is not a forecast or a recommendation.

Iceland 2008 — a cross-border crisis and a guarantee scheme under pressure

What happened

In October 2008 the three largest Icelandic banks (Glitnir, Landsbanki, Kaupthing) collapsed within a few days, following the global financial crisis and the banking sector's excessive expansion. Iceland's banking sector was disproportionately large relative to the country's GDP — the banks' assets before the collapse were many times Iceland's annual GDP.

A particular dimension of the problem for deposit protection were the Icesave accounts — retail savings accounts offered by Landsbanki online in the United Kingdom and the Netherlands. Their customers (UK and Dutch citizens and residents) formally fell under the Icelandic deposit guarantee scheme Tryggingarsjóður, which proved insufficient to cover the obligations to foreign depositors given the scale of the losses.

How the protection mechanisms behaved

In 2008 Iceland was not an EU member (it is in the EEA), and the Icelandic deposit guarantee was minimally harmonised under the earlier directive (94/19/EC), but its funding did not keep pace with the scale of the sector's expansion. The UK and Dutch governments paid the guarantees to depositors from their own public funds, and then sought reimbursement from Iceland for years. The dispute was settled by the EFTA Court in a judgment of 28 January 2013 (Case E-16/11, ESA v Iceland "Icesave"), dismissing all charges against Iceland: it held that Iceland had not breached the then directive 94/19/EC (which at the time guaranteed a minimum of EUR 20,000 per depositor) or the prohibition of discrimination, partly because of the scale of the systemic crisis. Icelandic depositors ultimately recovered a significant part of their funds in a lengthy liquidation process, although access to accounts was initially blocked.

What changed after 2008

The Icelandic experience and the general financial crisis of 2008–2009 were a direct cause of a thorough reform of the EU's deposit guarantee rules, completed with the adoption of Directive 2014/49/EU (DGSD2). Key changes relative to the previous directive 94/19/EC: raising the limit to EUR 100,000 and fully harmonising it (previously the limit was lower, with a co-insurance mechanism), a requirement for ex-ante funding of schemes (an obligation to build funds before a crisis, rather than reacting ad hoc), a shorter payout deadline, and more precise cross-border rules. It is worth noting that Iceland is not an EU member state — the framework of its guarantee scheme differs from the EU's even after the reforms.

Cyprus 2013 — bail-in above the guarantee limit

What happened

In March 2013, as part of a rescue agreement between Cyprus and the troika (European Commission, ECB, IMF), the euro area saw its first use of the bail-in mechanism against depositors of large banks — Bank of Cyprus and Laiki Bank. The Cypriot banking sector was strongly linked to Greece and had a disproportionately large exposure to Greek bonds, whose value was reduced as part of the restructuring of Greek debt.

How the protection mechanisms behaved

The troika's original proposal envisaged a one-off levy on all depositors, including those below the then guarantee limit (EUR 100,000). This proposal provoked strong political opposition and was ultimately not passed by the Cypriot parliament. The final solution differed fundamentally from the original proposal:

• Deposits up to EUR 100,000 were fully protected — the guarantee worked according to the then rules.
• Deposits above EUR 100,000 at Bank of Cyprus were subject to bail-in: ultimately 47.5% of the amount above the limit was converted into bank shares (a 2013 decision of the Central Bank of Cyprus), and the remaining part was temporarily frozen. Losses for depositors above the limit were therefore significant.
• Laiki Bank (the second-largest Cypriot bank) was closed and put into liquidation; its deposits above the limit were transferred to the liquidation estate.

Important context: the events described took place before the entry into force of the BRRD Directive (2014/59/EU), which introduced a standardised bail-in mechanism into EU law. The Cypriot bail-in was in effect one of the first large applications of this logic — and became one of the reasons for adopting the BRRD. After the BRRD was adopted (implemented in Poland in, among others, the 2016 Act on the BFG), the bail-in rules are formally set out in law: the order of burden (shareholders → bondholders → large institutional deposits → and last, deposits above the limit of individuals and SMEs), and guaranteed deposits (up to EUR 100,000) are excluded from bail-in.

What changed after 2013

The Cypriot experience accelerated legislative work on the BRRD and SRM, which entered into force in 2014–2015. They established a clear order for covering losses (the creditor hierarchy) and explicitly excluded guaranteed deposits from bail-in.

Why it matters

Both episodes illustrate two different mechanisms in which the standard notion of "deposit safety" proved insufficient: (1) underfunding of the guarantee scheme in a small jurisdiction with a disproportionately large banking sector (Iceland); (2) bail-in of funds above the guarantee limit in the context of rescuing a bank (Cyprus). In both cases funds up to the harmonised limit were ultimately protected; the problems affected depositors above that limit or, in the Icelandic case, foreign customers in the first phase of the crisis.

Watch out

This article describes historical events. The regulatory rules described above (DGSD2, BRRD, SRM) entered into force after these events and changed the legal framework. This does not mean future crises cannot have unexpected consequences — it means the formal framework today differs from that of 2008 or 2013. A historical account is not a forecast or a risk assessment. For questions about a specific situation, consult a financial or legal adviser.

This content is for information only — it is not financial, legal or tax advice. WTP Finance does not advise on how to allocate funds.