Last week European Union leaders announced there would be a tax levied on deposits in Cyprus banks to raise money for a bailout of the country. The plan sent global financial markets downward as Cyprus began experiencing bank runs. As a result a bank holiday was declared and is now being extended into Thursday.

The Cypriot central bank has announced that the country’s banks will stay closed until later this week as fears mount of a bank run.

The country’s banks were closed for a scheduled Bank Holiday on Monday, something that allowed Cyprus to try to implement a levy on savers’ deposits.

That move triggered unease among depositors in Cyprus, where cash machines soon ran out of funds.

Questions have also arisen as to whether the plan of taxing depositers will occur in other countries in the eurozone as a report by Goldman Sachs notes the possibility of such plans being implemented in Italy, Spain, Greece, Ireland and Portugal. The so-called “PIIGS.”

“Despite Cyprus being small, and arguably unique, a depositor in a peripheral bank is likely to ask the obvious question: how likely is a deposit tax for me? The answer to this question, we believe, will differ, depending on the peripheral country where it is asked,” Jernej Omahen,  head of European financials research in London at Goldman Sachs said in a note.

The problem of course being that the tax plan in Cyprus triggered bank runs which would in theory also occur in the other countries. In fact, just seeing this happen in Cyprus might stoke fears in the PIIGS leading to instability or even runs as part of a self-fulfilling prophecy.

The justification for taxing depositors is also raising concerns. Usually bondholders are the first ones to face a haircut but not in Cyprus.

In a rare move, Cyprus is trying to raise around 5.8 billion euros ($7.5 billion) from a one-time bank charge on local deposits. Unlike in other European countries, local banks only have a small amount of outstanding bonds, which have their own set of legal complications. So the Cypriot government was unable to require the banks’ creditors to take major losses to finance the bailout.

“Authorities have taken a calculated risk. If the problem escalates, the entire euro zone banking system could implode,” said Cormac Leech, a banking analyst at Liberum Capital, in London. The deposit levy “shows that it’s O.K. to break the rules. Politicians are betting that they won’t have to do this again.”

So it is “OK to break the rules” unless it hurts bondholders? Then everyone needs to respect the “complexities of the legal situation.” Sounds familiar.

In any case, the fear of future taxes on deposits is causing concern all over the eurozone and with surprise moves like this tax levy on depositors coming out of nowhere the trust gap is expanding in the European Union between the elite and the people. The outright refusal by the elite – also known as the bondholders – to share the losses while forcing austerity to pay back their odious debts has strained the economy and put the future of the union itself at risk. We’ll have to see what happens Thursday.

 Photo by Ras67 under Creative Commons license