Markets of the Poor: Limits and Opportunities

Aneel KarnaniDr. Aneel Karnani is Associate Professor of Strategy, Ross School of Business, University of Michigan. His interests are focused on three topics: strategies for growth, global competition, and the role of business in society. He studies how firms can leverage existing competitive advantages and create new ones to achieve rapid growth. He is interested in global competition, particularly in the context of emerging economies. He studies both how local companies can compete against large multinational firms, and how multinational firms can succeed in these unfamiliar markets. Karnani researches poverty reduction and the appropriate roles for the private sector, the state and civil society. He is interested in how society can strike the appropriate balance between private profits and public welfare in tackling major societal problems.

The ‘base of the pyramid’ (BOP) proposition, famously popularized by C.K. Prahalad and other business gurus, assumes that there is much-untapped purchasing power at the base of the pyramid, and urges companies to make a fortune by serving the poor masses. The Economist magazine, given its market-oriented ideology, has been a strong advocate of the BOP proposition. On the opposite side, I have long been a skeptic, and in my book Fighting Poverty Together I argue that while private companies should try to market to the poor, the profit opportunities are modest at best and I suggest a cautious approach. In a recent article ‘The limits of frugality: Making things cheaper is not the same as making profits’ The Economist starts to walk back from its earlier support of the BOP proposition.

The Economist article acknowledges that it is politically correct for many executives to espouse the BOP proposition, because it serves an ideological purpose by showing that capitalism is inclusive, rather than only for the middle classes. “Whether their firms profit as a result is less clear.” The article goes on to cite examples of several firms in a variety of industries including mobile telephony, consumer goods, insurance, and consumer finance that have failed to profit from targeting the poor.

Contrary to the BOP literature, there are very few examples of profitable businesses that market socially useful goods in low-income markets and operate at a large scale. After an extensive survey in India of 270 market-based solutions to poverty, the consulting firm Monitor Group concluded “only a small handful – mostly well publicized ones like Grameen Bank and Aravind Eye Care – attained a scale sufficient to transform a ‘business model’ into a ‘solution’.” It is ironic, and instructive, that even both these examples are not really profitable businesses. The generous and well-intentioned social objectives of BOP initiatives must not hide the fact that these opportunities present tough economic and strategic challenges. The desire to do good should not blind managers to the realities of underlying economic forces that determine business success and failure.

There is no fortune at the base of the pyramid. Marketing socially useful products to the poor offers only limited business opportunities. Still, there are some profitable opportunities and we need creative entrepreneurs to design the right business models to serve the poor. It is necessary to understand that unmet needs do not necessarily constitute a market opportunity. A ‘market’ can exist only if there are buyers willing and able to pay a price that covers the total cost of production, including the opportunity cost of capital used. Unfortunately, due to the very meager income of the poor, markets for many socially useful goods simply do not exist. The French company Essilor found that not enough poor people were willing to pay even $5 for a pair of customized eyeglasses conveniently delivered on the spot. Procter & Gamble found that not enough poor people were willing to pay even $0.01 per liter for clean drinking water.

To serve the markets of the poor, firms have to dramatically reduce costs, by as much as 90 percent in many cases. A significant improvement in technology could reduce costs dramatically, as for example in telecommunications. Unfortunately there have not been such technological leaps in most other product categories. It is thus often necessary to reduce quality in order to reduce costs significantly. This does not imply selling shoddy or dangerous products. To profitably serve the poor, firms need to make the cost-quality trade-off appropriately in order to make the products affordable by the poor; the challenge is to do this in such a way that the cost-quality trade-off is acceptable to poor consumers. A simple or minor adaptation of the business model from affluent markets usually results in products that are too expensive and not affordable by the poor.
Selling low quality products to the poor might seem unethical. But in fact, selling products at the appropriate cost-quality trade-off is not only ethical, it is socially virtuous. The appropriate reference point for quality is not the standard prevailing in affluent markets, but rather the status quo in BOP markets, which usually is unfulfilled basic needs. A low quality product is better than no product at all.

A good example of this logic is the low-price detergent successfully marketed by Nirma in India. The quality of Nirma is clearly inferior to that of Surf, the product marketed by Unilever. Nirma contains no active detergent, whitener, perfume, or softener. Indeed tests performed on Nirma confirmed that it was hard on the skin and could cause blisters. It seems the poor like inexpensive, low-quality products. This is not because they cannot appreciate or do not want good quality. They simply cannot afford the same quality products as the affluent; so, they have a different price-quality trade-off. They are even willing to put up with a detergent that sometimes causes blisters! The standards to judge what is acceptable have to be from the perspective of a poor person who before could not afford any detergent, and not from the perspective of an affluent person who routinely buys a high-quality detergent.

The biggest difference between BOP and affluent markets is the obvious but under-emphasized fact that the poor have very low purchasing power. Designing business models to serve markets of the poor has to start with this basic insight rather than a minor adaptation of the business models successful in affluent markets.

Ganging Up on Poverty

Aneel KarnaniDr. Aneel Karnani is Associate Professor of Strategy, Ross School of Business, University of Michigan. His interests are focused on three topics: strategies for growth, global competition, and the role of business in society. He studies how firms can leverage existing competitive advantages and create new ones to achieve rapid growth. He is interested in global competition, particularly in the context of emerging economies. He studies both how local companies can compete against large multinational firms, and how multinational firms can succeed in these unfamiliar markets. Karnani researches poverty reduction and the appropriate roles for the private sector, the state and civil society. He is interested in how society can strike the appropriate balance between private profits and public welfare in tackling major societal problems.

This is an interview based on his book “Fighting Poverty Together: Rethinking Strategies for Business, Governments, and Civil Society to Reduce Poverty” he gave to iMpact of the University of Michigan. Prof. Karnani authorized us to publish it in the Business Thinker.

Despite global efforts to alleviate poverty in the past half century, it remains a vexing social problem. Livable wages and lack of access to the basics — clean drinking water, sanitation, roads, and security — remain far too elusive for far too many. Recent efforts such as microfinance and base of the pyramid (BoP) ventures may generate attention, but they don’t achieve the objective, says strategy professor Aneel Karnani. Efforts should instead focus on ensuring that governments provide access to essential services while creating a climate in which businesses create jobs. Nonprofits, meanwhile, should serve as catalysts and watchdogs.
In his book, Fighting Poverty Together: Rethinking Strategies for Business, Governments, and Civil Society to Reduce Poverty (Palgrave Macmillan), Karnani argues this alignment across multiple sectors is critical for raising the incomes of the poor.

In the following Q&A, Karnani discusses why he thinks this approach is more effective than microfinance and BoP outreach.

Q: What motivated you to write a book on fighting poverty?

Karnani: I’ve been at the business school for 30 years. And for the first 20 I did the traditional things — teaching, research, and consulting, all focused on competitive strategy. But in the last 10 years, as I get older and more philosophical, my interests have broadened. Rather than studying how companies can get a competitive advantage and make more money, my interests have shifted more to the role of business in society, how society tackles larger problems, what the tradeoffs are, and how we manage these tradeoffs. I hear a lot of executives these days talking about corporate social responsibility and asking, ‘What is the role of business in solving these problems?’ When I talked to MBA students 20 years ago, most of them just wanted to go into consulting or investment banking and make money. Now many of them want to influence the world and have an impact on social issues. So all of these factors came together and my own interests shifted in that direction.
The second motivation is that when I hear other people talking about these social issues — whether it’s business people or academics — they all talk about win-win, feel-good solutions. I’m very skeptical that we’ll all be able to hold hands, sing, and solve the world’s problems. I see major tradeoffs in the world, and the whole field of economics is about how to manage tradeoffs. So I wanted to come at this with a more critical approach in terms of questioning popular perspectives.

Q: In the book you question the more recent solutions to poverty alleviation, including one that has a real home here at Ross — the BoP approach. Why do you think these recent attempts, notably microfinance and BoP, have fallen short both philosophically and on the ground?

Karnani: The major problem with microfinance is an underlying assumption that poor people want to be entrepreneurs. It also assumes they have the skills and drive to be entrepreneurs. I think this is a major fallacy. What’s an entrepreneur? It’s a person who has creativity, drive, persistence, and vision, who manages to bring an innovation to market, create value, and bring a new business model to the table. It is wonderful when people have entrepreneurial skills, and some of them do, but to expect a large majority of people to have them is not realistic.
If you look at a rich, advanced country like the U.S., more than 90 percent of the workforce is on a salary. If 90 percent of the people in the U.S. don’t want to be entrepreneurs, why do we think poor people in emerging countries want to be entrepreneurs? If you ask a poor person, ‘What’s the one thing you would like,’ I think the most common answer is, ‘A job at a reasonable salary.’
The second problem is that the bulk of microcredit isn’t used to fund a business. The bulk is used to finance consumption. That cannot increase your income in the future and, in fact, it can decrease your future income.
The third problem is that microcredit, even when it’s used to finance a business, usually does so in a highly competitive sector. The entry barriers are low, not much skill is required, and there’s no physical capital or assets. Profits are low and they just don’t earn enough. To top it off, the interest rates on microcredit are very high. The rates are often 50 percent, and in some cases 80 to 90 percent, effectively. It’s a rare business that’s going to get a rate of return on investment of 80 to 90 percent. So you put all of this together and microcredit is not going to lift people out of poverty.

Q: You mentioned that the poor, along with having low incomes, have vulnerable incomes. Does microcredit, microfinance, address that?

Karnani: No. It doesn’t do anything to change the vulnerability of a person’s income. The only good purpose it serves is that it can smooth out the consumption. As a poor person, if you earn a lot today but not tomorrow, a loan can help you smooth out the gaps. But even with that, it’s doing it at a very high price. What the poor need instead are microsavings accounts rather than microcredit. The trouble with microsavings is that the cost of providing the account is too high and nobody can do it today on a for-profit basis. There are a few NGOs offering microsavings, but it’s a very small part of the industry.
My argument is not just theoretical. There is now empirical evidence that shows microcredit does not help. I don’t know if it hurts or not, but we are putting a lot of resources into it and not getting enough impact out of it. So as a world, we can put those resources to better use in helping the poor.

Q: Why do you think the BoP approach doesn’t work?

Karnani: The thrust of the BoP logic is to sell things to the poor that are profitable and simultaneously will help alleviate poverty. I think this basic logic is very problematic. A poor person is not going to become better off by consuming more. He’s going to become better off by producing more. So I think the starting point is key: Treat poor people as producers, not as consumers. I think the BoP logic focuses too much on consumption and too much on large, multinational companies rather than small- and mid-size enterprises that are the engine of economic value creation in emerging countries. After years of exploring the BoP approach, we still don’t have good examples of how well this is working. I think it’s interesting and not accidental that the most celebrated example used by BoP proponents is Aravind Eye Care, which is a nonprofit organization.

Q: But the BoP proponents have recognized that this is a difficult challenge. They never expected it to be a success overnight, and agree there haven’t been homeruns. One of the things they’ve noted is that early BoP ventures focused on market entry, not market creation. For example, in your book you laud the example of TechnoServe, an NGO that facilitated a rebirth of the cashew-growing industry in Mozambique. That looks like market creation so wouldn’t that be along the lines of a BoP 2.0 venture? Certainly there is a role for NGOs in the BoP model.

Karnani: It’s true that Stuart Hart and (Ross professor) Ted London (authors of Next Generation Strategies for the Base of the Pyramid: New Approaches for Building Mutual Value) are critical of the early BoP ventures. But I think there is a difference when you talk about market creation. The difference is this: In the market created, who is the consumer? Even the BoP 2.0 literature is still talking about the poor as the consumers with that market creation. Whereas in the TechnoServe example I used, the consumers are people like you and me who are eating the cashew nuts. The poor are selling the cashew nuts, they’re not eating them. The fundamental issue here, which is absolutely central, is that if you want to help the poor people you have to treat them more as producers than consumers. What is the defining characteristic of a poor person? Low income. Let’s increase their income. The way to do that is to provide jobs, increase their productivity, increase their education, increase their access to markets.
I’m not dismissing the BoP logic totally. We have to try to sell things to the poor that are truly good for them at a price they can afford. I think both of those are critical points. We need to ensure these are prices the poor can truly afford and that the products serve high priority needs, such as housing, basic nutrition, healthcare, education, and clean drinking water. The trouble is there aren’t too many successful examples of that. I have several examples in the book of companies trying to sell things to the poor that are beneficial and high priority, like nutritious yogurt and clean drinking water. But it’s very hard to make it cheap enough where the poor can truly afford it and where the company will make a profit. But we can find some positive examples, like Nirma (the Indian detergent company) and mobile phones.

Q: It sounds like that’s a philosophical difference between your position and the BoP position. They might argue that selling a low-quality product to the poor is exploitative. You think taking the time to create high-quality products they can afford isn’t necessary.

Karnani: That is a big difference. The way to resolve it is to find enough examples, and I just don’t see that many examples where you can keep quality high and reduce the price dramatically and make a profit by selling to the poor. I think it’s disrespectful to the poor to say, ‘Let’s wait and find a way to do it.’ We can’t keep waiting. Let’s do what needs to be done now.

Q: Let’s talk about your framework. In a nutshell, you want to use the engine of business to push job creation, while governments provide the proper landscape with a legal framework and infrastructure to make that happen. At the same time nonprofits, or NGOs, will facilitate the connections and serve as watchdogs. Why is that more effective?

Karnani: To reduce poverty we have to increase the income of the poor and the best way to do that is to provide jobs. In fact, the International Labor Organization says nothing is as fundamental to poverty reduction as job creation. The last 50 to 60 years shows conclusively that business is the best engine of job creation. We’ve seen countries try communism and heavy-handed government intervention in the economy and we know that we need markets and private enterprise to create jobs. But you just can’t tell a private company to create jobs. Private companies will create jobs when it’s in their self-interest to do so.
What society needs to do, especially the government, is to foster job creation, employment growth, and business growth. The World Bank has a useful project called Doing Business Right that analyzes what’s needed to foster business growth and job creation — things such as reasonable regulation, property rights, and infrastructure. The role of business is to create jobs and the role of the government is to create the environment for this to happen. Unfortunately, many emerging countries have not done that in the past. In fact, they have often had policies that stifle business. We need to change that.
NGOs can play a role as a catalyst. Sometimes markets don’t work very well and NGOs can play a role in un-sticking these markets. A good example of that is TechnoServe, which is a mid-size NGO. All it does is emphasize job creation. It helps local entrepreneurs who are sort of stuck. TechnoServe doesn’t create the business, it just helps get rid of the bottlenecks, and it’s doing it very well.
I think we should concentrate our efforts on job creation among small- to mid-scale enterprises. And this is where I differ with the BoP logic, which I think emphasizes big, multinational companies. But if you look at even a rich country like the U.S., more than 60 percent of employment is in the small- to mid-scale enterprises. If you go to countries like India, what you see is a polarized economy. There are a lot of microenterprises, there are large enterprises, but the mid-size enterprises are missing. It’s these midscale enterprises that are the engine of job growth. I think countries like India need to encourage the growth of small to mid-scale businesses rather than microcredit at the bottom and large companies at the top.
The second area where we should focus our efforts is on the people who are getting the jobs. I think we should focus our efforts on the youth, say from 16 to 25 years. If you don’t get this young person a job, it has a lifelong impact on this person. If this young person is not given a proper job by the age of 25, he or she will probably go on the wrong track.

Q: What else does government need to do besides foster job creation?

Karnani: Next to a job, the poor need basic public services — education, clean water, sanitation, roads, public health, vaccinations, and public security. Those are the basics of life. Without that, very little else is going to work. Even a job isn’t much use if a child is dying of malaria or diarrhea. In many poor countries, the government has failed miserably at this. I don’t have a magic formula for doing it but we know it can be done. In some poor countries there are hopeful signs. I think we need the public will to do it. One of my objectives in the book is to present the facts, to provide some stimulation leading to rage that we shouldn’t accept the status quo as inevitable. We should say it’s essential that we provide clean drinking water to poor people. In some countries, like India now, there is a movement called the rights-based approach to development. It is the moral right of every human being to have access to the basics of life.

Q: Poverty is such a long-term problem and we’ve seen such slow progress despite tremendous economic growth in some sectors. Is it hard to get people enraged and engaged?

Karnani: I think we haven’t tried the right policies. You can’t do it with business alone. But governments alone can’t do it, either. We need to find the right balance. That’s why the title of my book is Fighting Poverty Together. There’s a role for business, there’s a role for government, and there’s a role for civil society. We need to understand these roles and everybody needs to do their share. One thing that is different now is that poverty and affluence have come closer together physically. You see slums right next to rich neighborhoods; the media expose us to poverty everyday. This is not a stable situation. The rich and the middle class just cannot turn a blind eye to poverty. Our sense of social and moral justice does not let us tolerate such pervasive and desperate poverty. My objective is to stimulate a public debate leading to action. This book is meant for smart people with a conscience. You don’t have to be an economist or a business expert. I think we should all be engaged in this debate. Business schools, companies, trade organizations, civil society and governments are in fact engaged in a widespread dialogue. I am hopeful that this dialogue will lead to both private and public action to reduce poverty.

Europe’s Disturbing Precedent in the Cyprus Bailout

G.FriedmanMr. George Friedman is Founder and Chairman, Stratfor, a private intelligence company located in Austin, TX.

This article is published here in by permission of Stratfor.

The European economic crisis has taken different forms in different places, and Cyprus is the latest country to face the prospect of financial ruin. Overextended banks in Cyprus are teetering on the brink of failure for issuing loans they cannot repay, which has prompted the tiny Mediterranean country, a member of the European Union, to turn to Brussels for help. Late Sunday, the European Union and Cypriot president announced new terms for a bailout that would provide the infusion of cash necessary to prevent bankruptcies in Cyprus’ banking sector and, more important, prevent a banking panic from spreading to the rest of Europe.

What makes this crisis different from the previous bailouts for Greece, Ireland or elsewhere are the conditions Brussels has attached for its assistance. Due to circumstances unique to Cyprus, namely the questionable origin of a large chunk of the deposits in its now-stricken banking sector and that sector’s small size relative to the overall European economy, the European Union, led by Germany, has taken a harder line with the country. Cyprus has few sources of capital besides its capacity as a banking shelter, so Brussels required that the country raise part of the necessary funds from its own banking sector — possibly by seizing money from certain bank deposits and putting it toward the bailout fund. The proposal has not yet been approved, but if enacted it would undermine a formerly sacred principle of banking in most industrial nations — the security of deposits — setting a new and possibly destabilizing precedent in Europe.

Cyprus’ Dilemma
For years before the crisis, Cyprus promoted itself as an offshore financial center by creating a tax structure and banking rules that made depositing money in the country attractive to foreigners. As a result, Cyprus’ financial sector grew to dwarf the rest of the Cypriot economy, accounting for about eight times the country’s annual gross domestic product and employing a substantial portion of the nation’s work force. A side effect of this strategy, however, was that if the financial sector experienced problems, the rest of the domestic economy would not be big enough to stabilize the banks without outside help.

Europe’s economic crisis spawned precisely those sorts of problems for the Cypriot banking sector. This was not just a concern for Cyprus, though. Even though Cyprus’ banking sector is tiny relative to the rest of Europe’s, one Cypriot bank defaulting on what it owed other banks could put the whole European banking system in question, and the last thing the European Union needs now is a crisis of confidence in its banks.

The Cypriots were facing chaos if their banks failed because the insurance system was insufficient to cover the claims of depositors. For its part, the European Union could not risk the financial contagion. But Brussels could not simply bail out the entire banking system, both because of the precedent it would set and because the political support for a total bailout wasn’t there. This was particularly the case for Germany, which would carry much of the financial burden and is preparing for elections in September 2013 before an electorate that is increasingly hostile to bailouts.

Even though the German public may oppose the bailouts, it benefits immensely from what those bailouts preserve. As I have pointed out many times, Germany is heavily dependent on exports and the European Union is critical to those exports as a free trade zone. Although Germany also imports a great deal from the rest of the bloc, a break in the free trade zone would be catastrophic for the German economy. If all imports were cut along with exports, Germany would still be devastated because what it produces and exports and what it imports are very different things. Germany could not absorb all its production and would experience massive unemployment.

Currently, Germany’s unemployment rate is below 6 percent while Spain’s is above 25 percent. An exploding financial crisis would cut into consumption, which would particularly hurt an export-dependent country like Germany. Berlin’s posture through much of the European economic crisis has been to pretend it is about to stop providing assistance to other countries, but the fact is that doing so would inflict pain on Germany, too. Germany will make its threats and its voters will be upset, but in the end, the country would not be enjoying high employment if the crisis got out of hand. So the German game is to constantly threaten to let someone sink, while in the end doing whatever has to be done.

Cyprus was a place where Germany could show its willingness to get tough but didn’t carry any of the risks that would arise in pushing a country such as Spain too hard, for example. Cyprus’ economy was small enough and its problems unique enough that the rest of Europe could dismiss any measures taken against the country as a one-off. Here was a case where the German position appears enormously more powerful than usual. And in isolation, this is true — if we ignore the question of what conclusion the rest of Europe, and the world, draws from the treatment of Cyprus.

A Firmer Line
Under German guidance, the European Union made an extraordinary demand on the Cypriots. It demanded that a tax be placed on deposits in the country’s two largest banks. The tax would be about 10 percent and would, under the initial terms, be applied to all accounts, regardless of their size. This was an unprecedented solution. Since the global financial crisis of the 1920s, all advanced industrial countries — and many others — had been operating on a fundamental principle that deposits in banks were utterly secure. They were not regarded as bonds paying certain interest, whose value would disappear if the bank failed. Deposits were regarded as riskless placements of money, with the risk covered by deposit insurance for smaller deposits, but in practical terms, guaranteed by the national wealth.

This guarantee meant that individual savings would be safe and that working capital parked by corporations in a bank was safe as well. The alternative was not only uncertainty, but also people hoarding cash and preventing it from entering the financial system. It was necessary to have a secure place to put money so that it was available for lending. The runs on banks in the 1920s and 1930s drove home the need for total security for deposits.

Brussels demanded that the bailout for Cypriot banks be partly paid for by depositors in those banks. That demand essentially violated the social contract on the sanctity of bank deposits and did so in a country that was a member of the European Union — one of the world’s major economic blocs. Proponents of the measure pointed out that many of the depositors were not Cypriot nationals but rather foreigners, many of whom were Russian. Moreover, it was suggested that the only reason for a Russian to be putting money in a Cypriot bank was to get it out of Russia, and the only motive for that had to be nefarious. It followed that the confiscation was not targeted against ordinary people but against shady Russians.

There is no question that there are shady Russians putting money into Cyprus. But ordinary Cypriots had their money in the same banks and so did many Cypriot and foreign companies, including European companies, who were doing business in Cyprus and need money for payroll and so on. The proposal might look like an attempt to seize Russian money, but it would pinch the bank accounts of all Cypriots as well as a sizable amount of legitimate Russian money. Confiscating 10 percent of all deposits could devastate individuals and the overall economy and likely would prompt companies operating in Cyprus to move their cash elsewhere. The measure would have been devastating and the Cypriot parliament rejected it.

Another deal, the one currently up for approval, tried to mitigate the problem but still broke the social contract. Accounts smaller than 100,000 euros (about $128,000) would not be touched. However, accounts larger than 100,000 euros would be taxed at an uncertain rate, currently estimated at 20 percent, while bondholders would lose up to 40 percent. These numbers will likely shift again, but assuming they are close to the final figures, depositors putting money into banks beyond this amount are at risk depending on the financial condition of the bank.

The impact on Cyprus is more than Russian mafia money being taxed. All corporations doing business in Cyprus could have 20 percent of their operating cash seized. Regardless of precisely how the Cypriot banking system is restructured, the fact is that the European Union demanded that Cyprus seize portions of bank accounts from large depositors. From a business’ perspective, 100,000 euros is not all that much when you are running a supermarket or a car dealership or a construction company, but this arbitrary level could easily be raised in the future and the mere existence of the measure will make attracting investment more difficult.

A New Precedent
The more significant development was the fact that the European Union has now made it official policy, under certain circumstances, to encourage member states to seize depositors’ assets to pay for the stabilization of financial institutions. To put it simply, if you are a business, the safety of your money in a bank depends on the bank’s financial condition and the political considerations of the European Union. What had been a haven — no risk and minimal returns — now has minimal returns and unknown risks. Brussels’ emphasis that this was mostly Russian money is not assuring, either. More than just Russian money stands to be taken for the bailout fund if the new policy is approved. Moreover, the point of the global banking system is that money is safe wherever it is deposited. Europe has other money centers, like Luxembourg, where the financial system outstrips gross domestic product. There are no problems there right now, but as we have learned, the European Union is an uncertain place. If Russian deposits can be seized in Nicosia, why not American deposits in Luxembourg?

This was why it was so important to emphasize the potentially criminal nature of the Russian deposits and to downplay the effect on ordinary law-abiding Cypriots. Brussels has worked very hard to make the Cyprus case seem unique and non-replicable: Cyprus is small and its banking system attracted criminals, so the principle that deposits in banks are secure doesn’t necessarily apply there. Another way to look at it is that an EU member, like some other members of the bloc, could not guarantee the solvency of its banks so Brussels forced the country to seize deposits in order to receive help stabilizing the system. Viewed that way, the European Union has established a new option for itself in dealing with depositors in troubled banks, and that principle now applies to all of Europe, particularly to those countries with financial institutions potentially facing similar problems.

The question, of course, is whether foreign depositors in European banks will accept that Cyprus was one of a kind. If they decide that it isn’t obvious, then foreign corporations — and even European corporations — could start pulling at least part of their cash out of European banks and putting it elsewhere. They can minimize the amount of cash on hand in Europe by shifting to non-European banks and transferring as needed. Those withdrawals, if they occur, could create a massive liquidity crisis in Europe. At the very least, every reasonable CFO will now assume that the risk in Europe has risen and that an eye needs to be kept on the financial health of institutions where they have deposits. In Europe, depositing money in a bank is no longer a no-brainer.

Now we must ask ourselves why the Germans would have created this risk. One answer is that they were confident they could convince depositors that Cyprus was one of a kind and not to be repeated. The other answer was that they had no choice. The first explanation was undermined March 25, when Eurogroup President Jeroen Dijsselbloem said that the model used in Cyprus could be used in future bank bailouts. Locked in by an electorate that does not fully understand Germany’s vulnerability, the German government decided it had to take a hard line on Cyprus regardless of risk. Or Germany may be preparing a new strategy for the management of the European financial crisis. The banking system in Europe is too big to salvage if it comes to a serious crisis. Any solution will involve the loss of depositors’ money. Contemplating that concept could lead to a run on banks that would trigger the crisis Europe fears. Solving a crisis and guaranteeing depositors may be seen as having impossible consequences. Setting the precedent in Cyprus has the advantage of not appearing to be a precedent.

It’s not clear what the Germans or the EU negotiators are thinking, and all these theories are speculative. What is certain is that an EU country, facing a crisis in its financial system, is now weighing whether to pay for that crisis by seizing depositors’ money. And with that, the Europeans have broken a barrier that has been in place since the 1930s. They didn’t do that casually and they didn’t do that because they wanted to. But they did it.