While Cyprus has a GDP the size of a small city in the U.S., what really matters here is will this new type of bailout involving taxes become a precedent going forward for all euro countries. Much of the contagion risk hinges on how the public perceives things now and in the near future. Depending on how events unfold, it could cause bank runs as individuals in other euro countries decide it’s not worth keeping their money in the bank if there’s the risk they’ll wake up one day and 10% or more of their deposits are gone due to a tax.
On the one hand, Germany did not want to bailout an essentially bankrupt Cyprus banking system, instead choosing this time to put some teeth or pain in the conditions (esp. with Merkel election upcoming). However, if panic and bank runs do ensue, Germany stands to lose the most as it benefited the most with the intro of the euro, and an unraveling euro system stands to leave Germans with many billions in failed bailout losses. Quite a pickle, requiring delicate handling. But again, the complexity of the situation and myriad of domino effects that could result are just too unknown to be assured of an orderly outcome.
Something to keep an eye on is the Cyprus CDS chart.
Yesterday it jumped by 50% to 896, but you can see it's been much higher in the past. Much of the CDS rise last year was due to Greece (Cyprus & Greece banks very intertwined). But if this CDS continues to climb, it's a tell that Cyprus could become a bigger deal than is currently assumed.