Andrew Duff -  On Governing Europe

Last month, I blogged some questions which, I thought, needed answering by the Commission and the ECB about the chaotic circumstances surrounding the Cyprus bail-in/out. The questions were tabled by my colleague Sharon Bowles before the ECON meeting on 8 May with MM. Rehn and Asmussen. The Greens also tabled some questions. Here are the joint answers of the Commission and ECB to those questions. They are useful and revealing, and deserve to be read.

 

(1) Questions raised by Ms Bowles (ALDE, Chair of ECON Committee) and Mr Duff (ALDE)

1. Why was the situation allowed to worsen until such time as the two largest Cypriot banks collapsed?

• The Cypriot banking sector was too large for the size of the Cypriot economy. At the heart of the Cypriot crisis was the poor state of the country’s two largest banks. It was the problems of these banks which caused the troubles for the sovereign and the subsequent economic decline – not the other way around. An earlier acknowledgment by the Cypriot authorities of the size of the problem in the two biggest banks and quicker remedial action would no doubt have helped to contain the impact on the economy.• One major issue was that the banks were able to use certain loopholes in the national regulation to delay recognition of losses. Furthermore, the Cypriot authorities waited too long before taking action and it took too long for the Cypriot programme to fall into place.This is regrettable because it increased the cost for Cyprus.

• Already in autumn 2011, the Commission warned Cyprus that, unless urgent action was taken, a programme would be difficult to avoid.Even though Cyprus had lost access to markets, the authorities were able to obtain a loan from Russia in late 2011, enabling them to temporarily prolong the unsustainable situation in the country. In June 2012, Cyprus eventually asked for financial assistance. Their need for assistance came essentially from problems in the banking sector, but also from a deteriorating fiscal situation.

• The Commission remained constructively engaged in negotiations with the former government, but of course made no public comment on the situation as long as talks were under way. The Commission has done its utmost to assist Cyprus and to work for a constructive and managed solution. The Commission has facilitated and supported viable solutions in the interest of the people of Cyprus and the euro area as a whole throughout this process and we will continue to do so.

 

2. What lessons were learned from the previous experience in Iceland, Ireland, Spain and Greece that could have been deployed to good effect in Cyprus?

• In all these countries, the banking sector was in deep trouble. In Iceland, Ireland and Spain the banking sector was at the root of the economic problems, while in Greece public finances were out of control with dramatic consequences on the banking sector.

• An important lesson from these countries is the interconnection between the sovereign and the banking sector. On the one hand, via their government bond holdings, the banks are exposed to the state of public finances. On the other hand, when the government has to rescue a bank through a public capital injection, its debt sustainability may be at stake. Additionally, these cases demonstrate that rapid asset expansion on the basis of cheap access to volatile funding sources coupled with imprudent lending practices can lead to the build-up of huge financial sector imbalances. The build-up of such imbalances in the financial sector must be resolved well ahead of the crisis stage.• In the case of Cyprus, the size of the two largest banks was too much for the sovereign to bear. Ultimately, it was not able to finance the losses of the banks by itself, because the sovereign liabilities would have become so large at the outset of the programme that debt would have been unsustainable from the start. Therefore, it was undisputed that the size of the banking sector needed to be reduced and that there had to be some burden-sharing. The question was how this should be done.

• The peculiarity of these Cypriot banks is well known, namely that their liabilities consisted to a large extent of deposits.

• That’s why the classic recapitalisation route followed in Ireland,Spain, Portugal and Greece was not applied in Cyprus. A key lesson to be learned from all these experiences is that it is very difficult to protect taxpayers from a systemic banking crisis. The fiscal cost can be either direct (through public recapitalisation) – as in Ireland, Spain– or indirect, as in Iceland and Cyprus (through steep output losses). In order to minimize the costs it is essential that losses are recognized and allocated early in the process. This shows once again the importance of financial sector reform: to minimize the risk of such crises happening in the future and to ensure that if they do occur,they are solved at the lowest cost to taxpayers.

 

3. In particular, was the adverse spill-over to Cyprus of the measures taken in Greece taken into proper consideration? If not, why not?

• The Cypriot banks have been very negatively affected by the Greek crisis because of their exposure to private and public debt. However,many of the sector’s problems were home-grown and related to over expansion in the property market as a consequence of poor risk management. Furthermore, the financial sector was vulnerable because of its size relative to the economy.

• Cyprus has been under increasing pressure in financial markets,against the background of rising concerns about the sustainability of its public finances, including its weakened financial sector and the scale of potential public support measures.

• The Commission recommended – in country-specific recommendations starting in May 2011 – that Cyprus take measures to strengthen further the prudential framework for the supervision of banks and cooperative credit societies to ensure early detection of risks. The Commission also drew the attention of the Cypriot authorities to these risks in various contexts in autumn 2011. Further recommendations and warnings were included in the Alert Mechanism Report in February 2012, and in the in-depth review and in the country-specific recommendations addressed to Cyprus by the Council in July 2012.

 

4. How did the Eurogroup meeting on the night of 15-16 March reach its conclusions? How was the meeting prepared – and by whom?

• For various reasons it was exceptionally difficult to reach an agreement on the Cypriot programme. There were several rounds of discussions between the Troika and Cyprus, in continuous consultation with the euro area Member States, which are, as you know, the owners of the ESM.

• In the course of these discussions an idea had emerged of a levy on interest income on deposits, which could have been potentially combined with other fiscal measures to avoid a disorderly situation. For instance, a levy equivalent to a 100% withholding tax on one year’s interest income was under consideration, since Cypriot bank shave been paying account holders around 3% interest, or even higher, which is of course much higher than the average rates available elsewhere in the euro area.

• This low levy did not however fulfil the parameters set by the Eurogroup, which required that Cyprus mobilise internal resources in order to limit the size of the financial assistance to no more than 10 billion euros. The subsequent negotiations led to an agreement based on the Cypriot authorities’ decision to impose a one-off levy of 6.75%on deposits below 100,000 euros and of 9.9% on those above that threshold.

• In the end, while this did not protect insured deposits, not reaching an agreement would have put all deposits in Cyprus at risk in the absence of a funded Deposit Guarantee Scheme and have led to a disorderly default of the sovereign. This would have been far worse for both Cyprus and the eurozone.

• At the Eurogroup teleconference preceding the vote in the Cypriot parliament, the Troika made it clear that an alternative solution without a levy on deposits below 100,000 euros would be preferable, while respecting the financial parameters set by the Eurogroup. The Cypriot authorities did not accept this advice.

• Subsequently, rapid corrective action was taken by the Eurogroup and the Cypriot authorities.

 

5. How and when were the Russian authorities involved in the settlement?

• It is Cyprus that has undertaken the negotiations with Russia about changing the current loan contract. The talks have been going on since autumn 2012 and continued after the current Cypriot Government took office.

• We are looking forward to an agreement between Cyprus and Russia on a financial contribution in this respect.

 

6. Did the Cypriot authorities provide or withhold all relevant information at all stages of the crisis?

• The Cypriot authorities, particularly the Ministry of Finance and the Central Bank of Cyprus, have generally collaborated well by duly providing relevant information, including statistical data and pertinent legal documents, where necessary. In some cases, in particular for the banking sector data, the quality of the data has been less than optimal.

 

7. Did the national central bank fail in its supervisory role? If so, why?

• There are many challenges for a small country to supervise a large banking sector. Banking sectors that act as regional financial hubs, as the one in Cyprus, require vigilant supervision to ensure undue investment risks are not taken on the basis of volatile funding sources. Problems in the Cypriot banking system were manifold.

• First, the Cypriot banking sector was allowed to become very large compared to the size of the economy (above 700% of GDP including foreign banks operating in Cyprus) against the backdrop of an expansion abroad and a business model based on non-resident funding.

• Second, a large exposure to Greece (160% of GDP in loans and bonds in 2011) was built up, partly the result of inadequate liquidity regulations which did not sufficiently prevent an excessive concentration of exposure in Greek sovereign debt.

• Finally, as established in the course of the independent due diligence exercise, the governance rules for credit origination and the recovery of bad debts were not strict enough, which contributed to high non performing loans and insufficient provisions.

• These shortcomings are addressed in the Memorandum of Understanding underpinning the financial assistance programme.

 

8. What was the role of the troika in the sale of the Cypriot banks?

• The Greek branches of the three large domestic Cypriot banks are large. The sale was necessary for three reasons:

• First, the sale was a key contributor to decrease the size of the Cypriot banks and to break the channel of contagion between Cyprus and Greece.

• Second, given the overall situation in Cyprus, it was feared that the Greek depositors might move their money elsewhere. The viability of the Greek branches would have been definitively impaired and the value of its assets depleted. Therefore, for the Cypriot banks, a sale of their Greek branches, even if costly, was cheaper than keeping them and seeing them melt down through a bank run.

• Third, such deep difficulties of the Greek branches could have put into question the restored trust in the Greek banking sector, which is regaining deposits after two years of steep decline. A failure of the Greek branches would have therefore created a risk of contagion to the Greek programme.• For these three reasons, from the beginning, the Troika was supportive of the Cypriot authorities’ idea of a quick sale of the Greek branches to a bank able to absorb them and to inspire the trust of depositors.

• From early March, the Troika therefore encouraged the Greek side and the Cypriot side to negotiate a sale of these branches, at a fair price reflecting the value of their loans, taking into account the future losses which had been identified by the consultant PIMCO.

• The parties entered into bilateral negotiations, for which the Troika acted as facilitator, and they signed the sale contract on 26 March.

 

9. How did the Emergency Liquidity Assistance (ELA) operate in the Cypriot case?

• The provision of Emerging Liquidity Assistance (ELA) aims at supporting solvent banks facing temporary liquidity problems. This principle, as well as all other rules governing the provision of ELA, was complied with in the case of the Cypriot banks.

• Regarding Laiki: see detailed answer below to the question by ALDE.

• Regarding Bank of Cyprus: in November 2012, the ECB Governing Council decided to suspend Bank of Cyprus as counter party for monetary policy operations on the grounds of insufficient capital, and Bank of Cyprus started to receive ELA from the Central Bank of Cyprus. The Governing Council considered that the Cypriot banks receiving ELA could not be considered solvent in the absence of an EU/IMF programme for Cyprus, because there was no credible recapitalization perspective without such programme. In accordance with the prevailing rules, on 21 March 2013 the Governing Council decided and announced that the continued provision of ELA could be only considered if a programme was in place that would ensure the solvency of the concerned Cypriot banks. After the agreement between the Cypriot authorities and the Eurogroup on 25 March 2013, the Governing Council decided not to object to the request for the provision of ELA by the Central Bank of Cyprus.

 

10. What is the impact of the Cyprus crisis measures on thebanking sector in other EU states?

• The policy applied in Cyprus is in line with the principle that deposits below 100,000 euros are guaranteed and they were therefore not subject to any bail-in.

It is worth noting that deposits have remained stable elsewhere in the Union.

• The measures enacted to date appear to have had limited impact on the banking sectors of other EU member states. This in particular was achieved thanks to the successful ring-fencing of the Greek operations of Cypriot banks. More broadly, contagion via other channels, such as confidence, appears to be limited, in particular regarding deposit outflows, funding conditions, and issuance of medium and long-term debt.

• However, weak financial institutions across Europe will likely remain vulnerable to external shocks. This demonstrates the importance of making progress on all crucial components of the EU banking union, including the implementation of the Single Supervisory Mechanism,and of a European framework for resolution, restructuring, and recapitalisation of the financial institutions.

 

11. How can a bail-in of investors be sustainable in the absence o fa common deposit insurance fund and a common resolution authority?

• Bail-in, as set out in the Commission’s proposed Directive on Bank Recovery and Resolution, aims at ensuring that shareholders and creditors are first in line – not the taxpayer – when it comes to assuming the costs of resolving banks. In that sense this concept should be introduced regardless of whether we create any common fund or common resolution authority.

• However, it is true that the practical credibility of the proposed bail-in tool depends on certain conditions such as a sufficient quantity of bail-in-able liabilities within banks or properly funded financing arrangements. The current proposal acknowledges this and provides for a progressive build-up of bail-in-able liabilities and funds.

• Finally, a common resolution authority and a common resolution fund would bring about tremendous progress in two areas. First, whereas the current system suffers from the fragmented decision-making by Member States, an integrated authority would ensure swift,independent and consistent decisions. This is essential when dealing with cross-border bank failures. Second, a common fund would increase the fire power available to deal with a failure as compared to separate national funds.

• However, it needs to be taken into consideration that the build-up of the Single Resolution Mechanism, including a common resolution fund financed by the industry, will take some years to be completed.

 

12. Who exactly proposed (and who opposed) the levy on small depositors?

• In the search for a workable compromise, the idea had emerged of a levy on interest income on deposits which could have been potentially combined with other fiscal measures to avoid a disorderly situation.

• For instance, a levy equivalent to a 100% withholding tax on one year’s interest income was under consideration, since Cypriot banks have been paying account holders around 3% interest, or even higher, which is of course much higher than the average rates available elsewhere in the euro area.

• This low levy did not however fulfil the parameters set by the Eurogroup, which required that Cyprus mobilise internal resources in order to limit the size of the financial assistance to no more than 10 billion euros. The subsequent negotiations led to an agreement based on the Cypriot authorities’ decision to impose a one-off levy of 6.75%on deposits below 100,000 euros and of 9.9% on those above that threshold.

• In the end, while this did not protect insured deposits, not reaching an agreement would have put all deposits in Cyprus at risk in the absence of a funded Deposit Guarantee Scheme and have led to a disorderly default of the sovereign. This would have been far worse for both Cyprus and the eurozone.

• At the Eurogroup teleconference preceding the vote in the Cypriot parliament, the Troika made it clear that an alternative solution without a levy on deposits below 100,000 euros would be preferable,while respecting the financial parameters set by the Eurogroup. The Cypriot authorities did not accept this advice.• Subsequently, rapid corrective action was taken by the Eurogroup and the Cypriot authorities.

 

13. Is this is still part of the wider instrument set?

• The Commission’s proposed Directive on Bank Recovery and Resolution entirely preserves insured deposits, which are excluded from the bail-in tool or any form of burden-sharing.

 

14. What aspects of the Cypriot deal apply elsewhere?

• The Cypriot agreement consists of a fully-fledged and ambitious economic stabilisation programme, which is grounded in solid financial sector conditionality. The strengthening of banks’ capital buffers, the improvement of their liquidity condition, the enhancement of prudential regulation and of supervision are elements which have been common to all programme countries.

• The bail-in of creditors, write-downs or conversions of subordinated debt and hybrid capital instruments have been implemented, or are in the course of being implemented, in Ireland and Spain. The Irish programme included very strong own contributions by bank creditors.More than 5 billion euros of subordinated junior debt was bailed in. At the same time, the Pension Reserve Fund contributed close to 10 billion euros. The specificity of the Cypriot case is that given the heavy reliance of Cypriot banks on deposits, standard creditor contributions could only deliver a part of the needed funds. The bailing in of uninsured deposits followed from this.

• Given the unique nature of the Cypriot case, the approach followed in Cyprus should not be seen as a blueprint for future interventions. Indeed, there are no templates as such. While each programme may have its similarities, each is tailored to the needs of the country in question.

 

15. How do the capital controls in Cyprus that were eventually applied (and still apply) conform to EU rules?

• For the first time since the introduction of the euro, a Member State has introduced temporary direct restrictions on the free movement of capital. The legal provisions introduced by Cyprus impose limits on cash withdrawals, a ban to the termination of term deposits,prohibitions of certain payment orders, restrictions on the use of credit/ debit / prepaid cards, restrictions on banking transactions as well as a submission of some operations to the approval of a Committee established at Ministry of Finance and the Central Bank and other measures. Although in the meantime these restrictive measures have been considerably relaxed, their implementation represents a major challenge for the principle of free movement of capital under Article 63 TFEU.

• However, Member States may introduce unilateral restrictions on movements of capital, including capital controls in certain circumstances and under strict conditions, for reasons of public policy or public security. According to the jurisprudence of the European Court of Justice, the measures can also be introduced for compelling reasons of general interest. Such exceptions to the principle of free movement of capital, must be interpreted very strictly and be non discriminatory, proportionate and applied for the shortest period possible.

• The restrictions imposed by the Republic of Cyprus seem reasonable in the circumstances, in particular taking into account the high risk of uncontrollable outflow of deposits that might lead to the collapse of the credit institutions and the immediate risk of a complete destabilization of the financial system of Cyprus. Therefore, the Commission considered that risks that are imminent for the stability of financial markets and the banking system in Cyprus are a matter of overriding public interest and constitute a public policy justification for imposing temporary restrictions on capital movements.

• Although the initial assessment of these measures has confirmed the rationale and relevance in the given circumstances, this assessment will be reviewed on a regular basis to ensure that the remaining restrictions are strictly proportionate to the legitimate objective of preventing the risk for the financial stability of Cyprus and apply for a strictly limited time period necessary for that purpose.

 

(2) Questions raised by ALDE

16. Taking into consideration that according to the European Central Bank, the Emergency Liquidity Assistance is a tool «consisting of liquidity assistance provided by central bank in exceptional circumstances and on a case-by-case basis to temporarily illiquid but solvent institutions» and according to the rules concerning the Emergency Liquidity Assistance, the Central Banks provide assistance against adequate collateral. How have the Central Bank of Cyprus and the European Central Bank complied with the rules governing the process of Emergency Liquidity Assistance in the case of Laiki Bank of Cyprus?

• The provision of Emerging Liquidity Assistance (ELA) aims at supporting solvent banks facing temporary liquidity problems.The three successive steps in the provision of ELA to Laiki Bank:

• First step: In 2010 and 2011, Laiki Bank gradually lost access toprivate funding sources in relation in particular to the euro areasovereign crisis and losses made on its Greek government bondholdings. By September 2011, Laiki Bank faced more severe liquidityand collateral constraints and started to receive ELA from the CentralBank of Cyprus.

• Second step: At the end 2011, as a result of the recognition of the full amount of losses resulting from the Greek PSI and a significant increase in the amount of loan provisions, Laiki Bank’s solvency ratios fell below the minimum capital requirements set by the Central Bank of Cyprus. On 29 June 2012 the Republic of Cyprus issued a bond to raise EUR 1.8 billion of new capital for Laiki Bank to meet statutory capital requirements. On 2 July 2012, in view in particular of the unfunded nature of this government bond, the Governing Council decided to suspend Laiki Bank as counter party for monetary policy operations on the grounds of prudence. From that day on, the entire central bank funding of Laiki Bank was provided via ELA granted by the Central Bank of Cyprus, and it increased further as a result of deposit outflows.

• Third step: The Governing Council considered that the Cypriot banks receiving ELA could not be considered solvent in the absence of an EU/IMF programme for Cyprus, because there was no credible recapitalization perspective without such programme.Page 21 of 28In accordance with the prevailing rules, on 21 March 2013 the Governing Council decided and announced that the continued provision of ELA could be only considered if a programme was in place that would ensure the solvency of the concerned Cypriot banks.On 25 March 2013 the Cypriot authorities, in agreement with the Eurogroup, decided upon the resolution of Laiki Bank and the transfer of its good parts to Bank of Cyprus. After this agreement on 25 March 2013, the Governing Council decided not to object to the request for the provision of ELA by the Central Bank of Cyprus.

 

(3) Questions raised by the Greens group

17. Against the background of the initial decision to levy a tax on Cypriot bank deposits of less than 100.000 Euros, which threatened the credibility of European deposit guarantee schemes, the following question merits to be answered:

17. 1) What was your role in the process, which led to the above mentioned decision?

17. 2) In which meetings did you participate and when and with whom did you meet during the decision-making process?17. 3) Which positions did you defend?

17. 4) Why did you allow that such a bad deal was passed?

• See replies to questions 4 and 12, as well as the Commission Press Statement of 20 March: http://europa.eu/rapid/press-release_MEMO-13-264_en.htm

18. According to the leaked final report on the public debt sustainability assessment of Cyprus prepared by the Commission in liaison with the ECB in compliance with article 13.1(b) of the ESM Treaty, the Cypriot real GDP growth is projected to contract by 12.5% cumulatively in 2013 and 2014. The same document points out that the banking sector has been immediately and significantly downsized to 350% of GDP (from more that 700% before the agreement on financial assistance) by means of the bail-in and asset transfers operated within the sector. Having in mind that:

– the banking sector represents around 40% of domestic GDP;

– additional fiscal consolidation measures are foreseen in the same document as well as in the updated (and also leaked) MoU on top of the efforts already foreseen in March 2013 and November 2012;

– the adjustment process foreseen, (including inter alia spill-over effects of wealth reduction and the spill over effects related to temporary capital controls) will have drastic and immediate effects on money circulation speed and therefore in aggregatedemand;

18. 1) How does the Commission manage to forecast such a modestcumulatively contraction whereas several other independentestimations point out to a much more severe GDP contraction overthe same horizon?

• The total size of the Cypriot financial sector was above 700% of GDP(including foreign operations), while the domestic financial sectoramounted to 550% (including branches of the Cypriot banks abroad).The downsizing of the Cypriot financial sector was 200% of GDP,about 130% of that happening via the ring-fencing of the Greekoperations of the Cypriot banks.

• The forecast for Cyprus over the horizon period of 2012-2016constitutes a joint assessment by the EC/ECB/IMF on the economicdevelopments over these years. The Commission services’ forecastpublished on 3 May reflects this joint assessment for the years 2012-2014.

• The immediate restructuring of the banking sector, tight credit conditions, fiscal consolidation pursued, rising unemployment, and the high degree of economic uncertainty have all been assessed and projected to weigh on private and public consumption and investment(final domestic demand). Only little reprieve is expected from exports(tourism being most promising) amid uncertain external conditions and a shrinking financial sector. Cyprus is a small open economy. Its degree of openness also affects the adjustment in economic activity as the contraction in domestic demand is partially compensated by the significant reduction of imports. By looking at the contraction of the domestic demand, it gets close to 20% over 2013 and 2014

.• The EC/ECB/IMF forecast takes also into consideration the impact of the temporary imposition of capital controls which are expected to hamper international capital flows and to reduce business volumes in both domestic and international-oriented companies. As these capital restrictions are meant to be temporary and proportional, and of an exceptional character, the forecast assumes that these will be removed as soon as the economic conditions, in particular the liquidity situation of banks, permits it.

• This joint forecast foresees that growth is to rebound in 2015-2016 on the assumption of potential gains from the restoration of a sound and well-capitalised banking system, of competitiveness gains resulting from the alignment of public wages, and the boosting of consumer and business confidence in the medium-term with the full implementation of fiscal consolidation.

• Indeed, given the particular uncertainties in forecasting the Cypriot economy at the current juncture it cannot be excluded that economic developments will turn out worse than projected by the joint forecast.The uncertainty is also evident in the strong swings of the estimates for the potential growth and actual growth in the successive forecasts undertaken. The Commission services have been clear that risks are tilted to the downside, relating inter alia to the implementation risks of the adjustment programme, increased unemployment and to any further losses of the banking sector.

• The close monitoring of the economic developments, and thus the revisions of the forecast, are to be pursued regularly, not least every three months when the review missions are to take place. Should available data at the time of these missions point to the need of revisions, then the forecast would be adjusted accordingly.Page 25 of 2818. 2) In compliance with the recently agreed ‘two pack’ will the Commission fully disclose the economic model used for reaching such a forecasts and transmit such model as an annex to an officially transmitted debt sustainability assessment to the Parliament so as to avoid having to refer to leaked versions transmitted by the press?

• This new provision will apply only after the entry into force of the twopack and for new requests for financial assistance or amendments to an existing adjustment programme. As such, it will apply to Cyprus if and when its macro-economic adjustment programme is revised.

• The Commission services’ economic forecast for Cyprus is based on the same forecasting system as for all other Member States. The most recent forecast for Cyprus has been published on 3 May. The main difference is that the period covered in the full programme forecast is 2013-16.

• Even if the Two-pack is not applicable to this case, the Commission services intend nevertheless to anticipate on the obligation established by the Regulation and to publish the assessment, as part of the full programme documentation during the month of May. This documentation will be sent to the European Parliament.18.3) As the same debt sustainability assessment acknowledges,the baseline scenario is extremely sensitive to lower growth and that downside risks appear dominant. What does the Commission foreseen as precautionary additional measures from the European side in case of slippage from the current forecasts in the short and the medium term taking proper account of high fiscal multiplier effects?

• It is indeed correct that important macroeconomic risks remain and they are tilted to the downside.• On the domestic front, downside risks are associated with domestic credit conditions and further deterioration of confidence in the banking system. Moreover, there is a non-negligible risk of a cycle of household and corporate defaults propagating through the economy,leading to further banking sector losses, worsening of labour market conditions, stronger than expected fall in house price and a prolonged loss of business and consumer confidence. Also, the deeprestructuring of the Cypriot banking sector could have strong spillovers on related professional business services and financial services exports.

• More generally, the transition to a more varied growth model will be challenging for the economy in the coming years and will imply a reallocation of economic resources across sectors, which may take time and will require flexible factor and product markets. Upside risks for the Cypriot economy are limited, relating mainly to higher investment activity in the energy sector and possible improvements in the external outlook, should the euro area economic activity strengthen beyond expected.

• Where necessary, the policies of the MoU can be adapted to changing macroeconomic or other circumstances. The integrity of the programme design relies, however, on certain key policies that are considered necessary to re-establish sustainable growth in Cyprus.Addressing the banking sector problems upfront and ensuring that financial institutions are well-capitalised will contribute to the trust in the financial sector and secure its long-term ability to intermediate savings and investment. The restoration of a sound banking system is therefore expected to gradually loosen the tight credit conditions in the economy.• Fiscal consolidation is expected to help restoring consumers and investors’ confidence in the medium-term. In the event of under performance of revenues or higher social spending needs, the government should stand ready to take additional measures to preserve the programme objectives, including by reducing discretionary spending, while taking into account adverse macroeconomic effects.

• The on-going deleveraging of both household and corporate balance sheets will over time remove the impediment to a more balanced growth. Also, in the medium-term, investments projects related to the energy sector and the prospects of exploitation of natural gas could contribute increasingly to economic growth. The recent reform of Cyprus’ wage-indexation mechanism will contribute to align public wages with developments in economic activity, improve competitiveness, and support the economic recovery. This is expected to have a positive impact on the external balance, with the current account deficit contracting over the programme period and external debt, in particular related to external liabilities of financial institutions, expected to decline.

• The policy efforts should focus now on steps to facilitate the emergence of new sources of economic activity and to alleviate the social consequences of the economic shock.

• The Commission stands by the Cypriot people in this time of deeptrouble and is committed to help Cyprus to get through the toughtimes and overcome the current difficulties. The Commission decidedto set up a Support Group for Cyprus with the implementation of theadjustment programme. It is now mobilising the resources to providetechnical assistance. An immediate priority is to identify the relevantresources available from the current structural funds

Tweet about this on TwitterShare on Facebook0Share on Google+0Share on LinkedIn0
Author :
Print

Comments

  1. It would be interesting to ask the ECB/Commission if EFSF funding for bank recapitalisation was ever considered for the Cypriot banks as this was possible without a macro-economic adjustment programme (see EFSF FAQ D1 below)

    D1 –What is the objective of EFSF’s participation of recapitalisation of financial institutions?
    The objective is to limit contagion of financial stress by ensuring capacity of a government (typically those with “small country, large financial sector problem”) to finance recapitalisation of financial institution(s) at sustainable borrowing costs.

    Although ESM is now taking the place of EFSF the programme can make new loans until July 2013 (see ESM FAQs).

    It’s a fairly safe bet that the answer will be that the Cypriot government could not have sustained the debt incurred by an EFSF loan.

    But it is interesting that the part of the banking system most implicated in the flows of so-called Russian Schwarzgeld (black money) which proved an incendiary issue in the German political cycle will not receive a single Euro of EFSF or ESM funding.

    And it is ironic that the bank that bought the Cypriot branch operations in Greece has been refinanced with EFSF.

  2. This statement is such nonsense that I start to wonder if the Commission are just lying throughout:

    “The peculiarity of these Cypriot banks is well known, namely that their liabilities consisted to a large extent of deposits.”

  3. The trouble with the Answers is not so much that they are nonsense – indeed Cypriot banking is peculiar in its reliance on deposits rather than bond finance – but that they render what was an intense and multi-faceted political situation into the bland language of economic inevitability.

    However there are some interesting revelations/confirmations. For example, the confirmation that discussions about a bail-in started as a tax on depositor interest – something that Michalis Sarris recently claimed responsibility for.

    It is disingenuous (Point 2) to say that the ‘classic recapitalisation route’ was not followed in Cyprus. Some bondholders were bailed in and €2.5bn of ESM has been made available for recap purposes. But this is aimed at the ‘good’ (ie uncontaminated with ‘Russian deposits’) commercial and co-operative banks.

    Point 3 on the Greek spillover is a bit of a whitewash in the way in which it attempts to deflect attention with the ‘many of the problems were homegrown’ gambit.

    There were homegrown problems but the willful exposure to Greek sovereign and corporate debt was staggering. In the case of Laiki Bank this was in large measure due to the takeover of the bank by a Greek concern (through a reverse takeover) in 2006.

    Again it is ironic that when the Cypriot side of the bank and Cypriot regulators finally got some control back – through as it turned out a disastrous shift from subsidiary to branch status finalised on 31 March 2011 – this actually shifted the liability for the Greek operations of the bank from the shoulders of the Greek to the Cypriot state and central bank.

    I have detailed this in my paper ‘Not so lucky Laiki’ at http://www.fergusmurraysculpture.com/cyprus/the-bailout-and-beyond/not-so-lucky-laiki-paper/

    On Point 5 regarding the Russian loan it is not entirely true to say that negotiations were just between Russia and Cyprus. The FT reported on back-channel communications between I think Rehn and Russian officials during the bailout negotiations. (I can supply the details if useful).

    On Point 7 one of the supervisory problems was that Laiki bank’s Greek operations (which accounted for about 50% of its total loan book) were contained within a Greek subsidiary supervised by the Bank of Greece until 31 March 2011.

    The Central Bank of Cyprus had attempted a supervisory visit to the Greek subsidiary in 2008 but was ‘not afforded access’. A joint BoG and CBC visit was conducted in 2009 that revealed considerable concerns.

    Given these concerns it seems surprising that there were apparently no further joint visits until the transfer of the Greek subsidiary into a Cypriot branch in 2011 (again see my paper above). This might be an interesting point for someone to investigate.

    On Point 8 regarding the role of the troika in the sale of the Cypriot banks Greek networks it should be noted that Piraeus Bank’s purchase of the Cypriot banks’ Greek networks was funded through the Hellenic Financial Stability Fund (according to Reuters of 26 March 2013) which in turn was funded by the EFSF .

    Because of the subsidiary to branch conversion at Laiki bank that took place in March 2011 there is a question as to whether the Bank of Greece/ECB liabilities of Laiki’s subsidiary were transferred to the Central Bank of Cyprus even though these were in effect covering liquidity problems that in large measure appeared to have originated in the Greek subsidiary operations of the bank.

    It seems from an equity standpoint (if not a legal one) that it would be highly unfair if depositors in the Cypriot side of the bank were having to pay down ELA or other ECB obligations with their deposits for a problem that largely originated in the Greek side of the bank under the control of what appears to have been a largely Greek management team under the supervision of the Bank of Greece (until March 31 2011).

    A further irony of ironies is that when the Greek CEO of Laiki left the bank in Dec 2011 he was awarded the sum of €941,000 (in a package totalling €1,543,000) that was paid in accordance with ‘the provisions of Greek Labour Law’ (Laiki Annual Financial Statement 2011 p.122).

    Such was the ECB and Commission’s fear of the contagion of the already weakened Greek banking system that expediency rather than principled burden sharing prevailed in the distribution of the costs of the bail-in.

    Otherwise surely Greek depositors in Laiki bank would have been required to participate in the bail-in (resulting in part from questionable loan policies and provisions in Greece) that fell only on the shoulders of depositors in Cyprus (which could in turn be politically legitimated by the existence of all that Russian ‘Schwarzgeld’ swirling about in the Cyprus deposits of Laiki and Bank of Cyprus).

    I’m not sure if the ECB/Commission does an ‘equity standpoint’ but maybe that is something for the politicians to look at?

    In point 16 para 3 I’m what does this mean?

    ‘On 2 July 2012, in view in particular of the unfunded nature of this government bond, the Governing Council decided to suspend Laiki Bank as counter party for monetary policy operations on the grounds of prudence.’

    As I understand it the government-backed bank bond was rejected as collateral by the ECB because it was backed by the Cypriot government whose bonds had just been reduced to junk status by a third credit-rating agency. Is that what the above means?

    There are many more questions to be asked of the ECB/Commission answers above. I hope my comments are of some use in going back to them. Best wishes.

  4. On the issue of Laiki and Greece it is interesting to note that a senior source at the bank said in April 2012

    “We think there is good reason to treat Popular like a Greek bank and to partake in the liquidity and capital support available to Greek banks in so far as its activities in Greece are concerned, since it was a subsidiary of a Greek bank until March 2011,” the source told Reuters on condition of anonymity. (Reuters http://www.reuters.com/article/2012/04/18/cyprus-popular-recap-idUSL6E8FIFJX20120418).

    The un-named source said that contacts were taking being made in Washington and Brussels. It would be interesting to know what happened next.

Comments are closed.