The search for guilt in the Cypriot financial crisis: a tale of two banks

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By Dr. Jim Leontiades

It is understandable that Cypriots are still looking for someone to blame for the pain and disruption of the financial crisis. And who more likely than the banks? They were at the centre of the crisis. The country’s two largest banks, Laiki and the Bank of Cyprus, were the ones whose deposits received the devastating haircuts. It is little wonder that many have come to believe that the problems of the banks which ruined so many lives was due to their behaviour. But was it? Tracing the guilt for the financial crisis might well begin with the events surrounding the two major Cypriot banks, the Bank of Cyprus (BOC) and Laiki.

Dilemma and Solution

The Eurogroup meeting of March 2013 found the country’s second largest bank, Laiki, in serious financial difficulty. Even though the Cyprus government had pumped 1.8 billion euros (borrowed from Russia) into the bank and was now the owner, it was not nearly enough. Laiki was forced to borrow billions more from the European Central Bank (ECB) in the form of Emergency Liquidity Assistance (ELA). Laiki’s debt to the ECB amounted 9.4 billion euros, equal approximately to half of the Cyprus GDP, probably a world record. This presented both the government of Cyprus and the Eurogroup with a dilemma. What to do with Laiki’s massive debt? The ECB (part of the Eurogroup) wanted its money back. Neither Laiki bank nor the Cyprus government could pay.

The solution arrived at was almost elegant in its simplicity. The Central Bank of Cyprus (which had been appointed to resolve the banking situation) merged the failed Laiki with the Bank of Cyprus, at that time a solvent and viable bank with no ELA debt. The merger made BOC responsible for repaying the 9.4 bln euro ELA debt of Laiki. The ECB was thereby assured of getting its money back. The Cyprus government, the owner of Laiki, was off the hook from a massive debt which it could not pay.

Questions of guilt and legality

These events are past history but the impact of the following decisions and questions as to their ethics and legality are still with us:

* Why did the Central Bank of Cyprus, charged with enforcing laws that restricted foreign ownership of local banks, allow a Greek investor (Andreas Vgenopoulos) to circumvent these rules and acquire control of Laiki. This was instrumental to the failure of Laiki and the subsequent financial crisis.

* Guilt should also be considered in relation to the ECB which continued to supply loans to Laiki long after it was obvious that the huge amount of ELA it was supplying to a failing bank was irresponsible. The ECB has consistently claimed that the responsibility was entirely that of the Central Bank of Cyprus. However, Article 14.3 of the Maastricht Treaty states that national central banks “shall act in accordance with the guidelines and instructions of the ECB”.

* What law or logic determined that the ELA debt of government-owned Laiki should be imposed exclusively on BOC? BOC management was not consulted on the merger with Laiki, which it considered unfair. The board of directors resigned in protest.

* The haircut imposed on BOC caused great damage to BOC depositors (including hospitals, charities, provident funds, small businesses) as well as to the bank itself. Why was the BOC haircut not shared with other viable banks? The initial proposal of the Eurogroup would have done just that, imposed a haircut on all depositors. This solution, rejected by parliament, would have resulted in a much less traumatic and fairer burden on what was after all a national problem.

* Why were the Cypriot banks allowed so little time by the Eurogroup to sell their Greek branches? The Cypriot banks had to sell their Greek properties under extreme time pressure at “fire sale prices” to protect Greece from contamination from the Cyprus crisis. The combined losses of Laiki and BoC are estimated at 3.4 bln euros. The Greek Pireaus Bank which purchased these assets declared a profit of 3.4 bln euros in its next quarterly report.

In its efforts to get to the bottom of the crisis, the government appointed an independent investigative commission comprised of distinguished jurists. These donated their time as a service to their country, refusing any form of payment (even buying their own coffee). The commission’s report places primary responsibility for the crisis on politicians, President Christofias and his political supporters. The government that had ordered the investigation ignored the advice of its own commission and turned the matter over to the Attorney General’s office which proceeded to focus mainly on the banks. After some four years of investigation and several court trials costing millions, a senior BOC manager was convicted of market manipulation, but no manager or director of that bank has been found guilty for the Cyprus financial crisis.