Download 1 The Banking Crisis in Cyprus What were the warning signs and

The Banking Crisis in Cyprus
What were the warning signs and what should regulators have done about them?
The class will read the case study below, and then the GARP trainer will lead the class through a
discussion of the warning signs that should have warned banking supervisors, both in Cyprus and
abroad, that a crisis was likely to occur.
As we discuss the case, our focus will be on identifying specific and actionable data points and
analytic issues. For example, if you, as a supervisor, were discussing the situation in Cyprus in a
meeting at the BCCL you couldn’t say, “There are lots of Russians in Cyprus so we should be
worried.” If you thought the Russian presence in Cyprus was a cause for concern you would have to
say precisely why their presence might affect the banking system. Is there a direct and plausible link
that goes from “lots of Russians” to “possible banking crisis”?
With banks and ATMs closed, an angry depositor tries to recover his savings by driving his
bulldozer into a branch of The Co-operative Bank.
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The Crisis of March 2013
In March 2013, banks in Cyprus closed their doors – and their ATMs – for nearly two weeks after the
Cypriot Parliament rejected an offer from the European Union to provide emergency liquidity to its
banking system, on condition that Cyprus contribute €5.8bn to the rescue package though a “haircut” of up to 9.9% on all bank deposits.
Efforts to secure emergency funding from Russia were unsuccessful.
A re-negotiated offer from the E.U. enabled banks to re-open, but depositors were limited to
withdrawing €300 per day and banned from cashing cheques, while overseas transfers were limited
to €5,000 per person per month. Transactions worth more than €5,000 would be reviewed by a
specially-established committee.
Money deposited in the two biggest banks – Bank of Cyprus and Cyprus Popular Bank (“Laiki”) –
were subject to big write-downs. For example, all bank deposit amounts up to €100,000 in Cyprus
Popular Bank were transferred to Bank of Cyprus, along with all deposits of financial institutions and
government bodies. All other amounts above €100,000 remained in Cyprus Popular Bank and were
subject to write-downs.
Deposit amounts up to €100,000 in Bank of Cyprus were left untouched but amounts over €100,000
were treated as follows: a) 37.5% were converted into Bank of Cyprus shares; b) 22.5% were frozen,
with the possibility that they might, at some point in future, be converted into Bank of Cyprus
shares, and c) the remaining 40% was temporarily frozen.
This was the first time that the European Union had required a “hair-cut” of retail bank deposits as a
condition of a rescue package.
In return for these, and other measures, the E.U. agreed a €23.5bn rescue package for the Cypriot
economy.
Some Historical Background
Cyprus was granted independence from Britain in 1960. Long-standing conflicts between the Greekspeaking community and the smaller Turkish-speaking community intensified, resulting in the
intervention of United Nations troops in the late 1960s. In 1974, President Makarios was overthrown
by a group of Greek Cypriots closely associated with the military dictatorship which was ruling
Greece at that time. Turkey landed troops in the north of the island (where the Turkish-speaking
community was concentrated) and after a brief conflict Cyprus was effectively partitioned into a
Greek and Turkish sector.
Though deeply scarred, Greek Cyprus recovered from the war. Its tourism sector grew, and its
financial sector flourished as an offshore banking centre (offering corporate tax rates as low as 4%).
By the time Cyprus joined the Eurozone in 2008, the financial sector was estimated to account for
40% of GDP.
Having initially attracted Lebanese businesses during the Lebanese civil war, and then a wider range
of Middle East business, in the early 1990s Cyprus became a home for Serbs who had fled the
conflict in Yugoslavia (Serbs are Orthdox Christians, like the Greek Cypriots) and then became an
attractive venue for Russians. The Russian involvement in the Cypriot economy extended from
touristic visits (the climate is a lot more attractive than Russia’s and there were direct flights
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between Moscow and Larnaca), real estate investment, and the use of offshore status to manage
businesses.
The influx of Russians and Eastern Europeans was striking to anyone living in Cyprus at the time.
Supermarkets produced advertising material in Russian, singers in restaurants learned Russian songs,
and shops selling fur coats opened along the Limassol Corniche. A statue of the Russian poet,
Pushkin, was put in the Limassol municipal gardens.
The number of Russian tourists visiting Cyprus grew by 20% per year in the late 1990s, accounting
for 10% of all tourist arrivals by 2010, second only to tourists from Great Britain.
In 2004, the Republic of Cyprus – Greek Cyprus – became a member of the European Union and in
2008 it became a member of the Eurozone.
The population of Republic of Cyprus is about 850,000 and its GDP in 2011 was €18bn, giving a GDP
per capita of about €21,000 – one of the highest in the Mediterranean.
Political Overview
The dominant political issue in Cyprus was the desire to solve the “Cyprus Question”, which, from
the Greek Cypriot point of view, entailed, inter alia, re-unifying the island and removing Turkish
troups. Many of the key political personalities came to prominence during the 1960s (or even
earlier) so their political lives had been shaped by conflicts between Greek and Turkish Cypriot
communities during the 1960s and the consequences of the Turkish invasion in 1974.
The Republic of Cyprus was (and remains) a democracy with free elections. There were four main
political parties of which the two largest have historically been (and continue to be) a right wing
party and Akel, the communist party.
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The Cypriot Banking System
Credit Extended by Cypriot Banks to Residents
€mn
Bank credit to residents,
of which:
To Cypriot residents
To residents from other
European countries
To residents from other
countries
Distribution of credit to
residents, of which
To Cypriot residents
To residents from other
European countries
To residents from other
countries
CAGR
2012
2011
2010
2009
2008
2007
2006
15%
72,466
68,520
61,475
57,874
54,443
41,020
31,417
12%
53,936
52,869
49,403
45,681
43,452
33,995
27,511
39%
4,858
3,232
2,787
3,521
1,954
953
666
27%
13,672
12,418
9,286
8,672
9,036
6,072
3,240
100%
100%
100%
100%
100%
100%
74
77
80
79
80
83
88
7
5
5
6
4
2
2
19
18
15
15
17
15
10
100%
Three banks dominated the Cypriot banking system: Bank of Cyprus, Popular Bank (Laiki) and the Cooperative banks. At the end of 2011, the total assets of Bank of Cyprus were €37.5bn and those of
Popular Bank €33.8bn. The Co-operative banks were believed to have assets of around €20bn or
maybe a bit more, but consolidated assets for the group were difficult to find, either in Greek or
English.
Other big banks were Hellenic Bank, with assets of €8.3bn and Russian Commercial Bank (a
subsidiary of Bank VTB) with €6bn.
Banks were regulated and supervised by the Central Bank of Cyprus. (Prior to March 2013, the Cooperative banking group was regulated by the Ministry of Commerce Trade and Tourism.)
In May 2012, Dr. Panicos Demitriades was appointed as Governor of the Central Bank of Cyprus. His
appointment as Governor was a return to the Central Bank – Demitriades had worked in its Research
Department from 1985 until 1990, before taking up a series of academic posts in British universities.
Total assets of the banking system were about €120bn.
The existence of Russian businesses in Cyprus led to allegations of money laundering but Cyprus
received an overall positive evaluation in the 2011 MONEYVAL report. The ability of the Cyprus
authorities to respond to allegations of money laundering were not helped by the lack of certainty
over the volume of Russian deposits in the banking system. The Financial Times estimated that
Russian-controlled deposits totalled €25bn – about one third of the total in the banking system -while senior officials in the Central Bank put the number at around €7-8bn. As part of a plan to
strengthen banking supervision, agreed with the E.U. in March 2013, the Central Bank agreed to
require banks to provide a monthly breakdown of the country of origin of their largest depositors
and the main beneficiaries of loans.
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Cypriot banks invested heavily in Greek debt and so suffered losses when the Greek economy
collapsed and bondholders were forced to accept losses. For example, Bank of Cyprus was holding
about €2bn of Greek government bonds in late 2012 while Popular Bank was holding about €3.5bn.
Confidential data obtained from the Central Bank of Cyprus in mid-2013 indicated that the Chairmen
of both Bank of Cyprus and Popular Bank had received loans from their banks of several hundred
million Euros, while senior managers also received loans exceeding a million Euros. In some cases,
loans were issued without full collateral, with the result that, for example, Popular Bank exceeded
regulation limited uncollateralised loans to 2% of equity.
In recent decades, banks have taken a tolerant and long-term approach to non-performing loans.
The banks, the big local trading families, and the prominent businessmen all know each other, and
with the economy generally doing well, banks expect that bad loans will become good again over
time.
A stock exchange opened in Cyprus in 1996 and prices quickly rose to more than 5,000 points before
collapsing to less than 500 in the early 2000’s. Over the following years the index recovered to
about 3,000 but fell below 1,000 again during the Global Financial Crisis, and declined to around 200
as a result of the banking crisis in Cyprus.
Fitch’s Rating History on Cyprus
In June 2010, Fitch affirmed its AA-long-term rating on the Republic of Cyprus, noting that, “The
Cypriot economy has withstood the [European] recession relatively well and its public finances,
though weakened, remain in reasonable shape…..Nevertheless….the banking sector… is large in
relation to GDP, constraining the government’s ability to support it in a crisis – [and] is exposed to
difficulties in Greece…”
On 31 May 2011, Fitch downgraded Cyprus to A- and ten weeks later downgraded again to BBB. In
January 2012, Fitch downgraded again to BBB- and in June 2012 downgraded to BB+.
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