Sunday, 17 March 2013

Making a mess rather than a model of Cyprus bailout

Early morning last Saturday the EU finance ministers agreed on a Euro 10 billion  bailout package for Cyprus.

The bail-out package includes very onerous conditions on Cyprus, most relevant of which are a 6.75% tax imposed on all deposits up to Euro 100,000 and a tax of 9.9% on deposits exceeding one hundred thousand.

The purpose was to reduce the size of the bailout from the original request of Euro 17 billion and to capture within the burden sharing net the large volume of non-resident deposits, mostly Russian, included in Cyprus bank balance sheets.

In so doing the EU has set a precedent which might unnerve holders of deposits with the banking system of other countries in distress, most notably Greece, Ireland, Spain and Portugal.   One might also include Italy that has not asked for bailouts but whose banking structures are fragile given the large quantity of sovereign debt they carry on their balance sheets.

The EU ministers have been emphatic that these measures are tailor-made for the specific situation in Cyprus where the banking sector is 800% of the country's GDP, mainly as a result of influx of Russian hot money, and that the same recipe will not apply to other countries who are already undergoing restructuring under other EU programmes.

However this is like asking people not to think of a white horse, and it has to be seen whether the markets in other countries will be unnerved by this precedent next week.

To understand the precarious situation that Cyprus has found itself in, one can draw parallels with the situation in Iceland where even there the banking sector had grown unstably large to eight times the country's GDP.    Russian money flooding into Cyprus banking system had to be placed somewhere.   Cyprus economy was too small to find a productive place for such huge inflows.   Given their cultural links with Greece, the main Cypriot banks stacked their balance sheet with Greek government debt and also built in substantial exposure to the economy of Greece when they opened full banking subsidiaries on the Greek mainland.

When Greece had to force substantial private sector write-offs on holders of their sovereign debts, Cypriot banks lost heavily and further losses were accumulated on their Greek operations as Greece experiences what seems like a never-ending recession with features of a depression.

Putting such austerity conditions on the Cypriot population, apart from other fiscal tax increases, is unfair.   It breaks the assumption that banks in the EU are safe places and that any losses would be suffered by shareholders and debt-holders but depositors would be the last to take any hit and should be safeguarded to the fullest extent possible to preserve confidence in the European banking system.

After all the losses of Cypriot banks mostly stem from the private sector involvement write-off of some 70% of the nominal holding of Greek sovereign debt.  Given that private holders of such debt were given several assurances that no EU government would be allowed to default on its debt, one can understand that the Cyprus population is being forced to carry a bigger share of the burden than they deserve.   I cannot help feeling that the Cypriot population is caught in the cross-fire between the EU and Russia, as the EU seeks to force Russian depositors to share the burden, but cannot isolate the Cypriot population from such punitive measures.

The question  is whether the EU is a Union or not.   There are better ways to carry this burden sharing.

Cyprus bank  bailout should not go through its government at all.  Rescue funds should flow directly from its source to Cypriot banks to serve as a model for a safer European banking structure, one that breaks the pernicious link between bust banks and bankrupt governments.   Each bank should be dealt on its own merits but as a condition for capital injection shareholders and bondholders should be wiped out, more cautious bank management installed, but depositors should have been protected up to a much higher limit than the insured value of hundred thousand Euro.

And funding of such bank recapitalisation should not be a burden on other countries.   The ECB should have the necessary authority and wisdom to monetise such capital injections through the ESM, a process that can be fully reversed when the economy heals and the banks as recapitalised switch from zombie banks to real banks contributing to economic growth and returning good value to its shareholders.

The Cypriot saga should also serve as a warning for Malta.    Our banks do not have the same problems as those of Cyprus.   Our main banks are domestic affairs with no exposure to foreign operations.

The balance sheet totals of our main four domestic banks ( BoV, HSBC, Lombard and APS)  is just 203% of our GDP compared to 800% in Cyprus.   Private sector debt with these four banks is just 116% of GDP and is very well structured with impairment losses of just 0.44%.

What Malta needs to be careful with is the foreign banks who do foreign operations and whose performance has little impact on the domestic economy.  The risk with such organisations is mostly reputational.

But extra care is needed with deposit type banks that have sprung up out of nowhere these last few years who are only interested in raising local deposits to invest overseas and help themselves to the deposit protection insurance guarantee.   These banks are a grave risk to the Maltese banking system and should never have been allowed to operate with a full banking licence if they restrict their function to mere deposit taking.

For me this shows that the regulatory function of the local financial structure needs to be reconsidered.  In line with international trends the regulatory and supervisory function should migrate back to its origin within the central bank and the remaining functions of the MFSA, including the Registry of Companies, should become a division of Malta Enterprise to promote financial services with the full co-operation of Finance Malta.    The Regulatory and Promotional functions sit uncomfortably within one organisation as presently.


  1. Please have a look here:

    Total assets: Cyprus €126.4 billion. Malta €53.4 billion. Euro area €32.8 trillion.
    Total assets as a percentage of GDP: Cyprus 683%. Malta 774%. Euro area 345%.
    Debt securities as a percentage of liabilities: Cyprus 1.3%. Malta 0.75%. Euro area 14.7%.
    External liabilities as a percentage of liabilities: Cyprus 27.5%. Malta 41.2%. Euro area 10.6%.

  2. Malta percentage 774% total banking assets as a percentge of GDP and 41.2% external liabilties as a percentage of total liabilities is very misleading and not comparable to the statistics of other nations. Take the 774%. Of this only something between 200% and 250% relates to banks covered by the deposit insurance scheme. The rest is interntional business booked through Malta subsidiaries but which is not covered by the depsoit insurance scheme and generally held by banks operating international business tru Malta but not integrated with the local economy.

    Consequently the liabilties of truly domestic banks raising deposits locally and doing local business is well within the EU average.

    Such overseas banks operating thorugh Malta need to be well regulated as though they do not cause strategic and financial stability risk, they could potentially represent reputational risks.


  3. EU cannot avoid helping this country. After decades of internal strife and foreign occupation, Cyprus regarded acceptance into the European family as a promise of stability and the chance to forge a more modern economy.