ECB/Commission answers to MEPs Duff and Bowles and Greens on the Cyprus débâcle

The answers given by the ECB/Commission to the questions tabled by Sharon Bowles at the EC ECON meeting of 8th May 2013 are available at Andrew Duff's blog.  They make for interesting if dispiriting reading.


Here are the comments I made to some of the answers.

14 May 2013

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.


15th May 2013

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'.


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.


Later 15 May 2013


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.

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


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