In this brief paper with a slightly pompous name I have put together some notes that link the development of Cyprus’s particular domestic lending model with the development of Cypriot banks – particularly Laiki and the Bank of Cyprus – and the social transformation of (well, at least in part) Cypriot society.
The notes were written in New York in May 2013 at the height of the Eurozone crisis. I edited them in the UK in May 2014 as Portugal announced its intention to exit its Eurozone rescue package.
These notes are not as closely referenced as I would like them to be but most of the sources can be found on other pages of the Cyprus section of my website.
At one time I thought I would pursue this line of enquiry further but have decided against this. I hope they may be of some use to other researchers
The Domestic Lending Model: Social Solidarity, Collateral-backing and Debt Rescheduling
The 2013 PIMCO Europe report, Independent Due Diligence of the Banking System of Cyprus, March 2013 gives an insight into the development of Cyprus’s particular domestic banking model and its strengths and weaknesses. I have summarised the main findings of the report elsewhere (see summary of PIMCO here towards bottom of page).
With regard to domestic banking there seems to be a relatively ‘comfortable’ relationship between domestic borrowers and lenders. You could almost say it is ‘solidaristic’. For example, it is
amazing that in the current crisis the Cyprus parliament was unwilling to pass a
bank debt foreclosure bill in August 2014. At that time the banking system had a massive €16.7bn of uncovered non-performing loans, an amount equivalent to the entire GDP of Cyprus.
From the description in the PIMCO report domestic lending in Cyprus seems to harken back to a different era of banking. Loans are made on conservative loan-to-value ratios and are backed by collateral – usually property – either by the borrower or by a third party or in the case of ‘cross-collateralisation’ through a complex web of multiple loans to different borrowers arranged across a range of assets – some of which will be pledged to more than one loan.
Whilst asset backing is a key part of the model an assessment of the borrower’s ability to pay the loan schedule is less important or made unrealistically. And when payments are missed rescheduling is preferred to aggressive remedial action.
The whole system appears to be predicated on rolling-up payments and accrued interest until such time as the borrower releases some assets and pays back the total. Thus there are few penalties for missing payments and loans are attractively easy to push into the future.
In the cooperative bank sector the social mission of lending is even more marked.
Whilst provisioning consistently underestimates non-performing loans, particularly in the cooperative sector, until now loan cure rates have been good. This seems to be predicated on rising property prices and the broad network of assets or guarantors, family members etc. that can be drawn on to pay off loans.
Repossession is difficult because the mortgage law does not give the lender a right to repossession. Court procedures are slow and cumbersome and the average time it takes to force through a repossession-type property sale is 10 to 12 years.
The cost of accumulating non-performing loans is hidden in the banking system due to optimistic collateral asset valuations and the practice of reflecting unpaid interest as accrued interest in balance sheets based on optimistic forecasts of eventual loan resolution through asset disposal.
The Development of the Banks and Cypriot Society
Looking at the development of Laiki bank as a Limassol-based popular savings banks in the early 20th century you get the impression of a quasi-mutual society that develops quietly up until the 1990s (see From Popular Savings Bank of Limassol to Laiki Bank 1901-2013).
It is maybe interesting to think of the links between these banks and the cooperative banks as reflecting something about the island identify of Cyprus, the close knit family and village-based networks and the sense of a people united against external threats and occupation that stretch back to the dawn of Cypriot history.
M Persianis has blogged about the particularity of this ‘island culture’ with regard to what he calls ‘cronyism.’ He says,
Bankers have always insisted that connected lending is inevitable because of the small size of the economy. Much like Iceland, the point made was that everyone is everyone’s cousin, in-law, partner or brother-in-law [for a comment on gender relations in Cyprus see here].
Hence, connected lending is “natural”. On top of this, another argument, … was that the particulars of national defence and geopolitical concerns make such decisions necessary.
Cypriot leaders have cited the occupation of the northern part of the island by Turkish forces as reason to avoid the privatization of Cyta, a national telephony near-monopoly whose loss-making tv carrier branch, Cytavision regularly sponsors organizations which are intimately connected to political parties
Perhaps what we see at Laiki and Bank of Cyprus is the development of banks that are independent of the colonial powers of the British (1886-1960) meeting the needs of the local population and becoming embedded in the social relations of the island.
At some point that model undergoes a radical change.
It would be interesting to look at external shocks and opportunities to the Cypriot domestic banking system – for example with regard to independence, the conflict and partition.
The penury and dislocation that followed partition and a sense of being a pawn in Cold War games perhaps gave both a particular need and impetus to bend the rules and to duck under the wire of weakly formulated, let alone enforced, international banking, tax and money laundering standards. Sauvé chi peut, as they say. Or make your money where you will.
The enosis campaign with its love of all things Greek – except Greek poverty – and involvement with the Non-Aligned Movement also opened up new opportunities. And a strong communist party closely aligned to Moscow meant that some people went off and got their educations in Russia (ex-President Demetris Christofias for example).
Expansion and the fortunes of war
The banks gradually expand into the east Mediterranean, particularly Greece where there are strong personal, business, political, security and cultural contacts, and (I would imagine) into particular sectors – domestic lending and corporate lending in areas like shipping and construction.
By the 1990s when Yugoslavia is in flames and Slobodan Milosevic is looking for somewhere to park his billions of cash DM500m is eventually delivered in suitcases to Laiki’s Larnaca branch.
(See my timeline From Popular Savings Bank of Limassol to Laiki Bank 1901-2013 f or the arrival of ironically, given the current state of German/Cyprus relations, millions of Deutsche Marks under the supervision of Yugoslav couriers, local Serbian bank officials and Laiki staff and the denials of the embargo busting by the then bank Chair, Kikis Lazarides and the alleged involvement of the law offices of President Tassos Papadopoulos in setting up the ‘front companies’ that channelled the Milosevic billions.)
The break up of the Soviet Union as a self-contained banking system and the Lebanon as a regional banking centre created new and lucrative opportunities for Cyprus’s often UK-educated elite of bankers, lawyers and financial intermediaries.
The ‘big bang’ of EU Accession
With accession to the EU in 2004 and the rise of the global cheap credit cycle Cypriot banks underwent a ‘big bang’ of breath-taking proportions.
Laiki’s reverse takeover by the Marfin Investment Group in 2006 (see Unlucky Laiki for details) transformed it from a modest domestic bank with relatively conservative lending traditions (Milosevic excepted) to an investment bank increasingly caught up in grand Greek corporate ambitions and an invidious competition with the Bank of Cyprus to see who could grow and expand the fastest.
For example see the bids and counterbids for Laiki/Piraeus Bank and Bank of Cyprus’s failed bid to takeover Greek state-controlled bank, Emporiki Bank and the subsequent resignation of chair, Vassilis Rologis and the movement of younger bankers into senior positions at The Banks.
The take-off of the domestic economy in the 2000s fuelled a huge construction boom and rising property prices. Strong public sector unions acting as a vanguard pushed up wages faster than productivity with the infamous thrice-yearly COLA – (Cost of Living Allowance), while successive governments used the public sector and state and semi-state organisations to expand their clientelist fiefdoms.
At the same time ‘non-domestic’ deposits were flooding into the banks and the Russian turnaround trade was flourishing. This fuelled the expansion of the lending in Cyprus and more importantly in Greece and the corporate sector became an increasing target of lending departments (see for example Reuters March 22 2013).
There were also loans for shares schemes where affiliates of the lending institution took loans that were processed through offshore vehicles that then bought shares in the loan-issuing institution (see the scheme with the Vatopedi monks near Mount Athos Greece for example and the Greek/Cypriot regulators inspection of Laiki in 2009). Though not apparently illegal this was a method creating a circularity of value and assets that was propped up by pretty thin air.
Seeds of Crisis and the property bubble
The big banks had more deposit money than they knew what to with and went on acquisition sprees in Eastern Europe and the Russian Federation. When things began to sour with a rising toll of non-performing loans the banks bet on distressed Greek government debt and lost big time.
A growing liquidity crunch caused by disappearing deposits and the run down of capital buffers to cover losses on Greek bonds was met through increasing recourse to the European Central Bank’s LTRO (Long Term Refinancing Operation) funds and then to Emergency Liquidity (ELA) funding.
In the meantime back on the home front the conservative solidaristic lending model with its predilection for
assets as collateral over ability to pay had been ramped up through the construction boom and the never-had-it-so-good times of the 2000s. Nicosia ranked in 2012 as the 5th richest city in the
world (up from 10th in 2011) in terms of relative purchasing power.
But the viability of the whole thing was based on rising house prices and a neverland of non-performing loan resolution through eventual asset sales. But by the turn of the decade house prices had started to fall. And as the downturn intensified highly leveraged corporate debt in Cyprus and Greece began to sour.
These growing losses added to the catastrophic hit taken though the Greek private sector debt haircut of October 2011.
The big two banks were now in a desperate struggle to survive. Laiki had taken on over €9bn of ELA funds and Bank of Cyprus €1bn.
In order to keep deposits coming in the banks had to offer market beating interest rates – at least in their foreign operations. In Cyprus it seems that directors at Laiki were busy cajoling their staff to take out loans to buy Laiki shares to keep the bank solvent, while, it is alleged they were divesting themselves of their shares in the bank. At the same time Board members at Laiki had lent themselves €400m in 2011 (see Simon Cox BBC World Service piece –see my Blog).
The two big banks were by now woefully short of capital reserves as global and EU pressure to raise capital ratios was growing. The Pimco report of 2013 calculated that Laiki and Bank of Cyprus had recapitalisation shortfalls of €3.8 and €4bn respectively by the end of 2012 according to the assumptions of the Adverse Macroeconomic Scenario given to them by the report’s sponsors - the EU/ECB/IMF 'troika' - to inform their calculations.
From village poverty to suburban affluence
Cyprus’s banks and Cypriot families and consumers had come a long way since the day the Popular Savings Bank of Limassol opened its doors in 1901. Society had been transformed from a neglected, village-based rural peasantry overwhelmed by the burden of colonial taxes to an urban and suburban middle class grouped into the sprawling new suburbs of Paphos, Limassol, Larnaca and Nicosia.
Households found themselves with surprisingly high levels of wealth and income compared to European averages even though they had high debts and deposits. The old village and family networks of self-help were weakened both by economic progress and the physical and social dislocation and trauma affected by de facto partition in 1974.
Corporatist interests looked after themselves through unions and cooperatives and the elite of bankers, lawyers and financial intermediaries flourished taking forays into and maintaining their links with the government and its key institutions.
A great sprawl of retired and sun-seeking Brits settled on the island (40,000) and Russians and Pontic Greeks made their homes in Limassol.
Workers once living on a pittance in agriculture and the copper and asbestos mines now shunned low-end jobs and imports of cheap and poorly-treated domestic, agricultural and tourist industry labour grew rapidly.
The two big banks, Laiki and Bank of Cyprus by now employed 20,000 people between them and their well-being was synonymous with the well-being of the Cypriot middle class and the economy.
A rich European society?
There has been a fierce debate since the bailout as to the relative wealth of German and Cypriot households (see my Blog). There are those who once they have exhausted the statistical quibbling fall back on a position that seems to say,
“But you only have to look at Germany, stroll its streets, to see that it is absurd that average Cypriots could be more wealthy than Germans.”
But indeed, you only have to walk and drive around Cyprus to see how it has been transformed. Whilst not actively looking for poverty I have not come across areas in my extensive travels of what you might call urban decay and deprivation (with the possible exception of parts of old town Nicosia in the South and North and in the abandoned houses of Turkish Cypriots occupied by migrant workers in villages like Kofinou).
Maybe these areas exist somewhere. And certainly there is poverty and at shocking levels amongst the elderly for such a rich country. And there are mountain villages that are semi-abandoned in the Pitsilia hills and there are modest houses in villages like Peristerona and dusty Astromeritis and suburbs like Kokkinotrimithia, west of Nicosia.
But there seems to be nothing to match the dreadful housing estates and run down tin-mining towns of West Cornwall, or the despair of private multi-occupancy housing in East Kent towns like Margate and Dover in the UK, or the banlieu of France or even the knackered and undesirable Lander of the former East Germany.
The great pity in the dynamic growth of Cyprus’s ‘Icarus Economy’ is that so much wealth has been squandered, that so few taxes have been collected and that so few bulwarks of social provision and public healthcare have been built during the years of plenty (see my page Social Fallout for deprivation, wealth, income, GDP per capita and social provision statistics).
A quick look at current provision and the low level of social protection as a percentage of GDP suggests Cyprus is not in a good position to protect its – especially most vulnerable citizens - Cyprus Aid, the church and Presidential rhetoric notwithstanding.
Of course some Europeans feel a sense of Schadenfreude at Cyprus’ fall from grace. And the melting of the economy’s wings precisely as the German elections hoved into view has not helped.
But there again the unwillingness of Cyprus’s leaders – particularly Demetris Cristofias - to face the inevitability of their fragile economy’s derangement has been a breath-taking tour de force of delusion and ‘workerist’ rhetoric.
And although the shock is severe and the forecast dreadful Cypriots are not alone in this. It is hard lesson
being learnt across Europe from Bari to Blackpool and from Seville to Scunthorpe. And a lessen usually 'learnt' most by those who can afford it least.
How Cyprus will rebuild itself and its economy is a huge challenge. When the anger has passed and the enormity of the loss has sunk in, there is a hope that Cyprus’s resilient people will stay in the Eurozone and the EU and put in a place a more enduring model of economic development and social protection that comes to term with and tempers the rampant consumerism and fragile accumulation of the last decade.
Again the beautiful, divided, trammelled and resource-stretched island of Cyprus is not alone in this and I hope that the harsh rhetoric and inconsistencies of its bailout will be softened and remediated and that a more generous side of European solidarity will come to bear.
The burden sharing is imbalanced and bankers’ folly is not a disease exclusive to Southern Europe as Germans well know.
And how we build new models of development, social protection and global sustainability is a common project that should unite us all.
Fergus Murray May 2014