Abstract
The Cyprus debt crisis provides some unique lessons. By the time an assistance program was agreed with the Troika of international lenders, the problem had become so complex that a depositor bail-in was implemented to safeguard financial stability. The bail-in was an ad hoc solution applied for the first time in the eurozone but is now the blueprint for dealing with future banking crises. This paper examines the events for the 18-month period before the two eurogroup meetings on Cyprus in March 2013, and the resolution and restructuring of the two systemic banks of the country with depositor bail-in. We show how delays in dealing with the crisis exacerbated the problem but also how the tools brought into solve the problem had significant unintended consequences that fit the reflexivity principle. Available evidence questions the validity of confidential studies guiding the policy decisions on depositor haircut and supports the argument that the bail-in, as implemented in Cyprus, violated international principles of fairness. We use the analysis to draw some lessons on the use of bail-in for future crises.
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Notes
Quotes in this paragraph form President Christofias message. “Botched bailout” is from Forbes magazine http://www.forbes.com/sites/eamonnfingleton/2013/03/18/the-botched-cyprus-bailout-european-markets-roll-with-the-punches/.
The haircut, known as PSI for “private sector involvement” exchanged Greek government bonds with new long-term bonds and European Stability Fund bonds with a nominal discount of around 50 % and much higher fair value discount. PSI took place on July 21 and October 26, 2011.
Statement during the public hearings of the Special Investigation Commission on May 15, 2013.
CPB was the country’s second largest systemic bank also known as Laiki by its greek name and Marfin-Laiki following a controversial acquisition.
Quote from Central Bank Governor Panicos Demetriades in an Interview to the Cypriot edition of KATHIMERINI of March 26, 2013.
Hadjipapas, A., March 10, 2013, Cyprus Central Bank Governor resigns, Financial Times, available at http://www.ft.com/intl/cms/s/0/b1ce2278-a875-11e3-b50f-00144feab7de.html#axzz3N2LEDYe8.
EBA stress tests at http://www.centralbank.gov.cy/nqcontent.cfm?a_id=12394&tt=article&lang=en. Data for Hellenic from private communications. The EBA stress test focused on sovereign exposures, while the CBC analysis considered also domestic deteriorating conditions. Hellenic Bank, with estimated needs 212.8mil had losses of 77mil from the Greek PSI.
Opinion of the European Central Bank on the recapitalization of Cyprus Popular Bank (CON/2012/50) at http://www.ecb.europa.eu/ecb/legal/pdf/en_con_2012_50_f_sign.pdf.
The Basel AML Index, at http://index.baselgovernance.org/index/Index.html#ranking, accessed on December 26, 2014.
Data reported on 12 January 2013 in Cypriot english-language newspaper Financial Mirror, available at http://www.financialmirror.com/news-details.php?nid=28565; checked by the author from the MoneyVAL reports.
The Special Investigation Commission decided by majority 2–1 not to investigate the collapsed Cyprus Popular Bank. By majority it was also decided not to incorporate the analysis procured from the expert advisor in its final report. A dissenting opinion was issued by ex-Obudsman Judge Eliana Nicolaou, who also adopted the report of the advisor. All three documents (in Greek, with the expert advisor’s report censored from the confidential parts) are available at http://wp.me/p2GuKg-dD.
See C. Xiouros and S.A. Zenios http://blog.stockwatch.com.cy/?p=1734, (in Greek).
Opinion of the European Central Bank on the recapitalization of the Cyprus Popular Bank (CON/2012/50) at http://www.ecb.europa.eu/ecb/legal/pdf/en_con_2012_50_f_sign.pdf.
This Directive was in proposal form from the European Commission to the European Parliament at the time when decisions where made about Cyprus. It was issued as an official directive a year later on 17 May 2014 and is available at http://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1440431136877?uri=CELEX:32014L0059. The EC proposal is available at http://ec.europa.eu/internal_market/bank/docs/crisis-management/2012_eu_framework/impact_assessment_final_en.pdf.
The PIMCO report is available at http://ftalphaville.ft.com/files/2013/04/reportasws.pdf.pdf.
Results obtained from Fig. 7 of the PIMCO report.
Fingleton, E., 17 March 2013, The botching of the Cyprus bailout: Worse than Lehman brothers”, Forbes, available at http://www.forbes.com/sites/eamonnfingleton/2013/03/17/the-botching-of-the-cyprus-bailout-worse-than-lehman-brothers/.
See “Incremental deposit levies and untouched covered deposits” (in Greek), at http://www.stockwatch.com.cy/nqcontent.cfm?a_name=news_view&ann_id=169958&lang=gr.
An article in the NY Times, cites “lawyers, economists and politicians in Cyprus” to argue that PIMCO analysis “relied too heavily on aggressive financial assumptions that in some cases deviated from international accounting standards, thus inflating how much cash banks needed to survive”, see, Thomas Landon Jr., 24 July 2014, A secret in Cyprus bank bailouts stirs resentments, at http://dealbook.nytimes.com/2014/07/24/a-secret-in-cyprus-stirs-resentment/?_r=0.
Newspaper Alitheia, Friday 9 August 2013, p. 39 (in Greek).
Note that the numbers in this paragraph refer to overall banking sector needs, including cooperative banks, and not only to the three banks listed in Table 2. We adjust downwards by 21 % only the CPB, BOC and Hellenic. A similar adjustment is warranted for the cooperative sector, but in the absence of any other studies, the original PIMCO estimates are used for the cooperatives.
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Acknowledgments
The author was a non-executive director of the Central Bank of Cyprus when this paper was written. The opinions expressed herein are his own and do not represent the Central Bank. The paper benefited from the insightful comments of two anonymous referees and seminar participants at the London School of Economics, Norwegian School of Economics, School of International and Public Affairs at Columbia University, Luxembourg School of Finance, Financial Engineering and Banking Society International Conference and the Institute for Economic and Industry Studies, Greece. I thank in particular Georgia Channi from Stockwatch for assistance with banking data and Alexandros Apostolides and Yiannis Tirkides for numerous discussions.
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Zenios, S.A. Fairness and reflexivity in the Cyprus bail-in. Empirica 43, 579–606 (2016). https://doi.org/10.1007/s10663-015-9306-2
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DOI: https://doi.org/10.1007/s10663-015-9306-2