FinancialMirror.com
September 5 - 11, 2012
CYPRUS | 5
Investigating the banks The banks that had once been the pride of Cypriot business are in dire straits, not only financially but also under suspicion of some sort of malpractice, or worse. The banking disaster has cost the Cypriot people and the economy dearly. Many Cypriots have lost most of their savings. Pension funds have been decimated. Loans are difficult to obtain. Jobs are threatened. How did this come about? Why is it that the two major Cypriot banks have had to ask for state support? It has recently been announced that this will be the subject of an investigation. It is important that any such investigation be carried out with impartiality and with sensitivity. The international reputation, the credibility and the future viability of the islands leading industry is at stake and with it the jobs and fortunes of many of its citizens. The Greek Bond Disaster Any explanation of the current bank situation has to consider that the disaster that has befallen the Cypriot banks would not have happened but for their investments in Greek sovereign debt. Their holdings of Greek bonds, originally worth many billions of Euros, were reduced to a fraction of their value when Greece defaulted on this debt, the so called “haircut”. Those who are looking for a simple cause may be disappointed. There is never just one “cause” for an event. All events take place within the context of numerous circumstances which also have an influence. These events can be considered in two categories. First, there are the events external to the banks over which they had no control. Secondly there are internal managerial decisions made by the banks themselves and for which they are responsible. External Events Behind the Haircut Back in 2010, Jean-Claude Trichet, the then president of the European Central Bank (ECB), stated in no uncertain terms that he was opposed to any haircut of Greek bonds. He opposed it on principle. Such a devaluation would undermine confidence in the Euro zone.
Leading banks around the world had invested heavily in the sovereign debt of Greece and other Euro zone countries. As members of a common currency union including some of the world’s richest countries, a default on their sovereign debt was almost unthinkable. In those early days, few investors considered it a serious risk. Subsequent events have shown that Trichet was right. After Greece defaulted on its debt, confidence not only in Greek finances but also in the sovereign debt of other Euro countries plunged, eventually driving up the cost of borrowing by countries such as Spain and Italy to unsustainable levels.
By Dr JIM LEONTIADES Cyprus International Institute of Management
Unfortunately, toward the end of his term Trichet was persuaded to change his mind. He eventually agreed to a haircut of 21 % on Greek bonds. If things had stopped there – we would not be experiencing the current bank crisis. But, this was not to be. The Greek economy continued to worsen. The decision was made to shift more of the burden onto private bondholders, including the banks. The haircut was then raised to 50% of the face value of the Greek bonds. Even this might have been a level which the Cypriot banks could manage. However, during negotiations between Euro Zone and IIF (the International Financial Institute) , the goal posts were moved once again. The haircut on the face value of the Greek bonds was finally decided at 53.5%. Taking account the new interest rate which was also renegotiated, the final reduction on the present value of the bonds finally reached over 70%. Once this degree of haircut was decided, the problem of the Cypriots banks was in effect unavoidable.
These are only some of the main external events leading to the default on Greek sovereign debt and the banks subsequent requirement for state support. One could look even farther back. If Greece had not been allowed to join the Euro or if it had not borrowed so much etc., etc., again things might have been different. Management Decisions Within the banks themselves, there were also decisions which if they had been different might have avoided the current debacle. Reports indicate that some significant percentage of the Greek bonds were sold before the haircut only to be repurchased. If so, why? Any investigation would have to clearly distinguish between bad management decisions and some form of fraud. Bad decisions happen in all sorts of companies, indeed all companies. They are not necessarily a crime. But recently there have been reports that there were also management actions bordering on malpractice. Should these be investigated? Certainly. What about the managerial role of government? Now that Laiki has been nationalised – the government is responsible for its management. Investigations here should also include recent managerial decisions made under government ownership. The difficulty and sensitivity of the task should not be underestimated. The banks depend for their future on the confidence of international depositors and investors. These see a country which is in deficit and dependent on the mercies of the troika. It is governed by a Communist party which has publicly stated its distrust of markets and indeed the capitalist system. Having taken over Laiki Bank, the government now appears to be applying some of the same methods that have proved their effectiveness (or otherwise) in other nationalised industries such as Cyprus Airways. There have been reports that new bank board members have been chosen with emphasis on their party affiliations rather than their competence. Hopefully, this is not the case. Should the investigation look into this? Certainly. The credibility and future viability of the most important industry on the island is at stake.