THE GLOBAL FINANCIAL CRISIS THAT STARTED IN 2007 WAS CERTAINLY A MAJOR UNDERLYING REASON BEHIND OUR COUNTRY’S PROBLEMS derstanding (MoU) signed with the Troika set aside with the purpose of being allocated for the recapitalisation of banks, as well as sources of capital from private investors. If we look at what happened recently with the successful recapitalisation of Greek banks and of a number of other banks in Europe, there is optimism that our own banks can source the necessary capital (if needed). There is an “appetite” for risk these days from funds abroad, as interest rates across the globe are extremely low and people are looking for investments that would provide them with higher returns (although these investments can come with higher risk). Furthermore, because of the quantitative easing programmes (QE) that have been going for some time now (especially in the US), there is ample liquidity these days in financial markets and investors are looking to the peripheral countries of Europe to invest.
practices, which resulted in massive loans given out based on the value of the collateral (mainly real estate) rather than the debt-repayment capability of the loan holder. These loans have proven to be problematic during the economic downturn and their value has sharply fallen as property and land lost value and became illiquid. Then there was the overexpansion of the balance sheet of our banks which, at some point, reached a level of eight times the country’s GDP. Our main banks had been attracting lots of deposits (domestic and foreign) by providing high deposit rates and lending them out as risky loans (mainly to the construction and real estate sector, creating a real estate bubble) or investing them in risky products (Greek government bonds). This over-expansion of the balance sheet created extremely high levels of individual indebtedness, reaching almost 300% of our GDP!
Gold: What, in your estimation, were the main problems of the past? G.T.: There are multiple reasons why our economy ended up in this very difficult and unpleasant situation. There were both fiscal and banking problems, and the interaction of these proved catastrophic. I would said, for example, the indecisiveness by Government officials and politicians to take the necessary action to fix the fiscal imbalances of the last few years and the growing public debt, as well as the long-standing structural problems of our economy (health care reform, pension reform, tax compliance and collection, labour market reform, to name a few). There were many warning signs, e.g. the continuous downgrades by the rating agencies, the reports by the European Commission, the fact that we could no longer borrow from the foreign markets to re-finance our debt after March 2011, etc. Unfortunately, we failed to act properly on these multiple warnings. Instead, we resorted to a €2.5 billion, 5-year loan from the Russian Federation in December 2011, instead of taking all the necessary measures to fix our problems and return to the foreign financial markets.
Gold: The exposure to Greek bonds has been blamed for a great deal. G.T.: Yes. Risky investment decisions mainly in Greek government bonds resulted in massive losses of around €4.5 billion, i.e. 25% of the country’s GDP. There was obviously a lack of proper risk management, as the risk was not hedged properly (for example, by buying credit insurance products such as credit default swaps, or selling some of the exposure when Greece’s bonds were given junk status by the rating agencies). There was also no proper diversification, as almost all of the capital of our two main banks was invested in these products. Here, of course, is a classic example of moral hazard, i.e. bank executives were taking risky investments knowing that, in case of a negative outcome, the burden would not fall on their shoulders. On the contrary, in case of a positive outcome, they would reap the rewards in the form of big bonuses. Over-exposure was not limited to the Greek economy either. It also occurred in other foreign markets such as Russia, Ukraine and Romania where the banks did not have particular knowledge or expertise. In the end, their expansion into those countries also created huge losses.
Gold: What about the problems in the banking sector? G.T.: There were several banking-related problems. Firstly, there were bad banking
Gold: Doesn’t it all come down to a lack of proper governance? G.T.: Yes. Good corporate governance prac-
72 Gold THE INTERNATIONAL INVESTMENT, FINANCE & PROFESSIONAL SERVICES MAGAZINE OF CYPRUS
tices create shareholder value through the transparent disclosure of an organisation’s activities to its shareholders, holding directors accountable, and creating an effective two-way communication between the board and the shareholders. Unfortunately, it failed in this case and this should prove an important and useful lesson not only for our banks but for a number of other organisations in Cyprus. Furthermore, the rather loose regulatory supervision by the Central Bank of Cyprus allowed individual banks, as well as the overall banking sector, to dwarf the GDP of the country, and to take excessive risks without properly diversifying their portfolio. It’s ironic that people kept praising the regulatory authorities for protecting the banking sector from toxic products such as asset/mortgagebacked securities, collateralised debt obligations (CDO) and credit default swaps (CDS) at the height of the global banking crisis of 2007-2009, products that led to the collapse of banking and insurance giants all over the globe, such as Lehman Brothers, AIG, or Bear Sterns. Then, a few years later, we discovered that the simplest of the securities and supposedly the least risky (sovereign bonds) were to prove so fatal that they brought the country’s banking sector to its knees. The global financial crisis that started from the US in 2007 and eventually spread to Europe in the form of a sovereign debt crisis was certainly a major underlying reason behind our country’s problems. This highlights the impact of globalisation and how contagion effects can propagate financial crises from one region or country to another. Gold: And, consequently, Cyprus had to request help from the Troika. G.T.: From May 2011, Cyprus could no longer borrow from the foreign markets mainly because of the lack of fiscal discipline that had created substantial budget deficits in the preceding years and growing public debt. At that point, the problems with the banks hadn’t yet surfaced. Then, in the summer of 2011, there was the explosion at Mari which had its own negative economic impact on our economy. Later that year, we had the infamous PSI (public sector involvement) in Greek government debt (at about 80% of the nominal value). This decision, and our failure to agree on the recapitalisa-