A compelling cautionary tale

A Diary of the Euro Crisis in Cyprus: Lessons for Bank Recovery and Resolution
by Panicos Demetriades
Palgrave Macmillan, £26.99
(Buy at Amazon)

Eight years on from the start of the Greek debt crisis, the country is still suffering from unemployment of more than 20% and has yet to find a workable solution to bring down its vast debt burden. So few can dispute that the European Union’s handling of the crisis has been disastrous.

By contrast, Cyprus, which went through its own crisis five years ago, has much lower unemployment and the economy seems to be on the road to recovery. In this new book Panicos Demetriades, the former head of Cyprus’s central bank, tries to analyse what made the difference.

Of course, the roots of the crises were not the same, as Demetriades points out, but they were linked. While Greece’s problem was an inability to control public spending, Cyprus’s Achilles heel was its status as an offshore banking sector that attracted huge sums of money from Russia and elsewhere. Two banks in particular, the Bank of Cyprus and the Laiki Bank, took in so many dubious deposits that their assets amounted to several times Cyprus’s GDP.

Worse still, they decided to put a large amount of their funds into risky Greek bonds.When bondholders were forced to take a large haircut on Greek debt in 2011, both banks became essentially insolvent. Because of their size, they were too large for the Cypriot government to bail out, while Brussels was wary of bailing out Russians.

In an attempt to postpone the day of reckoning, the banks’ management, with some encouragement from the government, pretended that their debts were manageable. However, after the Cypriot parliament rejected a banking levy (which would have hit depositors in solvent banks, as well as smaller depositors), the government reluctantly agreed to a debt restructuring.

The resolution involved a European bailout, which forced large depositors – many of them Russian – to take haircuts in order to help recapitalise Cyprus’s banks. (Interestingly, Russian president Vladimir Putin’s reaction was relatively restrained, suggesting that even he felt the oligarchs deserved to share some pain.)

This is a compelling cautionary tale of what can happen when a country lets its banking sector get out of hand, and Demetriades makes a strong case that passing the costs on to bondholders and large depositors isn’t a bad idea.