PANICOS DEMETRIADES A DIARY OF THE EURO CRISIS IN CYPRUS Lessons for Bank Recovery and Resolution A Diary of the Euro Crisis in Cyprus [email protected] Panicos Demetriades A Diary of the Euro Crisis in Cyprus Lessons for Bank Recovery and Resolution [email protected] Panicos Demetriades University of Leicester Leicester, UK ISBN 978-3-319-62222-4 ISBN 978-3-319-62223-1 (eBook) DOI 10.1007/978-3-319-62223-1 Library of Congress Control Number: 2017951553 © Te Editor(s) (if applicable) and Te Author(s) 2017 Tis work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifcally the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microflms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. 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Cover design by Samantha Johnson Printed on acid-free paper Tis Palgrave Macmillan imprint is published by Springer Nature Te registered company is Springer International Publishing AG Te registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland [email protected] To Sofa, Emma and Polis. [email protected] Foreword Perhaps the standard image of the role of a Central Bank Governor is that of an aloof technocrat, dealing with the intricacies of monetary minutiae and econometric modelling, far beyond the ken of normal mortals. If that was also your own view, this book will come as a shock and a revelation. Central banking, especially the role of a Governor, can become unbearably exciting, especially in a crisis. My friend, Panicos Demetriades, was dropped into his new role of Governor of the Central Bank of Cyprus starting in May 2012, slap-bang right into the middle of one of the most extreme fnancial crises of recent years; and such crises are no longer rare events. Cyprus may only be a tiny country, but this crisis was big enough, and sufciently badly handled on occasions, to have international ramifcations. Although Panicos was only Governor for 2 years, May 2012 to April 2014, his period in ofce was action-packed, with one dramatic event fol- lowing another so fast that at times it all must have seemed a blur. So he has a remarkable tale to tell, and he tells it most efectively, with short crisp sentences and short crisp chapters. Would you expect a book about Central Banking to be too exciting to put down, (despite no sex, and violence only of the verbal kind, though Panicos did receive death threats)? Finance involves money, often lots of it. When a fnancial crisis hits, the way that such a crisis is resolved will determine who loses, or gains, and how much. So there are bound to be all kinds of vested interests, and many of such interests will have the funds and the power to try to swing the fnal outcome in the direction that they favour. vii [email protected] viii Foreword Demetriades’ book is largely about the clash of interests, between local and European interests, between commercial banks and the Central Banking fraternity, between political parties, with even the Church, though in its Temporal rather than its Spiritual capacity, playing a role. And, to add piquancy to this mix, there were the Russian depositors in the Cypriot banks. Te junior partner of any ‘special relationship’ is always likely to hope for more assistance from the senior partner than the latter will fnd it in their interests to give. Moreover, Panicos doubts whether the Russian depositors in the Cyprus banks were closely aligned with the Kremlin. But the hope of Russian funding support, as a deus ex machina, to replace the Troika, absorbed too much of the hopes, time and energy of Cypriot politicians. Te chapters on the boiling-point of the fnancial crisis give a vivid impression of the fog of uncertainty, (who was saying what to whom), the pressures of time, lack of sleep, legal uncertainties, etc. In such circum- stances, those involved need to stick to their training about what can, and should, be done (and the reverse). Fortunately, Panicos had had a good training as a monetary economist. Tis book should be on every reading list to train future generations of monetary economists and Central Bankers. It is also a ‘must read’ for any- one interested in the euro-crisis of 2012–2013 particularly, and in European recent political history more broadly. But beyond all that, it is a vivid and dramatic story. Read on. Charles Goodhart London School of Economics [email protected] Acknowledgements I am indebted to Svetlana Andrianova, David Green, David Lascelles, Michael Olympios, Andreas Panayiotou and Michael Zannetides, all of whom provided comments to drafts of various chapters. I am particularly grateful to two other individuals who provided extensive comments on most chapters but wish to remain anonymous. Naturally, any remaining errors or omissions are my own responsibility. Tis book would never have been written without the encouragement and support of many academics, graduate students, policymakers, interna- tional journalists and fnancial practitioners from a wide range of disciplines, including business, economics, economic history, European studies, fnance, law, politics and sociology. Most of these individuals had listened to my talks at several universities, central banks or conferences in the UK and the rest of Europe or in other parts of the world and were intrigued by the twists and turns in the way in which the crisis unfolded and was managed by Cyprus, Europe and the IMF. I was also encouraged to write the book by former col- leagues at the CBC, who wanted the world to learn the truth about what actually happened. Last but not least, I was encouraged to write this book by numerous relatives and friends, to whom I am particularly grateful for their support during some very difcult times. I hope that my narrative lives up to everyone’s expectations. ix [email protected] Contents 1 Baptism of Fire 1 2 Entering a War Zone 11 3 A German Question 31 4 Buying Time 41 5 “Two” Big to Fail 51 6 Too Big to Save? 63 7 A Russian Playground 69 8 A Bank Run and a Tearful Agreement 75 9 Te Euro at Breaking Point 81 10 Illusions 89 11 Taxing the Poor (to Protect the Rich) 95 12 Heading Towards the Abyss 107 13 “Take It or Leave It” 121 xi [email protected] xii Contents 14 Resolution and Capital Controls 129 15 Toxic Fallout 147 16 Te Final Act 165 17 Te Key Ingredients of the Crisis 179 18 Lessons for Europe and Beyond 195 Bibliography 207 Index 209 [email protected] List of Figures Fig. 17.1 Market share of banks (% of total consolidated assets) 181 Fig. 17.2 MFI interest rates on new deposits in Cyprus from euro area households (%) 182 Fig. 17.3 MFI interest rates on new euro-denominated deposits in Cyprus from euro area NFCs (%) 183 Fig. 17.4 Analysis of bank deposits by geographical area (% of total bank deposits) 183 Fig. 17.5 Asset allocation of the three Cypriot banking groups by country (%) 184 Fig. 17.6 Total consolidated assets of the banking sector as a percentage of GDP 184 Fig. 17.7 Bank credit to the private sector as a % of GDP 185 Fig. 17.8 Total household debt as a % of GDP 186 Fig. 17.9 Total non-fnancial corporate debt as a % of GDP 186 Fig. 17.10 MFI interest rates on new euro-denominated loans in Cyprus and the rest of the euro area to non-fnancial corporations in the euro area (% annually, period averages) 187 Fig. 17.11 Residential property price index (December 2010 100) 187 = Fig. 17.12 Provisions as a percentage of non-performing loans (coverage ratio) 189 Fig. 17.13 Capital adequacy ratios (%) 190 Fig. 17.14 Exposure of domestic banks in government securities by country (nominal value) (%) 191 Fig. 17.15 Exposure of domestic banks in Greek Government Bonds (nominal value, € million) 191 xiii [email protected] Prologue When in March 2013 the euro looked like it was about to break up in Cyprus, I couldn’t stop thinking that we were writing history. Te future of Cyprus, Greece and possibly the rest of the euro area was at stake, although some politicians in Europe, who feared what might happen, were bravely trying to convince spooked markets that Cyprus was not systemic. It wasn’t just economic or fnancial history we were about to write. It was European political history. After all, the euro was, frst and foremost, a pro- ject of peace. Tat was particularly important in Cyprus, an island at the eastern edge of Europe within close proximity of Israel, Lebanon, Syria and Turkey.1 An island that had joined the European Union in order to safe- guard its very own survival in a turbulent region.