By Stefanos Evripidou
THE GOVERNMENT’S efforts to apply pressure on the troika to stop the downward spiral of Cyprus’ banking system could backfire, warned one economist, as confidence in the banks took another battering following the leak of a letter to international lenders, warning of the serious dangers facing the economy.
“There is nothing that has not been leaked. It is totally irresponsible from all sides,” said economist Costas Apostolides.
He warned that the island’s leaders were playing a dangerous public relations (PR) game, which could backfire.
“People have to understand that the situation is extremely dangerous. The government and the Central Bank (CBC) have to work together and smoothly. They can’t be playing PR games instead of dealing with the essence. These leaks have to stop on all sides,” he said, without professing knowledge of who actually leaked the letter.
“The CBC and the government have to stop fighting. They need to work together and provide information to each other.”
In the letter, President Nicos Anastasiades criticised the terms of the bailout which forced massive losses on bank deposits, a first for the eurozone, and accused the troika of not displaying the kind of support to Cyprus that Greece was afforded.
He effectively told international lenders that the ‘bail-in’ of the Cypriot banking system was hastily prepared without any clear understanding of its lasting impact.
When the troika imposed Laiki Bank’s €9 billion emergency liquidity assistance (ELA) liability- provided by the European Central Bank (ECB)- on the Bank of Cyprus (BoC), it basically created the grave liquidity problems facing the BoC today.
According to the leaked letter, reported widely in the local press, Anastasiades warned that it’s not just the banking system that depends on the BoC’s healthy recovery, but the entire economy, as well as the success (or failure) of the troika’s bailout programme.
He urged lenders to find a long-term solution to BoC’s liquidity problems in a bid to regain confidence and allow the economy to function without restrictions.
The longer capital controls are in place, the more depositors’ confidence in the banking system erodes day by day, with “devastating effects” on the local economy, the country’s international business and GDP, said Anastasiades.
Based on anecdotal reports, the leaked letter appears to have caused panic among depositors. Ironically, had capital controls not been in place, Cyprus may have seen a bank run on the island’s most systemic bank.
One BoC official told the Cyprus Mail he was inundated with phone calls from worried customers asking whether the bank would close down.
Another BoC teller working at a Nicosia branch said she saw a significant increase in people going in to the bank to withdraw cash, following reports on the dire state of the banking system as outlined by the president.
Apostolides argued that the problem with the banks was “very largely a psychological one”, requiring a responsible and methodical approach.
“A lot of mistakes are being made, such as appointing a CEO to the BoC for four months only. It doesn’t make any sense at all,” he said.
Contrary to Anastasiades, the economist believes capital controls have to remain in place for all banks “for at least a year”, as they were for many decades before Cyprus joined the eurozone. “People shouldn’t be terrified about it. And the Europeans have to understand they put us in this mess, they’ll have to put up with it.”
However, according to a source, the government’s aim in writing the letter was to remind the troika, mainly the ECB, that the decision not to bailout two systemic banks of a eurozone country was their idea. The least they could do is give that country’s banking system, and by extension economy, a fighting chance of survival.
Since the troika, mainly the ECB, does not appear to be making any significant effort to keep the BoC alive, particularly after dumping Laiki’s €9 billion ELA on it, the government would like to hear the reasons why.
The source argued that the biggest problem facing the BoC right now is liquidity. In simple terms, for the BoC to start operating like a normal bank, it needs to get out of its resolution status so it can borrow from the ECB like other eurozone banks.
However, it cannot get out of the resolution status while it has the ELA hanging around its neck.
The ELA, meanwhile, is not a never-ending source of revenue. To pump ELA from the ECB, the BoC needs to provide assets as collateral. But these assets are discounted by 65 per cent by the ECB.
A crude example: if the BoC wants to borrow €100 from the ECB in ELA, it has to provide to the ECB assets worth almost €300 as collateral.
It doesn’t take an economist to realise that at some point, with prevailing conditions remaining unchanged- jittery depositors, and a bank that can only borrow using ELA- the BoC is going to run out of assets at some point, causing the ELA to dry up and the bank to collapse.
The government wants the ECB to recognise this dilemma and do something to help avoid a train crash.
By taking a clear stand in support of Cyprus’ banking system, and putting the weight of the ECB behind Cyprus, the need for capital controls would disappear, said the source.
“The panic comes directly from the capital controls, we saw it in Argentina. If you had an independent central bank (like the ECB) acting as a lender of last resort, the bank would cover the shortfall (from a panic) and recover.
“However, the ECB haven’t said a word to say they support the Cyprus banking system. ECB President Mario Draghi said he would do anything it takes to save the euro, but said nothing on Cyprus. You can’t get trust (in the banking system) unless you get the ECB to say it will support Cyprus, because right now it’s stifling the banking sector,” said the source.
Economist and member of the National Economic Council Alex Apostolides argued that a key problem was the fact that Cyprus has a weak government and weak banking system, with both needing money to survive.
However, the European bailout “pretends” the two are not related and prescribes solutions to fix one which stifle the other.
“The troika said fix your banking system but don’t borrow money to fix it because you already have a big government.”
He argued the ECB has four options regarding the BoC’s pressing liquidity problems.
It could either convert the BoC’s ELA liability into assets, which would “make the ECB the largest landowner in Cyprus”.
Or it could work within its own rules to convert the ELA into something else and allow the BoC to behave like any other eurozone bank and borrow from the ECB normally.
A third option is for the ECB to accept a bond from the BoC in lieu of ELA, but this is exactly what Germany has been fighting against, particularly ahead of September elections, because it doesn’t want the ECB to recapitalise private banks.
The fourth option, said Apostolides, is to replicate Ireland and let the government issue promissory notes. But in this case, Cyprus is up against the IMF which refuses to allow the country’s public debt to GDP ratio to climb any higher.