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Banking sector collapsed due to lack of national policy says report

CYPRUS had no coherent national policy to manage its large banking sector and there was no effective system of supervision, eventually leading to a disaster, an independent commission said yesterday.

Despite the island’s banking sector being deeply involved in international banking, there had been no coherent banking strategy to manage it, said David Lascelles, chairman of the

Independent Commission on the Future of the Cyprus Banking Sector and a senior fellow of London-based think tank Centre for the Study of Financial Innnovation.

“There was a lot of focus on the rewards – plenty of credit, large foreign earnings, a big offshore business – but little on the risks,” Lascelles told a news conference. “I would go so far as to say that people didn’t want to focus on the risks for fear of spoiling the party.”

The commission, which published its interim report yesterday, was set up by the Central Bank (CBC) last year to come up with recommendations for the long term recovery of the banking system.

And it faces more trouble unless it can successfully tighten supervision, escape political meddling and change its culture of overt risk-taking, the report said.

Lascelles said no one was watching the ‘big picture’ risk to spot the looming dangers – there was virtually no contact between the CBC and the finance ministry and “the distortions to the local economy caused by huge foreign deposits went uncorrected.”

The terms of reference of the commission do not include apportioning blame for the banking debacle, but to identify what went wrong and make proposals to correct it.
The interim report argued risk-taking by banks was overlooked, there were few checks and balances by directors, lending was based on personal relationships and there was poor supervision at all levels.
The commission said that while Cyprus made matters worse for itself by delaying agreement on a bailout for almost a year, the terms of the deal “have created a critical banking situation, and will make it very difficult for Cyprus to recover.”

It described as “unfortunate” the condition to merge the now defunct Laiki Bank with Bank of Cyprus (BoC) because it would create a lender with a dominant share of the market and raise competition and systemic concerns.

The merger should be completed as soon as possible, the commission said, but it should be reviewed once the dust had settled.

The commission also proposed that co-operative banks were merged into a single joint stock entity with commercial management and placed under the direct supervision of the CBC, “turning the sector into a competitive force.”

Lascelles said co-ops had an exceptionally poor business record, their structure was now obsolete, and they “have become quite a cost to the economy.”

Responding to a question, Lascelles suggested that “co-ops should have been bailed-in” in the same way BoC was.

As part of the bailout agreement, BoC used (uninsured) deposits over €100,000 to recapitalise.

In contrast, a €1.5 billion capital shortfall in co-ops will be covered by the bailout money.

Lascelles said it would be the third time Cypriot taxpayers bailed out co-ops.

They had received 22 million Cyprus pounds in the late 70s and a further 67 million Cyprus pounds in the late 80s.

“We think their day has passed,” Lascelles said of co-ops. “Cyprus is no longer the agrarian economy they were set up to serve 100 years ago.”

He acknowledged that their proposal was radical as co-ops are “liked and politically popular.”

The commission also recommended changing the banking culture, which was “tainted with politics and cronyism.”

“There is a direct political influence in the way the banking system was run in this country, and its one of our fundamental recommendations that Cyprus strive to get rid of that.

Otherwise you are never going to have a healthy banking system,” Lascelles said.

He added that the sector needed to be opened up to new people, fresh ideas, and given an independent spirit which would enable it to take an objective view of itself and its problems.

“One quick and easy way to do this would be by appointing non-Cypriots to the boards of banks – and the central bank.”

There must also be an overhaul of corporate governance to inject a culture of independence into board rooms, to provide stronger checks against the executive side, and to ensure that effective control processes exist and are enforced.

The commission also offered a more optimistic view of the island’s prospects as an international financial centre.

The business may have been large and profitable, but it was not of the highest quality, Lascelles said, as it relied heavily on tax breaks and inadequate policing.

The sector was insufficiently diversified geographically and much of the high value added corporate structural work was done elsewhere.

“We believe it could thrive in a more sophisticated form whose value lay in the quality of the corporate and banking services it offered, and the breadth of its services, including wealth management and fund administration, for example,” he said.

Read the interim report here: www.icfcbs.org

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