By Stefanos Hailis
IN ACCORDANCE with the European legal and operational framework concerning emergency liquidity assistance (ELA), the funding is granted in a crisis situation by the national central bank, against adequate collateral, to solvent banks which cannot obtain liquidity through other means, so as to prevent potential effects on financial stability.
Central Bank Governor Panicos Demetriades and former Finance Minister Charilaos Stavrinakis, stated before the Investigative Committee on the economy that Laiki had essentially been insolvent and only a financial assistance programme for Cyprus could render it solvent.
In addition, the Governor, in a letter to the President dated November 18, 2012 informed him inter alia, about the critical situation of Laiki and the exhaustion of assets that Laiki could use as collateral for ELA.
At the same time, the amount of ELA granted increased from €9.8 billion at end-October to €10 billion at end-November 2012 – according to the monthly balance sheets of the Central Bank of Cyprus – and continued at the level of €9-10 billion until the shutdown of Laiki in March 2013, in a vain attempt to stop massive outflows of deposits.
Apparently the Central Bank of Cyprus, with the tolerance or complicity of the European Central Bank (ECB), continued to grant huge amounts of ELA to Laiki for several months in violation of two basic European rules: solvency and adequate collateral.
How valid is the circular argument that while Laiki was technically insolvent, with capital adequacy ratios significantly below the minimum required by European directives (8%), the bank could be considered as solvent for ELA purposes merely due to the prospect of a financial assistance programme for Cyprus that would include a few billions for its recapitalisation while the reluctance of the Christofias’ government to reach agreement with the international lenders was making such a prospect unrealistic?
A related question is how Laiki became insolvent. The huge losses from the haircut of Greek bonds and to a lesser extent provisions for non-performing loans resulted in the fall of the formerly robust capital ratios to about half the required minimum.
Capital adequacy was temporarily restored through the nationalisation of Laiki by means of a €1.8 billion government bond on June 30, 2012, but again fell and remained below the minimum following the publication of the half-year results, which included increased loans provisions (due to a change in methodology?)
Already on July 2, 2012, the ECB in its opinion on the decree of the Minister of Finance for the recapitalisation of Laiki with government bonds, observed that the use of bank resolution (restructuring) tools would be preferable than state recapitalisation:
“In view of the fact that the support measures under the Ministerial Decree aim to address solvency problems at a financial institution [Laiki], the ECB considers that the objectives pursued by the support measures may be better achieved through bank resolution tools. A fully-fledged bank resolution regime, comprising tools such as bridge banks, asset separation and transfers of business would offer legally sound means of resolving institutions on the brink of insolvency, safeguarding financial stability, whilst addressing stakeholder rights”. (CΟΝ/2012/50)
At that time – July 2, 2012 – the ECB suggested the use of resolution (restructuring) tools that were used in other countries, instead of the onerous haircut of depositors and the shutdown of the bank.
Apparently this suggestion was ignored by the Central Bank and the Ministry of Finance and was not brought to the attention of the Parliament, which in May and November 2012 urgently approved legislation for state support to Laiki.
The Governor argues that there was no legislation on bank resolution but only insolvency (winding up) proceedings, which would entail loss of deposits and bankruptcy of the government due to its inability to pay compensation for insured deposits (up to €100.000).
Of course, the experience of the last few years shows that critical legislation can be swiftly prepared by the competent authorities and urgently approved by Parliament. It is also known that the draft law on bank resolution was kept in the Ministry of Finance and the Central Bank for some months before its coercive submission to Parliament on Μarch 21, 2013.
Moreover the introduction of legislation on bank resolution was included in the terms of the MoU that was proposed by the troika to the Cypriot authorities in July 2012 and was negotiated by the Central Bank for several months until in principle agreement as regards the financial sector in November 2012.
The Governor has stated that he warned the political leadership about the consequences of the delay in the signing of the MoU. Wasn’t the Governor himself part of the delay from July until November 2012?
Little information is available on the collateral offered by Laiki to the Central Bank for the granting of the ELA. From the Governor’s statements one may conclude that collateral adequacy was at best marginal since mid-November.
Some new collateral was created through the issue of government guaranteed bank bonds by Laiki on 14 and 27 November 2012, based on legislation urgently approved by Parliament.
Practically it appears that the collateral accepted by the Central Bank for the granting of ELA in the order of €10 billion was inadequate: the value of collateral assets was much smaller than the amount of the ELA and hence on March 25, 2013 the transfer of the ELA debt from Laiki to Bank of Cyprus was decided, instead of the liquidation of collateral and the absorption of any losses by the Central Bank itself rather than uninsured depositors.
Costas Xiouros of the University of Cyprus, who has resigned as consultant to the Investigative Committee, refers to informal estimates of the difference near €3.5 billlion.
The Investigative Committee should perhaps detect more thoroughly the facts concerning critical issues, acts and omissions of responsible officials that resulted in the fall of the Cypriot economy, rather than spend time in its summer hearings for philological questions about a posteriori views on the best timing of the application for European assistance, or comments of officials on letters sent by their predecessors.
Stefanos Hailis, MBA Stanford University, ΒΑ Economics Summa Cum Laude