Cyprus Mail
Opinion

The case against the governor

Strained relations, President Anastasiades with Panicos Demetriades just days after March's bailout agreement

By George Christou

PRESIDENT Nicos Anastasiades insisted this week he intended to refer the governor of the Central Bank of Cyprus (CBC) Panicos Demetriades to the Supreme Court “for inadequacy in the performance of his duties”.

Anastasiades was responding to earlier statements made by European Commissioner for Economic and Monetary Affairs Olli Rehn and president of the European Central Bank Mario Draghi on the need to protect the CBC’s independence, the implication being that the government was interfering in the work the governor and applying pressure on him.

While the government spokesman denied these implied accusations, saying the government was fully committed to safeguarding the independence of the Central Bank, Anastasiades said that significant documentation had been gathered to support the government’s case against Demetriades.

On Wednesday it was reported that the president had snubbed a written request by the governor for a meeting, referring him to the finance minister for any issues he wanted to discuss about the banking sector. Demetriades’ bridge-building attempts have come too late.

At the heart of the government’s case against Demetriades is the way he handled the provision of emergency liquidity assistance (ELA) to Laiki Bank from the time he took over as governor in May 2012, by which time Laiki had already been issued with 3.8 billion euros in ELA.

His decision to continue issuing assistance left the bank with an ELA debt in excess of €9 billion which was then transferred to the Bank of Cyprus when Laiki was wound down under the terms of the IMF-EU bailout in March.

Demetriades was exclusively responsible for the decision to keep pouring billions into Laiki – even if he was just obeying orders from the Christofias government – while it was, by most accounts, insolvent and therefore ineligible for liquidity assistance.

feature - Christou - ECB president Mario Draghi
President of the European Central Bank, Mario Draghi

ELA was under the authority of the CBC. President of the ECB, Draghi, speaking about the liquidity assistance at the European Parliament on July 31 with regard to Cyprus said: “… the provision of ELA to Cypriot banks, including the requirements for adequate collateral to be mobilised by the Cypriot banks receiving ELA, is the responsibility of the Central Bank of Cyprus.”

He also set out the requirements for its provision. “As a general principle, the requirement for any bank receiving ELA is (i) to be solvent and that (ii) the mobilisation of adequate and sufficient collateral by the bank ensures appropriate protection of the national central bank’s balance sheet.”

But according to the report prepared by the committee for the economy – set up by Anastasiades to investigate the causes of Cyprus’ economic crisis – this was not the case. In its conclusions released earlier this month, it said: “Laiki Bank was insolvent when it came under the control of the state (May 2012) and the granting of ELA to it, after this date, was not justified under the rules governing the provision of ELA by the Central Bank.”

In effect, the committee accused Demetriades of blatantly violating EU rules.

Stavros Zenios
Stavros Zenios

The committee’s advisor, Professor Stavros Zenios, who prepared a report about the matter after being given access to confidential information from the ECB concluded that Laiki was insolvent when it was receiving ELA and that the valuation of the security provided by the bank for the provision of ELA left sizeable financing gaps.

The Central Bank director, responsible for providing ELA at the time, Spyros Stavrinakis tried to justify these decisions, when he appeared before the investigative committee.

“One could say, from a clearly technocratic view that Laiki was insolvent, but what matters, even if Laiki’s capital adequacy was below the minimum, was the prospect of a programme. The Central Bank’s position was that if Laiki Bank was not solvent it could become solvent because of the prospect of the programme for the signing of an agreement with the troika.”

He added that all decisions “were taken on the assumption that a programme was in progress”, and further explained: “The troika had come to Cyprus and there was a programme in progress with the aim of re-capitalising Laiki Bank so it could become solvent.”

Stavrinakis admitted that Laiki was insolvent and justified the provision of ELA on the hope there would be a bailout programme. But there is no rule that allows this, based on the hope of a programme.

The senior press officer at the ECB, William Lelieveldt, told the Sunday Mail that the “the ECB is not the prudential supervisor of banks (yet) and has to rely on the judgement of national supervisors (in the case of Cyprus, the Central Bank of Cyprus), on whether a bank is solvent or not.”

Lelieveldt added: “There have been cases where banks received ELA even if they were seen as temporarily undercapitalised but only if they had a clear prospect of becoming recapitalised again, e.g. due to an adjustment programme. For example, this was the case in Greece where temporarily undercapitalised banks continued to receive ELA because the Greek programme had a clear time path for their recapitalisation.”

There was no clear time path for Cyprus, because when the CBC was drastically increasing the provision of ELA to Laiki there was no prospect of an agreement. In fact, in two months, from May 2012 when Demetriades took over as governor, until the end of June insolvent Laiki’s ELA debt had doubled, reaching €8.02bn. It was only at the end of June that the government finally applied for a bailout. More strangely, there was no commitment that the programme would undertake the recapitalisation of Laiki.

Regarding the CBC’s claim that Laiki would have become solvent after the €1.8 billion recapitalisation bond, issued in May 2012, Zenios believed that this was a “self-referential argument of the type, ‘it is, if you think it is’.”

In effect, Zenios wrote, “the ECB asks if the bank is viable before supporting it and the Central Bank of Cyprus responds that it is because it would be supported by the ECB. This was confirmed, eventually, by the fact that Laiki was put under resolution in March 2013, so that Cyprus could enter an assistance programme.”

In the end, Laiki’s resolution became a condition for Cyprus receiving the very financial assistance which was supposedly to have recapitalised the bank.

The ECB was
The ECB was not convinced that the 1.8 billion government bond would be enough to save Laiki

The truth is that the ECB was unconvinced that Laiki would become solvent after the issue of the €1.8 billion recapitalisation bond by the Cyprus government. In a letter to the CBC (July 2, 2012), about the issue, the ECB said it “considers the objectives pursued by the measures (recapitalisation bond) could be better achieved with the use of the resolution tools for banks.”

In order for state support to be given, it had to lead to the solvency of the recipient. Demetriades wrote the following on May 16, 2012 to justify the Cyprus government’s decision to Alexander Italiener, the EU Director-General for Competition:

“The management of the (Laiki) Group forecasts a return to profitability in 2013, the time during which the two main countries in which the Group operates, Cyprus and Greece, will exit the economic crisis. According to the bank’s five-year business plan 2012-2016, expected total operating profits of the Group would reach €3.2 billion, an amount considered adequate to cover future provision that could possibly be necessary, for the loan portfolio of Greece as well as Cyprus.”

Zenios considered these forecasts totally unrealistic, as they were not supported by any study, adding that Laiki had not enjoyed such high profitability even in its ‘golden period’ from 2005 to 2010.

In his report for the committee he was very clear. “All available data from May 2012 were testimony to the fact the bank was in no position to repay ELA. This, combined with the absence of any viability analysis, leads to the conclusion that the provision of ELA was taking place without the bank satisfying the essential requirement of solvency.”

This was also evident in the PIMCO investigation. Although the final report was delivered in February this year, preliminary information about the situation at the bank had been given in November 2012. Not that the CBC needed PIMCO to establish whether Laiki was solvent.

In his testimony to the investigative committee, former CBC governor Athanasios Orphanides noted that “the acceptance of the PIMCO findings created a noteworthy inconsistency for the CBC, because by accepting the findings, it meant that Laiki was clearly an insolvent bank.”

But the warnings were there long before this. On the same day the ECB had spoken to the CBC about resolution tools (July 2), the ECB Governing Council had decided to suspend the participation of Laiki from the credit transactions of the Eurosystem. This decision, apart from increasing the ELA requirements, was a clear vote of no confidence in Laiki.

In the conclusions of the ECB Governing Council’s meeting of September 19, 2012, which noted that “the total capital ratio had decreased below the harmonised requirement of 8”, doubts were expressed about Laiki’s solvency. “The Central Bank of Cyprus’ banking supervision department assessed that Cyprus Popular Bank (Laiki) was solvent, although the assessment of solvency could not be taken for granted unless the programme was swiftly concluded.”

The following month, October, the twitchy Governing Council, warned the CBC, according to Demetriades’ testimony before the committee, that if a support programme was “not concluded soon it would raise the issue in order to stop providing emergency liquidity assistance to Laiki.” And in early November, with then President Christofias dragging his feet over Cyprus’ bailout programme, the ECB set January 24, 2013 as the day the provision of liquidity would finally stop.

But during the very period the ECB was issuing these warnings, the CBC was still using every possible method to convince the ECB that Laiki was solvent. It even cited the first restructuring plan, prepared by international consulting firm KPMG, despite the fact that the European Commission had not accepted it.

Former Laiki Chairman Andreas Philippou
Former Laiki Chairman Andreas Philippou

Speaking to the investigative committee, the former chairman of Laiki, Andreas Philippou said that the bank was obliged to prepare a restructuring plan, with the help of an international consultancy firmthat “would lead to a situation that would be considered viable”. KPMG’s first plan was submitted to the CBC at the end of August 2012.

“Two to two-and-a-half months after it had received the plan, the CBC said that this approach was not acceptable to the European Commission and asked us to modify it.”

In his report Zenios noted the paradox. Despite the fact that the KPMG plan was not acceptable, “in the requests submitted to the ECB for ELA, the Central Bank presents the implementation of KPMG’s proposals as the main argument to support that Laiki was solvent.”

Zenios said “there is a contradiction in that the CBC based its assessment of Laiki’s solvency on the KPMG plan, in order to carry on the provision of ELA, while it did not allow the bank to implement the plan.”

Laiki had been insolvent since May 2012, but the Christofias government and its newly appointed governor were not prepared to place it under resolution. Instead, the governor maintained the myth that it was solvent, in order to keep it afloat, at a cost of €9 billion which is now threatening the future of the Bank of Cyprus. He explained his thinking earlier in the year, when he said:

“The ELA for Laiki reached 60 per cent of the country’s GDP. It was not something pleasant, but we had to keep it afloat. It was an imperative to keep it afloat so that elections could be held, so there would be a new government to take its decision, to come to an agreement with our European partners so that we would avoid not only the bankruptcy of Laiki Bank, but also the bankruptcy of the state.”

Demetriades put €9 billion into Laiki but did not save it from bankruptcy because it was bankrupt before he started pumping the billions into it. If this was not inadequacy in the performance of his duties, at an extortionate cost to the country, what is?

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