By David Lascelles
WE ALL know that the need to reform and strengthen banks is pressing. The question is how? For the past year the Independent Commission on the Future of the Cyprus Banking Sector has been working to produce some of the answers, and we published our final report this week.
What is striking is how much Cyprus has already done to strengthen its banking system. The banks have been restructured and recapitalised, banking laws have been reformed, and supervision has been strengthened.
However, public confidence in the banks is still lacking. The haircut on bank deposits had a profound effect on the psychology on bank depositors, and is still, six months later, prompting people to use every opportunity allowed by the banking controls to take their money out of the banks. This leakage of deposits cannot go on without causing wider damage.
The current policy devised by the troika is to rebuild the capital of the banks, and trust that this will bring back confidence and allow capital controls to be lifted as “milestones” are passed. The economy can then begin its recovery.
We doubt that this will happen within a time frame to prevent further erosion of the Cyprus economy. Without a normal banking system, credit is in short supply, people are reluctant to put their savings in banks, foreign investors stay away – and the leakage continues. This could produce a negative feedback loop in which banking controls prevent the economy recovering, and the lack of recovery makes people mistrust banks even more.
To break this loop, we recommend that the government issue a blanket guarantee of deposits in the Cypriot banking system. This, we believe, would restore banking confidence, and allow normal banking services to be resumed. Deposits would flow back into the banks, the banks could begin lending, foreign confidence would return, and areas of the economy such as the property market would be unfrozen and start moving again. The country’s international financial business could also recover and contribute to Cyprus’ foreign earnings.
Of course, the government does not have the resources to issue such a guarantee, so it would have to seek a commitment from the European authorities to provide the necessary capital and liquidity support. It then becomes a question of whether these authorities would be prepared to provide that support.
The political reality at the moment is that the Eurogroup is not prepared to provide more money to Cyprus, but that could always change. We have been making the case to them that the issuance of a guarantee would not necessarily mean that money would have to be spent: if it was credible it would solve the problem.
Without a guarantee, Cyprus’ recovery could be long and painful: banking controls would probably have to stay in place, banking services would be severely handicapped, and foreign investment would stay away. At some point in the future, further financial support might even be needed, as in the case of Greece.
I stress that we make this recommendation not because we are concerned about the banking system – which is now strongly capitalised and under much tighter supervision – but because it seems to us pointless to string out Cyprus’ recovery and risk further damage down the line. With a guarantee, Cyprus’ economy could be back up and running within a relatively short period of time, and the sorry story of the last few years could be ended. It is for Europe to decide.
But if Cyprus is to have a healthy banking industry the changes must go deeper than that. Another of our recommendations is that Cyprus develop a national strategy for its banking industry. It is surprising, when one looks back over the events of the last few years that Cyprus never had a policy framework for an industry that was nine times the size of its economy, and on which it depended for vital financial services. Even as the banks were toppling in 2011, the Central Bank of Cyprus and the Ministry of Finance were not talking to each other, and the warnings signals were being ignored because proper processes were not in place to ensure that all this happened.
It is vital that Cyprus has effective political and government machinery to oversee this important but difficult industry. Our report contains a detailed set of proposals on what this strategy should consist of. Above all it has to recognise that running a big banking industry is about risk as well as reward, and that resources and processes need to be in place to ensure that it can be managed.
We also call for a change in attitudes in banking circles from one where what matters is personal connection – “Who knows who” – to one where objective processes drive decisions – “Is this the right way to do it?” This will affect not only who runs Cyprus’ banks and how they are supervised, but also how simple banking decisions – like loans – are made in a bank’s local branch. Many of the Cypriot banks’ problems came from making loans to people as personal favours rather than on their true creditworthiness.
Many countries with big financial services industries have adopted a strategy of the kind we recommend. One of the latest is Switzerland which also had banking problems and is now determined to reorganise itself, and tell the world that it has cleaned up its act. This could provide a model for Cyprus.
We strongly believe that both these recommendations will hasten Cyprus’ recovery and ensure that it faces the future with a strong banking industry and appropriate policies to back it. Cyprus needs its banks: they are its main source of finance and also, potentially, a valuable source of foreign earnings. But they must be managed accordingly.
David Lascelles is chairman of the Independent Commission on the Future of the Cyprus Banking System. www.icfcbs.org