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Amid fears of Greek controls, Cyprus shows restrictions are bearable

By Michele Kambas

As Cyprus’s financial system imploded in the spring of 2013, the island’s leaders were given an ultimatum: sign up to a bailout deal or watch your banking system collapse.

The brief, painful drama that unfolded on the Mediterranean island led to the first capital controls in the euro zone to stem a bank run and stop money fleeing the country.

With Greeks pulling billions out of banks on fears that their country will default, the same drama risks being played out in Greece this time unless the leftist government clinches a last-ditch debt deal with international creditors this week.

Like Cyprus then, Greek banks are now relying on emergency liquidity assistance (ELA) authorised by the European Central Bank to cope with deposit outflows which accelerated last week as Athens and its lenders remained deadlocked..

For economist Michael Sarris there is little doubt what will happen if the ECB pulls the plug on Greece.

“Basically they would have to close in half an hour,” he told Reuters, referring to Greek banks.

He should know. As Cypriot finance minister in 2013, Sarris was forced into a deal contingent on winding down a bank on an ELA lifeline. A second bank was forced to raid its clients deposits to recapitalise, a process known as a ‘bail-in’.

Athens is similarly at risk of having its ELA funding cut if it fails to comply with European creditors’ demands and defaults on an International Monetary Fund repayment due by June 30.

Greeks pulled out more than 4 billion euros from the banking system last week, prompting the ECB to meet for a second time to raise the ELA ceiling. That will only keep the banks afloat until early this week when the decision will be reviewed again.

Greece’s government has strongly denied that it is planning capital controls.

The trigger in Cyprus, Sarris says, was lenders that warning ELA for Cyprus banks would be cut. Nicosia was forced to agree to conditions, and capital controls to prevent a bank run, since those deposits were needed to recapitalise the banks.

Two years later, capital controls have gone. That contrasts with Iceland, which is only just preparing to dismantle restrictions imposed after its own financial meltdown in 2008.

“They showed us a piece of paper saying they had a two-thirds majority on the governing council of the ECB,” Sarris recalls, referring to warnings of a cut to funding.

After a two-week shutdown, Cypriot banks reopened. Cash machines had remained in operation and were replenished regularly.

There were few queues and little fuss, a stiff upper lip trait islanders may have picked up from their former British colonial rulers.

After the two-week closure, a 300-euro-a-day cap on cash withdrawals was initiated for individuals; business transactions over 5,000 euros per day needed central bank approval; credit card spending abroad was capped at 5,000 euros a month; and travellers could not export more than 1,000 euros at a time.

The IMF and the ECB wanted tougher restrictions. Cyprus stood its ground. Within weeks, foreign banks were decoupled from the controls, and a timetable for a staggered withdrawal of the restrictions was introduced.

“It was difficult, there was a shortage of liquidity and bureaucracy in moving capital around, but gradually we got used to it and the situation improved,” said Michalis Pilides, head of Cyprus’s main business organisation OEV.

“Both the state and banks introduced deep structural changes and that was instrumental in regaining trust which allowed controls to be relaxed,” he told Reuters.

Sarris says Cyprus’s overriding concern was to avoid burrowing itself so deep in controls that it would be difficult to remove them.

“I don’t think many thought we could do it in two years, mainly because of the experience of Iceland,” he said.

The North Atlantic island imposed controls on the movement of capital after its three biggest lenders — Glitnir, Landsbanki and Kaupthing — folded under the weight of their debts as the global financial crisis reverberated.

They are gradually unwinding. This month, Iceland proposed that creditors would have to pay a 39 percent tax on money taken out of the country unless they all agree to “stability” conditions by the end of this year. These terms are in effect a form of contribution by the creditors to state coffers.

The finance ministry said the measures were about protecting Iceland’s balance of payments rather than extracting money from creditors, mostly hedge funds that bought into the debt after the collapse of the three key banks.

It said the measures related to 1,200 billion Icelandic crowns (roughly $9 billion) of capital: 900 billion of assets of the failed banks and foreign-denominated claims against Icelandic entities, and 300 billion of foreign investment in Icelandic instruments.

But there are few comparisons between Cyprus and Iceland. Both had outsized banks, but one was in a currency union with little wiggle room and the other had its own currency to protect.

“It wasn’t only a banking crisis in Iceland, but they had their currency to defend, and capital controls were trying to do two jobs at the same time,” said Fiona Mullen of Sapienta, an economic consultancy.

“In Cyprus is was just a matter of defending liquidity. The main impact was psychological on people, but it didn’t really stop the circulation of money,” she said.

Cypriot authorities are in the second year of an EU and IMF mandated reform programme in return for 10 billion euros in bailout funds, and expect to exit the programme in early 2016.

Cyprus returned to growth in the first quarter of this year for the first time since 2011, and officials say they may not need all the bailout money.

“There was a smaller impact than we feared. Cypriots reacted more maturely,” said Sarris. “It was a heavy blow to us, but were weren’t going to cry about it.”

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