Brussels, 05/07/2013 (Agence Europe) - It is in the interest of the eurozone that a successful restructuring of Bank of Cyprus (BoC), the island's biggest bank, takes place, says David Lascelles, president of the independent committee commissioned by the Cypriot Central Bank to draw up a report on the future of the country's banks. Lascelles explained to this newsletter the tricky nature of the operation and the sensitivity of the decisions that the ECB might take to support the process. (EL)
Agence Europe (AE) - The committee's report is critical of the aid programme. Will Cyprus come through?
David Lascelles (DL) - Part of the answer is that a lot depends on making a success of the merger and I think they will make sure that it does. However I cannot deny that Cyprus is in a very difficult situation at the moment. It's the beginning of the recession and other countries have already been through it and have shown that you can have 20% decline in economic activity, you can have unemployment up to 25%. Cyprus is only on the first step in that direction so it still has a very difficult path to go through. It's not a guaranteed success by any means, Cyprus could well have to come back for more money at some point. But I think everyone wants it to succeed and I would expect that the money would come.
(AE) - But you feel there are problems with the BoC-Laiki merger…
(DL) - Because of what's going on now, it's difficult to complete the merger successfully, it's very technical. Also it will result in Cyprus having a very large bank with more than half the market, which is not good for competition. It also means what that bank provides, if it gets into difficulties, is more than the whole of Cyprus' banking system and the whole of Cyprus' economy is also threatened. Finally, Cyprus does not have alternatives to banks to provide finance for the country, it has a stock exchange but that had to close down and no other activity so they're dependent on the banks. In the long run, we think they will have to restructure the bank.
(AE) - What are the potential costs of delaying BoC restructuring?
(DL) - Several things. One is that the uncertainty will continue. Capital control will have to continue and that creates a self-reinforcing downward spiral because the capital controls prevent economic activity taking place, it leads to recession and confidence is reduced, so you have to keep the capital controls. It's terribly important that stability is restored as soon as possible so capital controls can be lifted. But it's impossible to predict when this will happen. Some say they want to see it lifted in the autumn but the risks are enormous and it's one situation where you've got to be cautious rather than courageous so I expect they will stay for some time.
(AE) - Couldn't one imagine a big international bank buying up BoC?
(DL) - For a number of foreign banks at the moment, I don't think it's doable because they all lost confidence in Cyprus. But once stability has returned they can do it. I don't see any foreign banks taking on Bank of Cyprus before it has been restabilised. It would be a commercial action, rather than a symbolic one. With the haircut on deposits, there will be capital in the bank, so it would have value. In our report, we say that Cyprus should encourage more foreign banks to set up in Cyprus especially for competition, so we do see possibilities in that area, it would be desirable in the long run.
(AE) - Many people are criticising the Cypriot Central Bank and the ECB for providing €9 billion in emergency liquidity (ELA). Who was responsible for this?
(DL) - In our view it was necessary to have this liquidity provided because otherwise the banks would have collapsed and that would have been disastrous not only for Cyprus' economy but also for the eurozone. We now have a situation where there is an enormous amount of liquidity support from the European Central Bank and it's got to be stable because without it the restructuring of the Cyprus banking industry cannot succeed and it's got to succeed. If it fails then I can't think what the consequences might be.
(AE) - In his letter to the country's lenders, the Cypriot president, Nicos Anastasiades, criticises the transfer of Laiki's debts to BoC without the assets to guarantee them. What can be done about this?
(DL) - Actually the letter from the president contains a lot of very accurate facts and an assessment that we support. The ECB is going to have to make a very difficult decision, if it has to extend further liquidity to this new merged bank because it already stretched the rules on collateral and so on to make it possible. The merger has to work and the only way it can work is if the ECB stands firmly behind this, otherwise the merger could fail but that's also the reason why we think it will succeed is because everyone has to have it succeed and that's going to include the participation of the ECB.
(AE) - Does this mean converting the ELA into long-term bonds?
(DL) - No, I don't think so. I think it's the provision of liquidity and once the bank is back on its feet and is running and making profits then it can attract new depositors with the return of confidence and that's the point at which they can start paying back the ELA, that's the process we see. You get a strong bank then the ELA starts being paid back and reduced but that's going to be a long process.
(AE) - Did Cyprus rely on a banking sector for which it didn't have the necessary expertise?
(DL) - What Cyprus did is that they relied enormously on the banking sector but they did not have a national strategy to deal with it. By that I mean that they enjoyed the benefits and the profits of the business but they had no awareness of the risks involved and banking is a really risky business so they had no strategy which balanced the reward with the risks. So when the risks came, they were unprepared.
(AE) - The report says that the Cypriot economic model can remain based on the financial sector in the future. Is this because of the lack of alternatives?
(DL) - That's a good question. Yes it's partly that. It's a very small economy with very few activities and we believe that there is an opportunity there that has to be improved. The quality of the services has to be improved. It was not a high quality service; it relied heavily on tax breaks and on light supervision. We think there are enough professional skills in Cyprus to build a very high quality business which rely less on tax and more on professionalism. We also think that geographically Cyprus is well-placed to provide safe haven for regions of the Mediterranean which are really unstable politically and where people don't have somewhere safe to do business.
(AE) - How can banking be kept attractive if interest income is reduced?
(DL) - Interest rates have got to come down in Cyprus because the cost of borrowing is too high for the economy but, at the same time, deposits rates is what will secure money from depositors. This is a very difficult issue and may require administrative measures and the central bank is really taking steps to bring deposit rates down and it is also debated in Parliament.
(AE) - Did you find that misunderstandings between the Cypriot Central Bank and the government played a role in the emergence of the crisis?
(DL) - Definitely. You're aware that the new governor came a year ago. The previous governor had really bad relationships with the government and the consequence of that was no coordination of actions and, as I said, no policy to deal with banks and we think that was a serious cause of the crisis and we made recommendations for improving that relationship.
(AE) - The document is an interim report. What will be new in the final report?
(DL) - We are putting out our thoughts and recommendations in this report and we want them to react to this, to provide us with comments, criticism, tell us where we're wrong, where we're right, things we have missed and then we will consider all of that and put together a final recommendation in November.
The troika: we have acknowledgment from them that they have received it and I look forward to hearing what they have to say.