Herexamen voor Troika in Cyprus

7/30/2019 Herexamen voor Troika in Cyprus

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KBCECONOMIC RESEARCH (GCE)

MACROECONOMIC UPDATE

SIEGFRIED TOP (02/429.59.91) AND DIETER GUFFENS (02/429.62.87)

25MARCH 2013

Update on the Cyprus bailout deal

EXECUTIVE SUMMARY

Cyprus, the Eurogroup, the ECB and the IMF reached a new agreement on a financial assistanceprogramme of up to 10 bn EUR

After a week of intense negotiations with all the stakeholders, the initial deal was altered in thefavour of small depositors (below 100.000 EUR), which remain insured under the depositguarantee scheme, while investors and large deposit holders of Laiki and (to a lesser extent)

Bank of Cyprus will pay for the recapitalization of their banks

Potential contagion via the breach of the deposit guarantee scheme has been curbed, althoughthe option of bailing-in depositors seems now no longer a taboo. Senior bondholders are now

also involved. As a result, senior bank debt has become more risky, as the principle of bail-in

rather than bail-out with tax money, has been established

Cypriot debt sustainability will depend on the future growth performance, which may beproblematic as its role as offshore financial centre with close links to Russia could be done for

1. The problemThe initial Cyprus bailout deal, as was discussed last week (GCEs assessment 18/03), was rejected by the

Cypriot Parliament. The deal, by which deposits on all Cypriot banks would have been subject to a one-

off stability levy of 9.9% above 100.000 EUR and 6.75% below 100.000 EUR (insured deposits), thus

generating EUR 5.8 bn to recapitalize the Cypriot banks, was widely contested. Economists feared this

would be seen as a dangerous precedentof the breach of the deposit guarantee scheme, which could

trigger a silent bank run throughout Southern Europe, or even a loud' one in case of a bank getting

into financial difficulties.

After the rejection of the initial deal, Cyprus argued it would have a plan B, that would also generate EUR5.8 bn, but without placing any haircut on Cypriot deposits. This would halt popular unrest against the

levy on insured deposits but also shelter the larger deposits, which are for a large part from Russian

investors. As a result, the Cypriot government and parliament hoped to preserve the Cypriot status as

an offshore financial centre, which is next to tourism Cyprus main economic activity. However, the core

of plan B, the investment fund (or solidarity fund) that was set up and that was to be securitized with

social security fund reserves, state assets, church property and expected natural gas revenues, was


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rejected by the Troika. Moreover, negotiations with Russia in order to obtain a new or extended loan or

investments in the Cypriot banking sector or energy sector did not produce any results.

As the ECB threatened to cut off emergency lending (ELAs) to the Cypriot financial system, most

Cypriot banks would by Tuesday March 26th be bankrupt, as would the Cyprus sovereign if insured

depositors would have to be paid out. The Cypriot government and parliament thus had to find a deal

before the start of this week, and therefore return to plan A, in order to obtain a EUR 10 bn euro area

loan, while accepting the strong EU/IMF conditionality.

2. The proposed solutionIn order to resolve this Gordian knot, Cyprus first introduced some new legislation in parliament last

Friday, so that the appropriate tools were in place to start the final discussion with the Troika. Cyprus

introduced a new Bank Resolution Framework to deal with its failed banks, agreed with a split-off of

Cypriot bank subsidiaries in Greece and voted for capital controls, but also agreed on the investment

fund, so that plan B would still be possible. In the end, the Cypriot president headed to Brussels on

Sunday to conclude the negotiations with the president of the EU, ECB and IMF. Technical details were

then further discussed inside the Eurogroup, resulting in the following agreement:

Laiki Popular bank (2th largest lender of the country) is to be resolved immediately, with fullcontribution of equity shareholders, all bondholders and uninsured depositors. Insured

deposits (below 100.000 EUR) are transferred to the countrys largest lender (Bank of Cyprus).

Bank of Cyprus is to be recapitalized through a deposit/equity conversionof uninsured deposits(with estimates of the haircut of up to 40%) with full contribution of equity shareholders and all

bondholders, with a capital ratio of 9% to be reached at the end of the EU/IMF programme

(probably 2020). No EU/IMF money is to be used for recapitalizations.

Other Cypriot banks and deposit holders are not to be hit. Nevertheless, the Cypriot domesticbanking sector has to be downsized to EU levels. Depending on the measure used, this would be

a downsize of about 250 to 400% of GDP (assets of domestic banks stand at 450% of GDP, while

assets of all banks in Cyprus (including foreign owned subsidiaries) stands at 750% of GDP).

All subsidiaries of Cypriot banks in Greece are split off and sold to Greek lenders (which arealready nationalized and under EU/IMF control) to avoid contagion.

Reform measures announced last week (increase of the withholding tax on capital income and ofthe statutory corporate income tax rate) remain in place.

In return for this conditionality, the EMU (via the ESM) will support the Cypriot programme withup to 10 bn EUR, while the IMF may also participate by up to EUR 1 bn.


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The ECB will continue to provide liquidity to the Cypriot healthy banks, and to banks that arerestructuring via Emergency Liquidity Assistance (including ELAs), including the recapitalized

Bank of Cyprus, that will inherit the ELAs of Laiki

3. Assessment of the agreementThe Cypriot problem has been solved, with a solution that is definitely better than the first one. From the

positive side,

The immediate bankruptcy of the Cypriot banks and sovereign have been avoided. Thedeadline put in place by the ECB was respected, and the EU/IMF demands to address the failed

bank problem were in the end accepted.

The deposit guarantee scheme for insured depositors (below 100.000 EUR) was respected.Small savers are thus not hit, not even in the bankrupt Laiki bank. Uninsured depositors (above

100.000) in the other banks are also spared, so that the bail-in is not generalized. Contagion to

and bank runs in other countries as a result of the Cypriot problem has thus become less likely. As only two specific banks are affected by todays agreement, the measures taken with respect

to the two specific banks fit within the already approved Bank Resolution Frameworks, no

further Cypriot parliamentary votes are needed.

The number ofsenior bond holders that is affected seems to be limited in this specific case. Still,senior bank debt has become more risky, as the principle of bail-in rather than bail-out with tax

money, has been established

Because of the bail-in, the amount of (Cypriot and European) taxpayers money to be used inrecapitalizations remains limited. According to the Troika, Cypriot debt to GDP will remain

sustainable in the longer term (100% in 2020).

In the end, the deal that was struck reflects mostly the demands of Germany, the ECB and theIMF, indicating that they set the agenda in the euro area. The intention of Cyprus to play it hardand obtain Russian help were unsuccessful, thus limiting Russian influence on Cyprus.

Still, some risks remain:

Last weeks discussion on Cyprus have hampered again confidence in the handling of the crisisby the European leaders. There has been a lot of miscommunication, especially around the

insured deposits of below 100.000 EUR that were also part of the bail-in plans, that could have

been a source of contagion to the rest of the euro area. The principle of a levy on deposits is

therefore no longer a taboo. The Cypriot crisis has also highlighted the needto complete thebanking union and the single supervisor with both a single resolution mechanism and a single

deposit guarantee scheme. Until then, the application of the guarantee depends on a national

political decision, and may thus lack credibility.

Also, the question of legacy assets related to the banking crisis comes in the scope here. It isour view that so far there is little prospect for a transfer of legacy assets of past crises to a more

supranational level. The case of Ireland (cf. Promissory notes deal) has shown, however, that this


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can be circumvented, and that the ECB plays an important role here. Such a deal is for Cyprus

however less likely.

Even though the further steps are not to be problematic (the Troika and the ESM board have tofinalize the deal before the 23th of April and the plan has to be voted in the German, Dutch and

Finnish parliament), the inability to swiftly address this small problem (Cyprus is 0.2% of EMUGDP and the total costs only amount to 17 bn EUR), cast doubts on the EU/IMF capability to

solve larger problems (e.g. Italy, Spain), if the eurocrisis escalates again. It stresses the role of

ECB as the main guarantor of the survival of the monetary union (e.g. via the OMT).

The Cypriot economy will now go through a more severe recession than foreseen, as its statusas offshore financial centre has taken a severe blow. The Cypriot economy will have to readjust

to this new reality, and targeted European support will have to be put in place to prevent the

Cypriot economy from going into a Greek-like depression. Such a depression could endanger the

debt sustainability of the Cypriot sovereign. The question remains how the EMU will handle

legacy assets in the near future.


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Herexamen voor Troika in Cyprus

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