13 August 2013
Mr President, Members of the Investigation Committee,
I took office as Governor of the Central Bank of Cyprus (CBC) on 3 May 2012 and on that day I participated in a meeting of the Governing Council of the European Central Bank in Barcelona. On the same day, the Minister of Finance, Vassos Shiarly, telephoned and informed me about the state of Laiki Bank.
The total capital adequacy ratio of Laiki Bank on 31 March 2012 was 4,05%. Therefore, it lagged significantly behind the minimum 8% required by the relevant EU Directives and the minimum 9% Tier I capital, set by the European Banking Authority, which should have been achieved by 30 June 2012. The recapitalisation plan presented by Laiki Bank was to increase the capital participation of existing shareholders and other investors. Around mid-May 2012, it was already evident from Laiki Bank’s estimates that, of the planned €1,8 billion capital increase, only €300 million could be collected from the private sector.
On 26 October 2011, the Heads of Member States of the European Union decided to support banks which did not meet the minimum capital required by the European Banking Authority by 30 June 2012. Following this, the CBC, taking into account the systemic importance of Laiki Bank and the general adverse consequences of an unsuccessful recapitalisation programme, recommended the activation of the law on financial crises and the underwriting by the government of the planned share capital increase. What would have happened had Laiki Bank not received state support in June 2012, its operating license revocated and the bank entered into liquidation? It should be recalled that at that time there was no legal framework for the resolution of credit institutions.
On 30 June 2012, Laiki Bank’s insured deposits amounted to €7,3 billion. In addition, a significant part of its assets, including those which were liquid or of high quality, were used either as collateral for the liquidity received through the Eurosystem's operations or the emergency liquidity provided by the CBC. Only a very small proportion of insured deposits, probably less than 2%, could have been covered from the Deposit Protection Fund. For the remainder, the insured depositors should have expected a partial compensation over time from the liquidation of those assets which were not used as collateral, since the state was not able to secure financing for this purpose. Meanwhile, however, all the depositors of Laiki Bank would have lost almost all their cash flow which would have led to the collapse of the domestic financial system and put in doubt our country’s membership of the euro area.
The "alternative solution" just described is in my opinion the only honest answer to questions such as "was it necessary for the state to support Laiki Bank in June 2012?" Or "why had the CBC not stopped the provision of emergency liquidity to Laiki Bank?".
The aforementioned "alternative solution" was eventually avoided since the state decided to support the recapitalisation efforts of Laiki Bank. Despite estimates by the then Board of Laiki Bank, this state support did not attract the anticipated increase in capital from the private sector. More specifically, the private participation in the capital increase amounted to only €3 million. As a result, the Republic of Cyprus had to cover almost all of the increase of €1,8 billion. Let me mention here that the failure of the then Board of Laiki Bank to attract private investors led the CBC to ask the then President of the Board of Directors to resign, as a matter of principle, regardless of whether the then government, after state support, also wanted his departure.
A few days before the closing date of 30 June 2012 and the state support to Laiki Bank, specifically on 25 June 2012, Fitch downgraded the credit rating of the Republic under the minimum threshold set by the Eurosystem as a condition for accepting government bonds as collateral. In order to assist the Investigation Committee, I have given a copy of Fitch’s announcement to the secretariat. It is well known that the main reason for the above downgrade as well as the previous successive downgrades were, inter alia, the increased capital needs of the three largest domestic banks due to their exposures in Greece and, to a lesser extent, the deterioration of their asset quality in Cyprus. Fitch found that the ability of Cypriot banks to raise capital from private sources was limited and that, by implication, these banks would have needed state support, which would have resulted in a substantial increase in public debt.
Given that all other credit rating agencies had already downgraded the Republic of Cyprus, Cypriot government bonds ceased to be eligible as collateral for the Eurosystem’s credit operations. These downgrades limited access to liquidity from the Eurosystem for all credit institutions which held Cypriot government bonds. They were also particularly adverse for Laiki Bank, as they led to a reduction in the value of government bonds, which the government contributed to Laiki Bank in order to cover the capital increase. As a result, I suggested, in consultation with the then Minister of Finance, to the then President of the Republic to request financial support for the Republic through a programme. This was necessary due to the large imbalances and vulnerabilities in the banking sector, which are examined in detail in a written memorandum delivered to this Committee’s secretariat.
The request for financial support is critical to the actions taken by the CBC from 30 June 2012 onwards. Government support of Laiki Bank resulted in an improvement in its capital ratios, but this improvement was temporary as these ratios deteriorated again on 31 August 2012, when the results for the first half of 2012 were announced. In any case, given the failure of the Republic of Cyprus to find resources to support the recapitalisation of its financial system, the CBC could not in any way rely on this temporary improvement in order to continue providing emergency liquidity to Laiki Bank. Even if there was no need for emergency liquidity, the CBC needed to ensure the recapitalisation in order to maintain Laiki Bank’s operating license. Under the circumstances, this could only come about through the Republic’s financial support. The CBC continued to provide emergency liquidity to Laiki Bank, maintained the operating license of both Laiki Bank and the Bank of Cyprus (which also requested state support amounting to €500 million on 29 June 2012) and provided emergency liquidity to the Bank of Cyprus in November 2012 and again in February 2013. All these were on the basis of the request made by the Republic for financial support.
It should be emphasised that, taking into account the recommendation of the European Banking Authority, dated 8 December 2011, concerning the creation of temporary capital reserves to restore confidence in the banking sector, the Bank of Cyprus had a capital deficit of €1.560 million, which had to be covered by the end of June 2012. Part of this deficit was covered by the Convertible Enhanced Capital Securities of €887 million, and thus another €673 million was needed. Indeed, the management of the Bank of Cyprus assured me during our meetings in May and June 2012 that the impending sale of the insurance subsidiaries of the Bank of Cyprus would cover the requirements of the European Banking Authority by 30 June 2012. I have given to this Committee’s secretariat the correspondence between the CBC and the Bank of Cyprus prior to the request for state support as well as the request itself.
One can therefore understand the implications of each day’s delay in the completion of negotiations for the financial support of the Republic. The country’s two biggest credit institutions were jeopardised as well as the continuing provision of basic banking services to businesses and households.
Under this pressure, the CBC worked intensely towards an agreement on a financial support programme. Through the diligent work of its staff, a first agreement on the financial sector was reached with the Troika in November 2012. In addition, written and verbal warnings were given to the political leadership of the consequences of the delay in signing the Memorandum. I have given a copy of such written warnings to the Committee’s secretariat. As for the verbal warnings, I refer you, inter alia, to the meeting of the political leaders under the President of the Republic on 21 November 2012.
Let me make one more reference to the relationship between the financial support programme and the provision of emergency liquidity. Criticisms have been made against the CBC for an infringement of the rules on the provision of emergency liquidity. There was also a misinterpretation of a statement made that Laiki Bank was kept alive until the elections. The solvency of the two biggest banks in Cyprus could only be guaranteed if a financial support programme was in place. Without this perspective, the CBC ought by law to have terminated the provision of emergency liquidity and revoked the operating license of Laiki Bank and the Bank of Cyprus. This would have been devastating for the financial system and the country's economy. Once European officials began in late 2012 to believe that the then government was not prepared to sign a Memorandum and were stating publically that an agreement would be signed with the new government, the whole economy came to a halt until the elections. This postponement was confirmed by the Eurogroup on 21 January 2013. At this point, it is worth mentioning that a few days after the Eurogroup of 21 January 2013, Laiki Bank’s ability to raise emergency liquidity reached a plateau due to the reduction in the value of its available collateral. The CBC acted solely with the aim of maintaining financial stability, but found itself in the middle of a political debate at a national, European and international level, which often accompanies such support programmes (hence, it is now imperative to institutionalise financial integration in Europe, with the establishment of pan-European common supervision, deposit protection and resolution of credit institutions).
Before I conclude my introductory statement with some information on PIMCO diagnostic tests and the events of March 2013, I would like to refer briefly to: (i) the study on the future of the Cypriot banking sector, which is being conducted by an independent committee, and (ii) the investigation conducted by Alvarez & Marsal on behalf of the CBC on specific recent events which affected the two largest banks in the country. The impetus for this initiative was the situation in which the two largest credit institutions in the country found themselves and which caused them to require public support. These two reports, which complement each other, support the CBC in its supervisory role, by highlighting the gaps in the financial institutions’ corporate governance and the weaknesses of the supervisory framework. The findings of these reports will assist the CBC and other institutions, in general, to formulate recommendations for strengthening their role and streamlining the financial system. The Interim Report of the Independent Commission on the Future of the Cyprus Banking Sector is already available, and I have given it to this Committee’s secretariat.
With regards to the Alvarez & Marsal report, I realise that it has assisted the Investigation Committee in its work, without this meaning that the files of the CBC are not generally available to the Committee for the investigation of any other events. For example, let me mention that the CBC had serious concerns about corporate governance at the Bank of Cyprus before the resolution, with the then Board not having the necessary vigor, insight and foresight, but functioning more as an approving body, which was hesitant to change and modernise corporate governance. In fact, in some cases there was even conflict between the personal interests of Board members and the interests of the Bank of Cyprus. The evidence available to the CBC is of course also available to the Investigation Committee. I have given the relevant material to the Committee’s secretariat, which includes correspondence with the Bank of Cyprus regarding its cooperation during the Alvarez & Marsal investigation.
The obligation to conduct diagnostic checks to banks was put forward by the Troika during its first visit in July 2012. As is well known, a Steering Committee was established, with the participation of representatives from the Troika. The Steering Committee drafted the terms of reference and requested tenders from five companies. After an evaluation, information on which was given to the Investigation Committee, PIMCO was selected. At this point, let me mention that the Bank of Cyprus, which has repeatedly expressed its disagreement with the methodology and assumptions used by PIMCO, without informing the CBC and at an unnecessary cost of about €470.000, instructed another firm to conduct separate diagnostic checks. This was in order to question PIMCO’s reliability and use the results for exerting political pressure. The firm chosen by the Bank of Cyprus had given a tender to the Steering Committee and was rejected due to inexperience in specific areas of diagnostic checks. I should also briefly mention that PIMCO’s results went under a thorough and comparative analysis by experts from the European Central Bank, before being accepted by the representatives of the Troika. Thus, it is clear that the results of any other firm could not call into question PIMCO’s results, nor be used for the bank’s recapitalisation.
The Eurogroup’s decision on 15 March 2013 supplanted the first agreement reached with the Troika in November 2012, namely that the financial system would be recapitalised with programme funds amounting to €10 billion. The events which followed are pretty well known and I understand that the CBC has already given certain pieces of information which had been requested. Similarly, the decision of the second Eurogroup meeting on 25 March is known, which was along the same lines. Specifically, not using programme funds for the recapitalisation of Laiki Bank and the Bank of Cyprus. In other words, instead of the €10 billion for the recapitalisation of the financial sector which were included in the first agreement with the Troika in November 2012, the agreement reached on 25 March 2013 included €2,5 billion for the recapitalisation of the financial sector, with the explicit condition that this amount would not be allocated to recapitalise Laiki Bank and the Bank of Cyprus. The context in which the CBC moved from there onwards was determined by this political decision, which included the sale of branches in Greece, the basic principles for the absorption of Laiki Bank’s operations by the Bank of Cyprus, and the ‘bail-in’ at the Bank of Cyprus.
I would like to take this opportunity to remind you that, in relation to the operations of Cypriot banks in Greece, the CBC had long before explored the available options, in order to protect the stability of the Cypriot banking system against the difficult economic situation in Greece. In May 2012, I had a meeting with my Greek counterpart during which we discussed the option of converting the operations of Cypriot banks in Greece into subsidiaries. This option, for which press reports are available, would not have eliminated the need for recapitalisation, but could have allowed a more favourable final settlement for the banks concerned, compared with the one actually made under the pressure of time and following the political decisions taken on 26 March 2013. The sale made as a result of political decisions was the best possible under the circumstances. The circumstances, however, might have been different if the early efforts of the CBC were not impeded by the vigorous refusal, especially by the Bank of Cyprus, to consider the option of turning their Greek operations into subsidiaries and selling them. It is worth noting that the Bank of Cyprus rejected the invitation for holding a meeting at the highest level with a specific international investment bank which had experience with a similar project in Greece.
It is also worth noting that, before the resolution, the CBC had contacted the Bank of Greece in order for the latter to undertake the provision of emergency liquidity to the branches of Laiki Bank and the Bank of Cyprus in Greece. This attempt was not successful. I have given the relevant material to this Committee’s secretariat.
With regard to the transfer of emergency liquidity from Laiki Bank to the Bank of Cyprus, for which the CBC has received strong criticism, even though it is included in the decision of the Eurogroup on 25 March 2013, it is worth mentioning that the amount of emergency liquidity to Laiki Bank on 29 March 2013 amounted to €9,1 billion. However, this amount includes a debt of €1,2 billion by the Bank of Cyprus to Laiki Bank, which was created on 26 March 2013. More specifically, on 26 March 2013, while the sales agreement of the branches of Laiki Bank provided for payment of €1,7 billion from Piraeus Bank to Laiki Bank, the sale agreement on the branches of the Bank of Cyprus provided for payment of €1,2 billion from the Bank of Cyprus to Piraeus Bank. Given that on 26 March 2013 the takeover of Laiki Bank’s activities by the Bank of Cyprus was already initiated, Laiki Bank financed the debt of the Bank of Cyprus to Piraeus Bank and therefore the net debt from the emergency liquidity that was transferred from Laiki Bank to the Bank of Cyprus on 29 March 2013 was €7,9 billion.
The resolution measures taken at the Bank of Cyprus and Laiki Bank have led to many disputes brought before the court. For this reason, I will not elaborate on the subject and the arguments which support the CBC’s position. I will merely mention that the "alternative solution" would have been the liquidation of both institutions. This would have involved stripping them of a substantial part of their assets, which were used as collateral. In addition, the need to compensate the insured depositors would have reached the huge sum of approximately €19,7 billion for both banks (reference date: 31- December 2012). Finally, there would have been interruption of basic banking services and a loss of more than 5.000 jobs.