By Michalis Zaouras on April 19, 2013

Banks bail-in a template or not?

EU officials and Member States' representatives (national governments) have been discussing whether a bail-in approach to banks resolution is a template or not. I provide below some evidence that it might be a template after all. In 06/06/2012 the Bank recovery and resolution proposal is clearly suggesting a shift of EU's policy from bail-out to bail-in. To cite:

"What resolution tools will be needed?

(iv) bail in creditors (mechanism to cancel or reduce the liabilities of a failing bank, or to convert debt to equity, as a means of restoring the institution's capital position)."

The proposal also suggest the protection of secured depositors. See below for reference:

Interestingly, the proposal does not exclude a bail-out approach but rather allows a bail-in within a European context. Worryingly, a bail-out can be used in order to safeguard the big banks from failing (too big to fail) in the context of systematic risk while a bail-in approach can be used for smaller non-systematic banks. The problem with such an approach is how you define a big bank (or systematic). Consider the case of Cyprus, Laike-Marfin is definitely a small bank (and non-systematic) in the European context and as a result it can be bailed-in. However, this bank is "big" within Cyprus therefore generating systematic risks within Cyprus (but potentially not within EU). As a result, someone would expect big banks in large economies within EU to be bailed-out while "small" banks in small economies to be bailed-in. So is this a step forward for EU integration or not?

Please note though that the above analysis is based on a proposal. This has not been put as a directive (not yet at least), which means that it is not legalized as a template. Therefore, it is not a template (yet) but it is included in the proposal of Monetary and Fiscal Integration of the EU (and seen as a necessary tool).

Most interestingly I have found an EU discussion paper that proposes the bail-in approach (see below for reference) and suggests that this idea should be tested first. Guess where they have tested the bail-in approach? Hmm... wait a minute I know, Cyprus!

Finally, the above documents suggest that political parties (which take part in the EU Parliament) and the Government  of Cyprus (participating in the initiatives for Monetary and Fiscal Integration) were (or should have been) aware of what the bail-in and bank resolution within that context corresponds to. Therefore, I believe that the blaming game currently taking place in Cyprus is just ridiculous (everyone is responsible, maybe some of them to a lesser degree) and unproductive.  Most importantly, the root of the problem was not how we handled the crisis (though it has amplified the crisis) but rather the failure of the banking sector and the banks overexposure to risky assets.

By Michalis Zaouras on April 18, 2013

A new currency is born in Cyprus (or at least this is what is promised)!!!

What happened? Nicosia municipalities are planning to start a program where products and services can be exchanged for To.M.'s (an exchange vehicle). The owners of To.M. units can "cash them out" by buying other goods or services offered by individuals and companies within the exchange program.

Ring any bell? It should; this is the definition of paper money (mean of exchange)...

Why has this happened? Two reasons; lack of liquidity (businesses cannot use their bank accounts to buy supplies and as a result they are desperate for a mean of exchange - >To.M.). Furthermore, the threat of Cyprus leaving the Euro makes the business and individuals less willing to make payments in Euro (if Cyprus pound is introduced then one Euro will worth more than the pound so people are keeping their Euros under their "pillows"), adding to the liquidity problem.

See link below for reference (unfortunately is written in Greek though)

By Michalis Zaouras on April 12, 2013

Short - Medium Run solutions for Cyprus Economy (some first thoughts)

Unfortunately, in the last month we have seen something unprecedented happening in Cyprus; financial institutions melt down within a couple days. The immediate consequences have started to appear (internal and external capital controls, drop in consumption… ). Economists, media and politicians, up to now, have been consumed on analysing alternative scenarios (exit of Eurozone or not) and more recently consumed into a blaming game for the situation that we are up to. However, we have neglected to draw a plan on what economic model we should follow from now on (with exception today’s announcement by president Anastasiades). Therefore, I believe that an open dialogue on the future of the Cyprus Economy (which industries should we “help” to be developed) is of immense importance. Having that in mind, I have decided to put on paper some first thoughts on short – medium run solutions for the Cypriot economy.

First of all, without a good functioning of the financial institutions then one can not find a way out of the crisis. Therefore, I believe that we should approach foreign banks (Barclays, Societe Generale, City Bank, Gazprombank…) and propose acquisition of Cypriot owned branches (unfortunately this will come with a huge cost since these banks will not be willing to take such an investment without a large discount on the value of those assets). This will guarantee (I hope) that some of the financial institutions in Cyprus are healthy and those institutions will be able to gain the trust of the public (new banks created without the threat of recapitalization). As a result, these banks will be able to attract and finance international and local investments (this can be agreed with the government of Cyprus in order to increase the benefits of those banks and increase the attractiveness of such an investment). Having found a solution that stabilizes the financial sector we should draw plans on the economic model we should follow. Below I list some options.

1. Shipping;
Cyprus has been successful to attract offshore companies active on the shipping industry. We can privatize our ports (in Limassol and Larnaca) conditional on investment on updating and expanding the infrastructure. We should provide incentives to increase the hub operations in our ports. However, it requires some research to be done in order to pin-point what additional services, public and/or private, are required for Cyprus to become a major shipping center. This solution can have immediate effects (increase the hub operations) as well as medium effect to the Cyprus economy (investments on ports’ infrastructure).

2. Tourism;
We are currently faced with capacity constraints with respect to the number of tourists that we can attract (we cannot built new hotels within 2 months). Therefore, at the short run we should focus on how to expand the tourism period; casinos, academic conferences are some options. In the medium run we should provide incentives on quality updates in order to increase the “value of money”.

3. Financial services - Consultancy;
This sector can cope without financial institutions (a firm that specializes in fx trading can still trade through other European banks – not located in Cyprus), in Cyprus at least. A short –run negative effect is in place, since most probably some of their capital has been wiped out from Laike and BoC deposits hair-cut, but I feel confident that it will be revived (a mergers-acquisitions spiral might-should be facilitated by the Cypriot authorities).

4. Agriculture
I feel that due to the lack of the ability to invest on economies of scales this is not a promising sector (we cannot compete with other agriculture oriented countries). However, there is a market for genetically modified agricultural products (even though I am not really fond of this idea). Through proper legislation we might be able to attract some investment on a small scale testing ground for the development of these products (R &D). This will benefit both the agriculture sector but also R & D (high skilled - research jobs might be generated).

5. Internet services;
We do have the labor force (skilled-educated) to attract internet companies. Probably a serious research will be required to investigate how we can attract some of those companies (Malta can be an example I think).

6. Gas reserves;
I will not say much of this, there is a current (huge) discussion on whether we should presell some of our exploitation rights. However, I am a bit concern with the potential economic dangers (which no one is talking about). Cyprus has high seismic activity and this might increase the likelihood of an accident on a deep water gas production (not certain though, I am aware of the oil spill accident at the Gulf of Mexico). Shouldn't we start discussing on safety issues (and dangers) as well?

Please note, I am certain that there might be more alternative solutions which are more than welcome to discuss. Finally, notice that the above options can be used irrespective on our decision of a Euro exit or not (probably with the exception of Financial services - Consultancy).

By Michalis Zaouras on April 10, 2013

Cyprus Sells gold reserves valued at 400mn Euro

The recent announcement is very worrying. What are the implications? Without gold reserves there is no possibility of a Euro exit neither the threat of it. It also increases the control of the ECB to the Central Bank of Cyprus since an important tool to increase money supply within the country is foregone (and tackle future liquidity issues). As a consequence I believe that any negotiation (bargaining) power, through a potential Euro exit, that Cyprus officials have on future demands of Troika has gone as well. Can we do any worse?