Cyprus: from boom to bail-in

Abstract

This is a case study of how a country nearly reached bankruptcy in March 2013, within five years of entering the eurozone. The magnitude of the requested assistance is extremely large relative to GDP (100%) and studying this event provides useful lessons for avoiding such crises in the future. The crisis resulted from a worsening European economic environment (especially in Greece), bad choices with regards to public finances, weak corporate governance within the local banking sector, inadequate and/or difficult regulation of cross-border banking, worsening competitiveness, and bad political decisions at the European and, especially, the local (Cypriot) level. Local politics, reflected in short-term political calculations and/or inadequate understanding of the magnitude of the crisis, delayed corrective action for 18 months until election time, making a bad situation almost impossible to deal with. Overconfidence can be one behavioural explanation for why local politicians ignored the dramatic costs of inaction.--Alexander Michaelides

Capital Controls in Times of Crisis – Do They Work?

“…Moreover, although measures were taken to prevent capital flight, nonresident capital outflows remained significant, as investors circumvented the controls through INTERNATIONAL MONETARY FUND 10 the use of American depository receipts, paying large premiums to exit the country (Auguste et al 2002;Melvin, 2003). Recent uses of capital controls in response to the European crises, namely in Cyprus, Iceland, and Ukraine, have been less well-studied, although narratives on individual experiences are documented in Baldursson and Portes (2014), Michaelides (2014), andBaldursson et al (2017). Of particular interest is the prolonged duration of the controls in Iceland (more than eight years), where addressing the large claims of the creditors of the failed banks was necessary before lifting the controls.…”

“…The Cypriot case of imposing and maintaining controls was shorter, albeit equally dramatic given that the imposition of capital controls within the euro area amounted to an effective devaluation of the euro within Cyprus. Michaelides (2014) studies the imposition of the controls in the context of the bail-in agreement reached in March 2013, which led to a bank holiday of 11 working days, the temporary introduction of cash withdrawal limits, and strict ceilings on transfers within the country and abroad. The controls were gradually eased and then lifted within two years of their introduction.…”

Regulatory changes and long-run relationships of the EMU sovereign debt markets: Implications for future policy framework

“…This was found to be more likely to be associated with market sentiments and liquidity concerns. But long-term political changes have also manifested in the incredible economic events that had taken place in countries such as Cyprus and Italy (Michaelides, 2014;Deeg, 2005). Benediktsdottir et al ( 2011) found that Icelandic authorities as a matter of policy encouraged the creation of an international banking centre, involving the privatization and deregulation of the banking system, rules and regulations being relaxed and the neglect of financial supervision.…”

One-off wealth taxes: theory and evidence

“…Certainly, the sector was large relative to GDP, and highly concentrated -with the two largest banks, the Bank of Cyprus and Laiki, accounting for almost half of all banking assets (Stephanou, 2011). Nevertheless, the banking sector was still able to keep credit flowing to the economy, funding an ongoing construction and housing boom, well into 2012 -aided by inflows of capital from other countries during the early days of the Eurozone crisis (Michaelides, 2014).…”

“…From late 2012 to February 2013, the value of bank deposits in Cyprus fell from circa €80 billion to around €70 billion. A further €7.4 billion of deposits disappeared from bank balance sheets in March 2013, though this will have reflected the haircut imposed by the bail-in, as well as capital flight triggered by rumours about the possible terms of the deal (Michaelides, 2014). Once the bank levy was announced in mid-March, queues formed at ATMs as Cypriots sought to withdraw whatever they could from their accounts -even though the tax was to be assessed on the basis of deposits as at the time of the initial announcement.…”