Fairness and reflexivity in the Cyprus bail-in

Abstract

The Cyprus debt crisis provides some unique lessons. By the time an assistance program was agreed with the Troika of international lenders, the problem had become so complex that a depositor bail-in was implemented to safeguard financial stability. The bail-in was an ad hoc solution applied for the first time in the eurozone but is now the blueprint for dealing with future banking crises. This paper examines the events for the 18-month period before the two eurogroup meetings on Cyprus in March 2013, and the resolution and restructuring of the two systemic banks of the country with depositor bail-in. We show how delays in dealing with the crisis exacerbated the problem but also how the tools brought into solve the problem had significant unintended consequences that fit the reflexivity principle. Available evidence questions the validity of confidential studies guiding the policy decisions on depositor haircut and supports the argument that the bail-in, as implemented in Cyprus, violated international principles of fairness. We use the analysis to draw some lessons on the use of bail-in for future crises. JEL Classification

The Impact of the Eurozone Crisis on National Foreign Policy: Enhancing Europeanization in the Case of Cyprus*

“…As noted by the governor of the Bank of Cyprus at the time this was because ‘as a communist party they did not want to incur the political cost of adopting consolidation measures’ ( The Economist , ). Thus, unlike other countries that had sought assistance early from the troika to resolve their problems, ‘the Cyprus government followed a policy of procrastination’ (Zenios, , p. 3). When Cypriot banks were subsequently exposed and suffered severe losses following a decision by European leaders to write‐down Greek government debt on October 2011, ‘the joint effect of public debt accumulation and deterioration of the banks’ balance sheet set in motion a negative feedback loop between banking and the public finances' (Zenios, , p. 5).…”

“…Thus, unlike other countries that had sought assistance early from the troika to resolve their problems, ‘the Cyprus government followed a policy of procrastination’ (Zenios, , p. 3). When Cypriot banks were subsequently exposed and suffered severe losses following a decision by European leaders to write‐down Greek government debt on October 2011, ‘the joint effect of public debt accumulation and deterioration of the banks’ balance sheet set in motion a negative feedback loop between banking and the public finances' (Zenios, , p. 5). This added to the economic (a sharp fall in GDP) and political costs emanating from the ammunition explosion on 11 July 2011, which destroyed a major power station on the island that produced half of its power supply, and for which the opposition blamed the President directly.…”

“…Thus, though resistant to a troika solution to the crisis in Cyprus, the government did not have any policy measures in place to reduce public debt even though default seemed like an inevitable outcome. What was also inevitable following a downgrading of Cyprus to junk status by three major rating agencies (Iordanidou and Athanassios, , p. 65), which rendered government debt ineligible as collateral for borrowing from the euro‐system (a rule suspended for Greece, Portugal and Ireland but not Cyprus), was that the government had to approach the troika for assistance in June 2012 (Zenios, , p. 8). The negotiation – subject to considerable delay and taking eight months (compared to one month for other countries) – resulted in the construction of a programme of measures and Memorandum of Understanding (MoU) in December 2012.…”

Disparity in the Responses to the European Financial Crisis: Cyprus and the State of Bail-In Policy

“…54 (Investopedia 2015) 55 (Zenios 2014) 56 (Matthews 2013) 57 Although, it appears circumstantially damning. Even the business arm of Russia Today is unable to deny the strong and questionable financial connection between the two states.…”

“…61 ECB president Mario Draghi, with the support of Germany and other important players in the Eurozone, has lauded the bail-in response as the future model for the EU in dealing with financial crises. 62 Although the policy will officially go into effect in 2018, 59 (Birnbaum and Schneider 2013) 60 (The European Parliament and the Council of the European Union 2014) 61 (Zenios 2014) 62 (Steen 2013) Hess 18…”