The latest issue of the Central Banking Journal includes my review of a book about the Euro Crisis in Cyprus written by Panicos Demetriades, who was Governor of the Central Bank of Cyprus at the time. It is an fascinating book with insights about the challenge of bank recovery. You can read the review here or below.
Book Review: A Diary of the Euro Crisis in Cyprus: Lessons for Bank Recovery and Resolution by Panicos Demetriades, Palgrave McMillan, 2017
This book is about Panicos Demetriades’ tenure as Governor of the Central Bank of Cyprus between May 2012 and April 2014. It covers the banking crisis that hit Cyprus, the banks’ resolution and the wider lessons learned from the event. Reading this book felt in some ways like a simultaneous reading of Gabriel Garcia Marquez’s novel, Chronicle of a Death Foretold, and an economics-based thriller like Murder at the Margin by Marshall Jevons.
The book begins with Demetriades’ appointment as Governor of the Central Bank of Cyprus. You know from the beginning how it ends: Demetriades resigns as Governor. This is a manifestation of the challenge that Central Bank independence represents; banking resolution is the specific context in which the Central Bank’s independence is tested. In fact, writing this sentence already reveals one of the underlying issues: the only feature of Central Banks’s independence enshrined in European treaties is the independence of the Governor of the Central Bank.
As Demetriades discovered, there are ways to limit the practical independence of the Governor such as appointing (or firing) Deputy Governor(s), creating new Executive Directors with a seat on the Board whose roles are determined by the Board rather than the Governor, and requiring Board approval for bank licensing and amendments to existing licenses. These might look like arcane corporate governance issues, but they do matter, especially when independence is most needed, i.e. in times of financial crisis. Interestingly, the European Central Bank (ECB) and the Commission witnessed these changes but had limited powers to intervene other than expressing concerns through legal opinions.
Demetriades also plays a detective role and explains how the crisis in Cyprus came about. It is interesting that the origin of the crisis is traced back to the country’s business model – an offshore financial centre for wealthy Russians and Eastern Europeans, supported by a network of lawyers and introducers to banks. Like many of you, I have seen the term business model applied to companies, but this is first time I have seen it applied to describe a country. This suggests to me that avoiding the crisis would have required a very tough regulatory stance, and that it would have happened sooner or later, regardless of the Euro crisis.
The book identifies the trigger event for the crisis. Interestingly for me, someone who works in risk management, the trigger is the decisions of Cyprus’ two main banks to invest most of their equity capital in Greek debt in the spring 2010, when Greece was being downgraded. This resulted in losses in excess of €4 billion. As Demetriades notes, this decision ignored the fundamental relationship between yields and risk, and diversification of investments.
There were also challenges for international institutions in the troika. There are a number of references to the IMF analysis of debt sustainability and the assumptions underpinning it. A debt to GDP ratio of 100% was assumed to be sustainable for Cyprus, compared to 120% for Greece. In Demetriades’ view, this made the bail-in for Cyprus larger than might have been necessary.
Demetriades’ tenure as a Governor of the Central Bank spanned a right-wing and a left-wing government. You might have preconceptions about which government would find the notion of an independent Central Bank more challenging. In fact, both governments found it equally challenging because of national pride and voting considerations. These challenges weigh heavily on Demetriades who concludes the book with a stark warning about the future of the Euro, which is in fact relevant to all the members of the Eurosystem: ‘[P]opulism, if left unchecked, can shake the foundations of the monetary union beyond the point of repair’.
While the book is entitled ‘a diary’, don’t let that word put you off. It is much more than a personal diary.
Just as I did when reading Chronicle of a Death Foretold, I wondered if Demetriades could have done something to maintain the independence of the Central Bank and avoid the clash that led to his resignation. I could not identify anything.
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