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Inside Story

Inside Story

Panicos Demetriades served as Governor of the Central Bank of Cyprus (CBC) from May 2012 until stepping down in April 2014, a move that The Economist described as ‘a blow to central bank independence’. He returned to his academic position in the UK as Professor of Financial Economics at the University of Leicester shortly afterwards. He continues to speak regularly around the world on his experience as Governor of the Central Bank of Cyprus during one of Europe’s worst financial crises, and this forms the basis of his newly published book A Diary of the Euro Crisis in Cyprus: Lessons for Bank Recovery and Resolution, which has reignited passions in local politics and the media, partly due to the blame he lays on both for much of what happened during his two years at the CBC. Demetriades spoke exclusively to GOLD about the book and why he wrote it.

By John Vickers



As you note in the book, you were attacked from virtually all sides throughout your term as Central Bank Governor. Did you expect to find yourself at the centre of a media storm once again because of your decision to publish your account of what happened?

Panicos Demetriades: I am not very surprised. Normally, banking crises lead to political change as the general public begins to understand the true culprits. For example, in Indonesia the Suharto regime collapsed soon after the 1997 crisis. More recently, the collapse of the banking system in Iceland during 2008 led to a prolonged political crisis and constitutional reform. In Cyprus, political responsibility for the crisis has hardly been recognized, let alone accepted (although I am encouraged by the Attorney General’s recent comments that there are significant political responsibilities for the crisis). Myths stretching the bounds of plausibility have been created to deflect attention from the real causes. As my book debunks many, if not all, of those myths, it was bound to be met with a considerable political and media reaction.


GOLD: You note that Cyprus has always been rife with conspiracy theories so can we put one of the latest ones away? It’s been suggested that you have purposely chosen to publish your book now because the presidential elections are only three months away. How do you respond?

P.D.: Writing a book and getting it published is a very long process. Once it starts, when an author enters into an agreement with the publisher, the timetable is very much in the hands of the company. I completed the book in February with the aim of publishing it in July but there were delays in the last stages of the production process. Moreover, if my intention had been to cause a stir just before the elections, I would have written it in Greek.


GOLD: You were “thrown in at the deep end” when, at your very first meeting as Governor, you were informed that Laiki Bank was unable to raise the €1.8 billion needed to prevent its collapse. When you accepted the position of Governor, were you aware of just how dire a situation the country’s banking system was in?

P.D.: I was aware that the banks were trying to raise capital to address the shortfalls identified by the European Banking Authority at the end of 2011.  Like everyone else, however, I was reading the stories in the Cypriot media that painted an over-optimistic picture. The book starts with a phone call I received in Barcelona on 3 May 2012, soon after the ECB Governing Council meeting finished, from the then Minister of Finance, Vassos Shiarly. That was when I began to realize that the situation was very different from how it was being portrayed in the media.


GOLD: Although the economy was in a bad state during Demetris Christofias’ presidency, he always insisted that the banking sector was the main problem in Cyprus, a view that few were willing to accept at the time. But in this respect, he was, in fact, right, wasn’t he?

P.D.: Christofias was an obvious political scapegoat, not least because the general public is not familiar with the architecture of European Monetary Union. In that architecture, governments have responsibility for public finances, of course, but they have no responsibility for banking regulation and supervision. The Cyprus crisis was hardly a public finance crisis: public debt to GDP in 2011 was the eleventh highest in Europe, just below Germany’s. By contrast, private debt to GDP was 287% – the third highest in Europe, reflecting several years of rapid credit expansion by the banking system. The bill to save the banks was just under €10 billion or 57% of GDP, making the Cyprus crisis comparable to the 1997 Indonesian crisis, which is considered the biggest ever banking crisis in modern history. Up until 2015, the responsibilities for banking regulation and supervision in the euro area were in the hands of national supervisors, who are typically independent of government (now they are in the hands of the Single Supervisory Mechanism in Frankfurt). In the case of Cyprus, the national supervisor was the CBC, whose independence, which is protected by the EU Treaty, means that it does not take or seek to take instructions from government or, indeed, from any other body. However, central bank independence goes hand in hand with accountability to parliament. One of the issues I analyse in the book is that the main political responsibility for the banking crisis rests with parliament, which failed to recognize the accumulation of systemic risk and did not call on my predecessors to explain how the regulatory framework was addressing those risks. Had parliament asked the right questions, some of those risks could have been at the very least mitigated. It is also important to note that the tone of supervision and regulation is set by the top management of the supervisory body (in the case of the CBC, it’s the Governor, the Board and the Senior Director in charge of banking supervision) and not by the staff. In failing to control systemic risk, the CBC was not, of course, an exception. In the United States, in the build-up to the sub-prime crisis, Alan Greenspan ignored systemic risk and is well-known for stating that, if it is a bubble, “central banks will mop up afterwards”. However, by 2008 it was well known that central banks could get it wrong and one would have expected that, with this in mind, the Cypriot parliament would have expressed its concerns to the CBC.


GOLD: You appear to have been put in the position of bringing bad news to everyone and then criticized as if it was your fault. Was that how it felt? How frustrating was it to be part of a textbook example of ‘shooting the messenger’?

P.D.: That’s precisely how I felt.  Everyone wanted to shoot the messenger! I feel exactly the same right now because my analysis is helping to expose the real culprits.


GOLD: You state that, Bank of Cyprus and Laiki became, through their advertising expenditure, the main funders and financiers of the local media”, which is why the latter never discussed the risks being taken by the banks, even when the rating agencies started downgrading them. As a result, you found yourself portrayed as being part of ‘a communist conspiracy to destroy the banks’.  Weren’t things becoming totally surreal by then?

P.D.: Indeed. Although parts of the media could see and understand what was happening, the majority were repeating the myth that the capital needs of the banks had been inflated. It was surreal. I would like to think that many journalists were doing this inadvertently but I suspect that some knew exactly what they were doing. They were on a mission to distort and deflect attention from the true culprits. Developments, of course, proved them completely wrong. The ECB stress tests that were conducted only a few months after Bank of Cyprus was recapitalized in line with its allegedly inflated capital needs, verified that. If anything, the capital needs had been underestimated, as the bank needed to raise €1 billion of additional capital in order to pass the ECB stress tests. However, to date, I have heard no-one apologizing to the public for disseminating such misleading information. 


GOLD: The media and the political establishment come in for a great deal of criticism in the book. You say, for example, that both groups had little, if any, appreciation of European institutions” and note that few understood that central bank independence is one of the cornerstones of economic and monetary union. Were you surprised by the degree of ignorance of basic aspects of modern-day finance that you encountered?

P.D.: This is an area where Europe itself has responsibilities. It is not just in Cyprus that European norms and institutions are misunderstood. There is a lot to be done to educate the general public about how Europe works and why, for example, central bank independence protects us from the short-termism that is often associated with the electoral cycle. Inflation has, to a large extent, been ‘conquered’ throughout the industrialized world because politicians no longer have any say when it comes to monetary policy. The ECB is, in fact, the most independent of all central banks, acting to safeguard against undue political pressure from national governments on Eurosystem central bank governors. 


GOLD: You mention how shocked you were when you saw a table of European bank rankings that used bank balance sheet size relative to GDP. Number one in the EU was Bank of Cyprus with 211% of GDP. Number 2 was Laiki with 190% of GDP. When you saw this, didn’t you think to yourself, “I must try and do something about this” or was it simply too overwhelming a prospect?

P.D.: The data, I believe, related to end 2012. By that time it was too late to reduce the size of the balance sheets. The doubling of the balance sheets occurred during 2005-11 and had much to do with the influx of foreign deposits. In fact, what I did – and what needed to be done – was very much at the European level. It was obvious that national regulators, especially in small countries with big banks like Cyprus, face obstacles in trying to reduce systemic risk, given the political constraints. It is no exaggeration to say that the banking union in Europe was created, at least partly, in response to the Cypriot crisis. I was one of its most ardent supporters and I’m very pleased to see that it is now fully functional. Now that the ECB is asking banks to increase provisions for their Non-Performing Loans (NPLs), I don’t see much reaction from Cyprus (although I do hear noises from Italian politicians). When I tried to take action on NPLs as soon as I arrived in Cyprus, some politicians launched a vicious attack against me, arguing that I was trying to destroy the banking system. It was as if they believed that, if NPLs remained hidden under the carpet, the banking system would be healthy. Sooner or later, however, high NPLs cause banks to become fragile and vulnerable to bank runs. Supervisors need to take prompt and effective action in order to prevent that from happening.


GOLD: On this point you tellingly note that, When a bank’s balance sheet reaches 20–30% of GDP, it is considered systemic. When it is 200% of GDP, it is not just systemic. It is controlling. An entire society was completely captured.” Were you saying that, in a way, we were all to blame because everyone had something to gain from the situation?

P.D.: A lot of people certainly benefited from what went on. Easy credit creates euphoria and over-consumption. Over-consumption increases economic activity in the short run and shows up as increased GDP growth. However, unless credit helps to enhance investment and productivity, a credit-fuelled consumption boom is short-lived. Often, it is followed by a bust and a balance-sheet recession as the private sector tries to repair its balance sheet through deleveraging (reducing debt). While the party is in full swing, no one wants to put an end to it but this is where the responsibilities of the regulator come in. This failed not just in Cyprus but also in many other countries prior to the global financial crisis. One of the responses to the crisis has been the creation of macro-prudential authorities to monitor and deal with systemic risk. At the European level, the European Systemic Risk Board is now playing that role.


GOLD: You don’t hesitate to accuse the bankers of conflict of interest and out-and-out corruption, noting at one point, No wonder the bank’s CEO could get away with taking excessive risks in Greece and elsewhere, when the board chairman depended on the bank’s executives for approval of his loans.” Again, was there nothing you could have done about this?

P.D.: It was too late by the time I arrived to do anything about loan losses that had already occurred. In fact, the diagnostic exercise was carried out on the banks’ loan portfolio as it stood at end of June 2012, only a few weeks after I took office. I would encourage those who are interested to know more about the banks’ pre-2012 lending practices and who don’t want to read my book, at the very least to read the PIMCO report, which is available on the CBC website. It documents in some detail the corporate governance failures and poor lending practices that led to the crisis. Nonetheless, I started taking action to address issues of corporate governance in banks, to prevent any further deterioration. When banks are fragile, it is not uncommon for them to engage in ‘gambling for resurrection’, asset stripping or even looting by insiders. I have been teaching and researching issues in banking for over 25 years in the UK, and I am very familiar with the history of banking crises so it was easy for me to know what to look for.

Laiki was already in the hands of the state and it acquired a new Board, largely appointed by the Government and parliament, with Andreas Philippou, a former senior director of the CBC, as its Chairman. As such, it was in pretty safe hands. I, therefore, focused my attention on Bank of Cyprus as it was becoming obvious early on that they were supplying us with false information (they are now facing criminal prosecution over this). You may remember that the longstanding CEO of Bank of Cyprus stepped down a few months after my arrival and the Chairman followed. These were not coincidences. We also started the administrative procedure to remove Board members who refused to step down, but that was lengthy and cumbersome. At the same time, politicians attacked me for prioritising Bank of Cyprus and not Laiki in the investigations. It was as if they didn’t understand that whatever happened to Laiki was irreversible and could wait, while Bank of Cyprus was still at risk and could potentially deteriorate rapidly.


GOLD: Your descriptions of the two Presidents you served under make for interesting comparisons. You say, for example, that “Demetris Christofias wanted the CBC to get on with its job and did not want to interfere with its work, especially after the tense relationship between him and my predecessor” whereas Nicos Anastasiades made no secret of wanting you out at all costs. Have you worked out why they had such differing attitudes?

P.D.: I think one needs to read the book to understand. What has already come through in the public domain is that Board members and senior executives at Bank of Cyprus had influenced Mr Anastasiades so much that he was convinced that the bank was healthy – it was the tale of the inflated capital needs for which I was somehow responsible. It was beyond surreal, I must admit.


GOLD: I think that, even to a totally impartial reader, there are clear signs that you are venting your dislike of President Anastasiades in the book. You mention that he father was involved in EOKA B, for example; you quote foreign press reports claiming that his son-in-law had transferred €26 million; you give verbatim transcriptions of conversations that put him in an extremely bad light due to the language he uses. Did you consider omitting any of these references? Were they really necessary?

P.D.: I am only providing the facts. I felt that history was important in order to provide some context. Cyprus joined the EU largely for its national survival. The international reader doesn’t know that. What happened in the 1970s is also relevant as it has helped to shape characters and personalities. I think that is very relevant in order to understand styles of leadership today. Non-Cypriots who read the book (and haven’t lived in Cyprus) will find the history chapter very useful. The circumstances of my leadership of the CBC were very challenging and I was subjected to numerous personal attacks by local politicians and the media, who attempted to undermine my position in public and within the CBC. I wasn’t always able to respond to this criticism and this book allows me to provide my side of the story and to provide a robust response to those attacks. The book itself went through a process of legal clearance by the publisher.


GOLD: The most controversial parts of the book relate to statements that go against the ‘official’ version of events in March 2013. One is the assertion by Mario Draghi and Olli Rehn that the idea of a levy on uninsured bank deposits came from the Cyprus government, partly in an effort to protect the large deposits of Russians who had agreed to a 10% haircut but no more. Presumably you continue to believe this, despite all the denials?

P.D.: Everything in the book is factual. The truth is not controversial. Those who choose to believe distorted versions of the events – official or unofficial – are well advised to read what Olli Rehn, who was European Commissioner for Economic and Monetary Affairs in 2010-14, said about my book, which will appear on the cover. I reproduce it here for the benefit of GOLD magazine readers:   

The Cyprus banking crisis shook the country and was a major after-shock in the Eurozone crisis. The story of its crisis management as an interplay of politics and economics needs to be told. As the former Governor's account, this book is at the same time a most intense political thriller and an insightful economic analysis.”

Additionally, there is the ‘official’ version of the German embassy in Nicosia, which also confirmed that the broad-based deposit levy was the Cypriot Government’s idea. Moreover, the continued insistence by the Government itself that that ill-conceived deposit levy that was turned down by parliament was better than the bail-in is further evidence that they preferred the broad- based tax on deposits. 


GOLD: Almost four years after your resignation, are there things that, with the benefit of hindsight, you wish you had done differently? Do you consider yourself to have been in any sense responsible for the collapse of the banking system in 2013?

P.D.: I took over a fragile banking system that had pushed the economy to the brink of a national catastrophe in an island-state in which political leaders and the media were in denial about what was happening. By the time I stepped down, Cyprus had received four positive Troika reviews and the IMF, soon after, described the stabilization of the banking system as ‘a remarkable achievement’. All this was achieved in a very hostile political environment. I could certainly have spent more time doing PR to protect my own image but that wasn’t my priority during the crisis. The risk of financial meltdown, sovereign bankruptcy and an exit from the euro was a very real one. It first peaked in June 2012, when the banks announced they were not able to raise capital privately and had to apply for state aid. It subsided as soon as I was able convince President Christofias that the Government had no choice but to apply for an economic adjustment programme. It peaked again when the talks between the Government and the Troika looked like falling apart in November 2012. Once again, I intervened and convinced the President to accept what was on the table, notwithstanding his many reservations. The same risk reached its highest-ever level in mid-March 2013, when an agreement was looking increasingly unlikely. This was a banking crisis of unprecedented proportions. The cost to rescue the banking system was 59% of GDP – the same as the biggest-ever banking crisis up until then (Indonesia, 1997). But the case of Cyprus was, in some sense, even more challenging. Unlike Indonesia, we couldn’t inflate and/or devalue our way out of the crisis. Instead, we had to use modern bank resolution tools to carry out major surgery and to protect as much value as could be protected. 

Many people think that Laiki, for example, was ‘closed down’, which is not quite true. Laiki was split in two parts, a ‘good’ bank and a ‘bad’ bank. The good part of Laiki, which included all insured deposits and all loans booked in Cyprus, as well as the ELA liability, is still very much with us as it was protected and merged into Bank of Cyprus. The employees of Laiki and its branches were absorbed by Bank of Cyprus. Bank of Cyprus itself was recapitalized through the bailing-in of shareholders, bondholders and uninsured depositors. Although this was painful for all investors concerned – and very regrettable – they would have been worse off under any alternative scenario, e.g. liquidation. At the same time, the taxpayer was spared the cost of bailing out the two big banks. That is something that, as yet, is not fully appreciated. A bailout is not manna from heaven. It is a loan that is added to the public debt that ordinary citizens – not just wealthy investors – would have been called to repay through increased taxes and deep cuts in public expenditure. Cyprus was spared all of that. It was, in effect, spared Greek-style austerity. Moreover, a bail-in that protected insured depositors was less of a shock to financial stability compared to the broad-based levy on deposits that was first agreed with the Eurogroup and then turned down by parliament. So it was major surgery but surgery that actually saved the patient’s (i.e. the banking system’s) life. The Financial Times described Bank of Cyprus, for example, as ‘the bank that came back from the dead’. 


GOLD: What was the main reason behind your decision to write the book?

P.D.: I certainly had a lot of encouragement from many leading academics, policy makers, journalists, students, friends and family but I also felt a duty to set the record straight on the crisis. It is important to draw the right lessons from such a crisis and I do that in the last chapter. The first lesson – not surprisingly perhaps – is that prevention is always better than cure. Had the banking system not doubled in size during 2005-11, the crisis would never have materialised. It didn’t happen accidentally. On the one hand was the euphoria generated by joining the EU and the under-estimation of risks. On the other hand was the pursuit of easy money by the ruling elite, the politically connected law firms and the banks that actively pursued foreign capital inflows. And then there were the big businesses, especially property developers, who received much of the easy credit that generated the real estate bubble, and households that were encouraged by the banks to borrow and buy holiday homes and luxury cars.


A Diary of the Euro Crisis in Cyprus: Lessons for Bank Recovery and Resolution by Panicos Demetriades is published by Palgrave Macmillan.


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