Previous government to blame for Cyprus' economic woes, says former central bank governor

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The blame for Cyprus’ economic crisis lies squarely with the island’s previous administration for acting too slowly, exaggerating the problems and shifting blame to the banking sector, a former Cyprus Central Bank governor has told RBS.

Dr Athanasios Orphanides said that the Communist-rooted AKEL party, which ruled the island until last month, was not capable of handling the crisis. He also said the eurozone’s wider economic problems would be solved by separating banks from states and setting up a banking union, adding that a proposed fiscal union across the continent was “never going to happen”. Orphanides was speaking after taking part in a panel discussion on central banks at the RBS Macro Conference. The economist criticised the AKEL party, the only communist government in Europe when the financial crisis struck in 2008, for “exaggerating Cyprus’s banking problems as part of the election campaign that ended last month”. He said: “When they took power in 2008, they raised spending in an unsustainable manner and by May 2011 lost access to markets. “The communist government should have applied for assistance from Europe at that time – when Cypriot banks had weathered the crisis and were in a sound condition. “But instead of solving the problem, they delayed taking action for as long as possible and tried to shift the blame on to the banking system. Then, in October 2011, they agreed to saddle the banks with losses of about 25 per cent of the island’s GDP following the 2013decision to haircut the Greek debt. This is what led the country to the crisis faced today.” “Although they are no longer in power, the damage is done and the present government has some tough decisions to make.” Eurozone finance ministers have now agreed a EUR10 billion bailout deal for the island, now run by the conservative DISY party. It involves winding down the Laiki (Popular) Bank – Cyprus’ second biggest – and transferring its good assets to Bank of Cyprus. Savers with deposits of less than EUR100,000 will be spared paying any levy, but there are expected to be losses for those with deposits above that amount. A previous deal involving a levy on all deposits led to public anger across the world and was rejected by the Cyprus parliament. Orphanides said a proposed fiscal union across Europe would lead to member states giving up their sovereignty so had received “scant” political support. The former European Central Bank Governing Council member said the continent’s leaders should focus on and implement a feasible solution as soon as possible. He said they should work to de-link banks from sovereigns and create a banking union instead. Sovereign states would maintain control of their finances but give up control of their banking sectors. A central European banking body would be set up to deal with banks in trouble without the state getting involved. Equally, if the country experienced financial difficulties, the banks would be protected from it. Orphanides added that the impact of the financial crisis would have been significantly reduced if such a banking union had existed back then. He said it would require three elements: a single supervisory authority; a common deposit guarantee fund; and a common resolution authority. “It means that citizens living in those states where the authorities face challenges would not suffer from punishing financing costs simply because the sovereign was in trouble,” he said. “The financing conditions on household and business loans would remain uniform across the euro area. “It also better insulates sovereigns from the banks’ troubles. If, going forward, a bank is under threat of collapse, the responsibility and finances for sorting it out would rest with the European resolution and deposit guarantee authority, not with the state. So it would not create solvency concerns for the country it was based in.” He added: “If I look at the situation in Ireland in 2009 or Spain last year, problems with the banks led to concerns about the states which supported them. “The problems occurred only in a small fraction of the banking system. But because they adversely affected the sovereign, they raised the cost of financing for the whole country and all its businesses, and the cost of funding for banks. This is the ‘adverse loop’ economists talk about, and a banking union would break it.” Orphanides said such a union would involve creating something similar to the Federal Deposit Insurance Corporation (FDIC) in the US, which preserves and promotes public confidence in the financial system by insuring deposits in banks and other institutions for at least USD250,000. He argued that, although the financial crisis was worse in the US, it has been handled much better there than in Europe. “The FDIC would simply shut down a bank and reimburse its depositors if necessary. It has also been known to provide funding so that a struggling bank can be taken over by another institution – evaluated on a case-by-case basis. “This is exactly the kind of solution Europe needs.” He added: “In Greece for example, if there had been a single, supervisory body, the state would not have been able to nudge its banks to load up on Greek sovereigns. The banks would not have been bankrupted when the haircut on Greek debt was imposed by European governments. The country’s banks, households and businesses would have been protected. “The banking union would not have protected the Greek state – the government would still have overspent and over-promised future spending to its citizens – but those mistakes would not have had a destructive effect on the Greek economy as a whole.” 

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