Europe's forgotten bank crisis

Today is the 10-year anniversary of the decision to force losses on Cypriot depositors

This is part one in a two-part series to mark this anniversary. The second part is a guest post by Dr Alexander Apostolides, an economic historian and fintech researcher, on the legacy of the crisis in Cyprus, which you can read here.¹

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A DALL-E AI-generated approximation of an image I have in my head.

Ten years ago today, in one of the most fraught episodes of Europe’s debt crisis, euro-area finance ministers met in Brussels and decided that part of the cost of recapitalising Cyprus’s insolvent banks would be borne by depositors.

With incredible timing, this anniversary comes as the global financial news is once more dominated by a bank bailout — this time on the other side of the world in California.

It’s tempting here to reach for comparisons between the two, even though the truth is that these cases are extremely different in many ways. The one thing that does stand out, however, is that they both, in opposite ways, highlight the illusory nature of our separation of insured and uninsured deposits.

In the case of SVB, it’s because the Biden administration came riding to the rescue when tech sector financiers and entrepreneurs caused a run on their “community bank”. The Federal government guaranteed all deposits would be protected, including those above the $250,000 insurance limit.

In Cyprus, it was because people woke one Saturday morning to be told all deposits at the two largest banks — including those below the 100,000 euro insured threshold — would be subject to a haircut. The plan was abandoned after a huge backlash, with losses limited to uninsured deposits, but the initial misstep inflicted lasting damage.

Tangled states

Cyprus’s two biggest lenders, Bank of Cyprus and Laiki Bank, were a mess. They racked up huge losses when a real estate bubble burst — the same cause that led Ireland and Spain to bailouts. But with Cyprus’s banks, this was compounded by the fact that they were heavily exposed to Greece’s financial system. They built up large positions in Greek government bonds that defaulted in 2012.

By the start of 2013, the cost of recapitalising the banks was estimated at around 10 billion euros, which was more than half of the country’s gross domestic product. Coupled with the government’s own financing needs, it looked like the total size of the bailout package that Cyprus needed would be about 17.5 billion euros, close to 100 percent of GDP.

The sheer scale of the mismanagement at these banks is one reason why there aren’t many comparisons to be made with SVB — where the mishandling of the duration mismatch between their assets and liabilities looks pretty innocuous by comparison.

However, if the idiosyncratic nature of SVB’s deposit base complicated the discourse around its collapse, something similar could be said of Cyprus’s banks.

Enter the bogeyman

Cyprus in 2013 was the preferred offshore financial centre of Russians.

The financial crisis was still in full swing at this point. There was a toxic climate to talks due to “bailout fatigue” in northern European creditor countries — following lending packages to Greece, Portugal, Ireland and Spain — and “austerity fatigue” in the debtor countries, which had to implement swingeing budget cuts in return.

In the lead up to Cyprus’s bailout, hostility in the euro area’s creditor countries was heightened by the perception that it would amount to a bailout of Russian oligarchs.

So when, on the Friday evening of March 15, 2013, the Eurogroup of euro-area finance ministers convened for their monthly meeting, they informed Cyprus’s newly-elected President Nicos Anastasiades, who was also present, that the total funds available would be 10 billion euros — not the required 17.5 billion euros. The difference would come from depositors. The meeting was about deciding the details.

After an all-night session, the plan presented to the world around dawn on Saturday, March 16, involved imposing a “levy” of 6.75 percent on deposits below 100,000 euros and 9.9 percent on deposits above that.

Smash and grab

Understandably, the county woke up in a shock that turned to rage.²

Here’s a turbo-charged summary of what happened next: following a huge backlash, Cypriot lawmakers rejected the plan; the European Central Bank cut off the emergency credit line to Laiki Bank, in effect killing it off, and threatened that it would do the same with Bank of Cyprus; the Eurogroup convened again and agreed a new plan on March 25, which limited losses to uninsured deposits, but imposed far steeper losses on those; staring down the barrel of a gun, the Cypriot parliament this time approved the plan, which also involved merging the two banks.³

The banks reopened for the first time on March 28, with capital controls in place to restrict withdrawals and other movements. In the end, the haircut on uninsured deposits at Bank of Cyprus was 47.5 percent, while all of the uninsured deposits at Laiki were converted into 18 percent of the equity in Bank of Cyprus.

To this day, the cost of the mess is still being resolved.

Against that, the country quickly impressed observers with the speed of its economic recovery from the crisis. The last capital controls were lifted early in 2015, far sooner than initially thought possible. Some Cypriots acknowledge that bailing in uninsured deposits, by limiting the increase in public debt, helped make that recovery possible.

The Cyprus paradox

For outsiders like myself, Cyprus is a country that is endlessly fascinating when your attention is drawn to it, due to the confluence of geopolitical and financial currents that run through it. But because it’s so small — and I hope my Cypriot friends will forgive me for saying this — you forget about it quickly once you look away.

Cyprus’s financial crisis captures this paradox in a microcosm.

It featured many different strands of the eurozone debt crisis — a developer-fuelled real estate bubble, a sovereign-bank doom loop, exposure to Greece’s debt default — and added a few unique twists of its own in terms of the Russian dimension, as well as the ever-present background issue of a divided island.

Then, when the crisis broke, it seemed to cram all the tension, drama and emotion of the euro crisis into just two intense weeks. For its sheer chaos and distillation of the essence of the euro crisis into a supercharged burst, no other episodes that I can think of matched it.⁴

And yet, once the moment passed, it seemed to almost immediately get obliterated from the collective memory, outside of Cyprus. It became the forgotten chapter of the eurozone debt crisis.

Quite literally. Adam Tooze’s excellent book Crashed, which is regarded as the definitive history of the great financial crisis, glances over it with one sentence, which just says that Germany and France were divided over it. That’s it.

Uncommon insurance

The Cypriot crisis had several important legacies that spread beyond the island. The introduction of capital controls inside the euro area for the first time (though not the last) broke a major taboo. That the IMF had its fingerprints on this was fodder for countless pieces on the “death of the Washington Consensus”.

And the bail-in of uninsured deposits was an early test case for the principles laid out in the European Union’s Bank Resolution and Recovery Directive. The BRRD was not in effect yet, but what happened in Cyprus probably accelerated its adoption

But one proposed tool that the EU has not yet adopted is the European deposit insurance scheme, or EDIS.

In the blame game that followed the Cypriot parliament’s rejection of the initial plan, the spin from creditors was that the insistence on also bailing in uninsured deposits came from Anastasiades himself, in order to protect the island’s status as a tax haven. Regardless of who pushed for it, an important line was crossed.

Without EDIS, the fact of this line being crossed reinforces the bank-sovereign doom loop in times of extreme financial stress. Deposit insurance is only as good as the ability of individual member states to stand behind it, not the EU as a whole.

One place where we saw that was in Greece in 2015. When it went through its own bank run, faced with uncertainty over whether it would stay in the euro — in that moment, what happened in Cyprus was not forgotten.

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1. I am also indebted to Alexander for comments he made for this post. Any mistakes, however, are my own.

2. At the time, I was a reporter in the Athens bureau of a big international news organisation, and I was on duty that weekend. We had a freelancer on the ground in Nicosia, but Cypriot coverage would run through our bureau. He fed me information that Saturday morning, which I wove together into an on-the-ground reaction piece. It included the detail that TV footage showed someone driving a bulldozer into a branch of Laiki Bank in Limassol. I’ve never managed to find that image, but for me it has become seared into my imagination as a lasting symbol of the crisis, hence the image at the top of this post.

3. I’ve skipped over a bunch of stuff, including the finance minister spending a good chunk of this time on a wild goose chase in Moscow. It was pretty nuts.

4. The only other period that comes close, for me, is the first half of July 2015, between Tsipras’s referendum announcement and the new bailout that he subsequently agreed to. But while that matches the intensity of the moment, it doesn’t quite capture the chaos and the breadth of euro-crisis elements present in Cyprus in those two weeks.