Push to saddle BoC with Laiki’s debt

THE GENERAL view in Nicosia, after Thursday’s decision to restructure Laiki Bank, was that the road had opened for an agreement with the troika.
The legislature would approve the legal framework for the restructuring of the banks and the transactions’ controls on Friday night and the negotiations would then focus on how the remainder of Cyprus’ €5.8 billion contribution to the bailout could be raised.
There was another piece of ‘good’ news on Friday. The governments of Greece and Cyprus had reached an agreement over the transfer of the operations of Laiki and Bank of Cyprus in Greece to a Greek bank - Bank of Piraeus.
The Anastasiades government had complied with the orders of the EU which had set the reduction of the Cyprus banking sector as one of the conditions for a bailout. Greece’s government would pay €1 billion and Cyprus’ government €500 million for the re-capitalisation requirements of the Greece operations of the two banks.
One close associate of President Anastasiades was in buoyant mood on Saturday morning, saying that there would “almost certainly be a deal with the troika today, even if the Bank of Cyprus has to bail in depositors to the tune of 20 per cent”.
But the troika’s representatives had different ideas when they met Finance Minister Michalis Sarris and representatives of the Central Bank on Saturday morning. The government’s proposed haircut of between 20 and 25 per cent of the banks’ uninsured depositors was not satisfactory.
The troika had decided to change the rules of the game offering the government two options for the Bank of Cyprus, in the form of an ultimatum. It could be restructured (euphemism for controlled bankruptcy) like Laiki, or it could bail-in uninsured deposits by a percentage to be agreed, take over Laiki’s ‘good bank’ operations and undertake Laiki’s €9 billion debt to the European Central Bank’s Emergency Liquidity Assistance (ELA). The assets of the Laiki ‘good bank’ have been estimated by the troika to be €7 billion.
“If we take on an additional, several billion debt we would need to be restructured in a month from now, because the numbers just don’t add up,” said a Bank of Cyprus executive, unable to hide his incredulity. “The choice the troika has given us is bankruptcy now or in a month’s time.”
He said the only way the bank might have a tiny chance of surviving with such a prohibitive debt, would be if we returned to capital flow restrictions of the 1980s when there were tight controls and ceilings on money transfers out of the country.
The government dug in its heels refusing to make this choice, aware that the re-structuring of the island’s biggest bank would have devastating consequences for businesses, many of which would go under, if they lose their trading capital and are unable to borrow money from a contracting bank.
It is also a matter of rationality. Why should the Bank of Cyprus be lumbered with a crushing €9 billion debt, in exchange for taking over Laiki’s ‘good bank’ operations? Logically, it should have had the option of not taking over the ‘good bank’ and avoiding the debt. It could have carried out a haircut of uninsured deposits and opened for business as usual on Tuesday.
The troika refused to discuss this, its overriding concern being the €9 billion owed to ELA by the Central Bank of Cyprus which passed on the money to Laiki, over the last 10 months. Liquidity assistance is given to the national Central Bank which releases it to the commercial bank which, in turn, provides collateral for the funding.
In the case of Laiki, the Central Bank of Cyprus accepted as collateral, among other things, the €1.8 billion worth of shares issued by the government last May which were considered junk by the European Central Bank (ECB).   
“This is now a political issue,” said a banking source. “There are fears at the ECB that Cyprus would leave the euro and not repay the €9 billion owed to ELA,” the source said. “The ECB wants to protect itself and limit its exposure which is why it is eager to impose the debt on the Bank of Cyprus.”
By passing on the debt to the Bank of Cyprus, the Cyprus Central Bank could secure more sound collateral than it already has, but this would almost certainly reduce the ability of the former to draw liquidity from ELA. This is why the troika offered as an alternative the restructuring of the bank, the ‘good bank’ operations of which would not require ELA and thus the issue of the ECB’s exposure would be better managed.
The ECB has for some time been criticised for the ease with which it was offering liquidity to national central banks, for suspect collateral. Some of its critics had gone as far as accusing it of engaging in monetary financing. Being stuck with an exposure of €9 billion in Cyprus, would not affect the eurozone but it would leave the ECB open to more criticism.
And there would be questions as to why it allowed the Central Bank of Cyprus to carry on funding an insolvent bank?
This may explain why the ECB turned the screw on Cyprus last Thursday, taking the unprecedented step of issuing a public announcement that said the “Governing Council of the ECB decided to maintain the current level of ELA (requested by the Central Bank of Cyprus) until Monday, 25 March 2013.” It added that ELA “could only be considered in an EU/IMF programme is in place that would ensure the solvency of the concerned banks.”
It was the first time the ECB had made such an announcement public. It led to the decision for the restructuring of Laiki and put the government under pressure to agree to whatever the troika would demand with regard to the Bank of Cyprus, which would not last the day if it reopened for business on Tuesday, without the ability to draw liquidity from the Central Bank.