Colm McCarthy

The fateful Eurozone finance ministers meeting which signed off on the plan to haircut guaranteed depositors in Cyprus convened at 17.00 hours on Friday the 15^th, the Ides of March, in Brussels. The meeting was attended by the seventeen finance ministers but also by Mario Draghi and Jorg Asmussen of the ECB and Christine Lagarde from the IMF with Reza Moghadam, the head of the European division at the Fund. Cypriot president Anastasiades left the meeting with, he clearly believed, the consent of those present for the since-abandoned scheme to haircut guaranteed depositors (accounts below €100,000) in all Cypriot banks, including some that were solvent.

The Cypriot parliament threw out the plan and guaranteed depositors were spared. The substitute Plan B sees very large write-downs for unguaranteed depositors in the bust banks as well as write-offs for shareholders and bondholders. But deposits in Cypriot banks were frozen and could not be used, beyond low thresholds, for withdrawals, or for external payments. Remarkably, internal payments within Cyprus were also restricted. The thresholds have since been increased but the suspension of internal convertibility for the Cypriot Euro was an astonishing event, going beyond the re-introduction of exchange controls and the inability to transfer funds abroad. The Nicosia business was effectively told ‘you may not use your money to purchase dollars, or Euro deposits outside Cyprus’ (exchange controls) but also told ‘you may not pay a bill over a specified amount owed to a business in Limassol either’ (suspension of internal convertibility).

On March 25^th the ECB issued a statement which included the following (after Plan B had been cobbled together and insured depositors spared the threatened haircut):

‘Today, the Governing Council decided not to object to the request for provision of Emergency Liquidity Assistance (ELA) by the Central Bank of Cyprus, in accordance with the prevailing rules. It will continue to monitor the situation closely.’

The Purpose of Plan B was to resolve the Cypriot banks, through creditor haircuts and other re-capitalisation measures. Banks which have been resolved are solvent – their liabilities have been reduced to the point where their (written down) assets exceed their liabilities. If they face a depositor run when they re-open, a proper central bank will provide them with liquidity without limit, since the run is unjustified. With the bank’s assets now written down to realistic values, there is no question mark over collateral quality.

What appears to have happened in Cyprus is the following:

1. prior to the rescue deal, the ECB deemed the main Cypriot banks to be insolvent, and declined to approve ELA through the Bank of Cyprus.

2. The deal (Plan B) was done. The Cypriot authorities, fearing a run, froze deposits, creating internal as well as external, inconvertibility.

3. The ECB must have interpreted the ‘prevailing rules’ referred to in its March 25^th statement as forbidding ELA for the (supposedly now solvent) Cypriot banks.

If this interpretation is correct, the Eurozone now has a de facto bank resolution scheme with the following feature: the day the resolved bank re-opens, with creditor haircuts to whatever degree is needed to make the bank solvent, the lender of last resort will go missing. Deposits will be frozen (up to some limit) and the domestic economy can get by on cash, trade credit and barter. At a recent press conference, Mario Draghi was asked about the ECB’s role in the Cyprus debacle and responded thus:

‘Cyprus is not a template; Cyprus is not a turning point in euro area policy. We have said many times that our resolution – and I said the very same thing when I was Chairman of the Financial Stability Board – is to resolve banks without using taxpayers’ money and without disrupting the payment system. That is why we have to have a resolution framework in place. So, it is not a turning point. That is exactly the resolution framework that all other countries have and the euro area will have.’

Sorry Mario – you did disrupt the payment system, you closed it down. Does the ECB president intend that ‘…the resolution framework that all other countries have and the euro area will have’ will include the refusal by the lender of last resort to stop deposit runs on solvent banks? On further questioning, he elaborated: ‘On Cyprus – I expect many more questions on Cyprus, so that I will only respond to your question narrowly, the fine question as to what the position of the ECB was. The ECB had presented a proposal that did not foresee any bail-in of insured depositors. And let me also tell you that this was exactly the same for all the other proposals – the proposals by the Commission and the IMF had exactly the same feature. Then there were prolonged negotiations with the Cypriot authorities, represented at that meeting, the outcome of which was what you know, namely a levy also on insured depositors. That was not smart, to say the least, and it was quickly corrected in a Eurogroup teleconference on the next day. But that is what is past.’

Everyone is entitled to their own version of history. Here’s mine: it was the Cypriot parliament on the following Tuesday evening, and not some teleconference on the Sunday, which scuppered the Anastasiades plan to haircut insured depositors. The ECB, the European Commission and the IMF allowed the Cypriots to leave a meeting at 3 am on Saturday morning with a plan to haircut insured deposits and to freeze accounts in banks supposedly resolved.

It would be nice to hear the IMF’s version of what they think happened at the meeting on the Ides of March.