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Financial Mirror (Cyprus) - - FRONT PAGE - By Lan­don Thomas

As the Cypriot econ­omy reeled from the col­lapse of its sec­ond-largest bank in 2013, the Euro­pean Cen­tral Bank faced a thorny ques­tion: Should it keep the in­sti­tu­tion, Cyprus Popular Bank, alive with short-term loans or pull the plug?

By many fi­nan­cial mea­sures, the bank was fail­ing. Stung by a dis­as­trous bet on Greek gov­ern­ment bonds, Cyprus Popular Bank had been in trou­ble for the bet­ter part of 2012 and de­pos­i­tors were with­draw­ing their sav­ings in ever larger num­bers. It needed cash and fast. Un­der ECB rules, trou­bled banks that can no longer raise funds on the open mar­kets are al­lowed to bor­row from their na­tional cen­tral bank, which as­sumes re­spon­si­bil­ity for this so­called emer­gency liq­uid­ity as­sis­tance, or ELA.

Still, strict rules gov­ern this process. The bank in ques­tion must be sol­vent. And if the loans sur­pass 2 bln euros, or $2.56 bln, the ECB re­serves the right to refuse ad­di­tional re­quests for money. The method­ol­ogy for valu­ing the col­lat­eral used to se­cure the credit also has to be dis­closed.

Fear­ing pos­si­ble con­ta­gion if the bank failed, the ECB’s gov­ern­ing coun­cil, a decision-mak­ing arm con­sist­ing of 24 mem­bers, had ap­proved an emer­gency loan re­quest by one its mem­bers, the Cen­tral Bank of Cyprus, in late 2011.

As 2013 ap­proached, the short-term loans to Cyprus Popular Bank had grown to EUR 9 bln, about two thirds the size of the Cypriot econ­omy, and Jens Wei­d­mann, the hawk­ish head of the Ger­man Bun­des­bank, had be­gun to force­fully ar­gue that this ex­po­sure was too large, ac­cord­ing to the min­utes of gov­ern­ing coun­cil meet­ings.

By ap­prov­ing the loans - which were dis­bursed by the cen­tral bank of Cyprus - Mr. Wei­d­mann said that the ECB was violating a core tenet. That rule holds that banks on the verge of fail­ure should not be bailed out with ad­di­tional loans.

“It was not the gov­ern­ing coun­cil’s job to keep afloat banks that were await­ing re­cap­i­tal­i­sa­tion and were not cur­rently sol­vent,” he said at a meet­ing in De­cem­ber 2012, ac­cord­ing to in­ter­nal doc­u­ments from the bank. In a state­ment, the ECB said the fol­low­ing: The ECB nei­ther pro­vides nor ap­proves emer­gency liq­uid­ity as­sis­tance. It is the na­tional cen­tral bank, in this case the Cen­tral Bank of Cyprus, that pro­vides ELA to an in­sti­tu­tion that it judges to be sol­vent at its own risks and un­der its own terms and con­di­tions.

In this spe­cific case, there was full con­sen­sus in the gov­ern­ing coun­cil on the need to get as­sur­ances from the Cen­tral Bank of Cyprus that this bank was sol­vent. The sol­vency was con­firmed ex­plic­itly by the Cen­tral Bank of Cyprus, which also con­firmed the proper val­u­a­tion of col­lat­eral after an in­tense di­a­logue be­tween it and the ECB.

The ECB was not the su­per­vi­sor and fully re­lied on the as­sess­ment of the Cen­tral Bank of Cyprus. There­fore to draw con­clu­sions about the ECB’s fu­ture bank­ing su­per­vi­sion role on the ba­sis of ELA to Cyprus is ten­den­tious.

Re­spon­si­bil­ity for the loans, though, seemed times.

A close read­ing of min­utes re­veals nu­mer­ous in­stances in which ECB of­fi­cials said they would cut off the pro­gram if progress was not made by Cyprus in se­cur­ing an eco­nomic res­cue pro­gram.

In March 2013, just a few days be­fore the bailout, the cen­tral bank said as much pub­licly. It stated that loans to Cyprus Popular Bank would not be con­tin­ued un­less an agree­ment with the In­ter­na­tional Mon­e­tary Fund was reached.

Un­like the Fed­eral Re­serve and the Bank of Eng­land, which re­lease the min­utes of rate-set­ting meet­ings in a mat­ter of weeks, the ECB de­crees that its in­ter­nal de­lib­er­a­tions must be kept un­der wraps for 30 years. The con­cern has been that the air­ing of th­ese dis­cus­sions would re­veal na­tional strains and weaken the ECB’s fed­eral man­date.

The New York Times has re­viewed gov­ern­ing coun­cil min­utes dat­ing from May 2012 to Jan­uary 2013 - just two months be­fore the con­tro­ver­sial Cyprus bailout.

And th­ese strains, par­tic­u­larly be­tween Ger­many, an eco­nomic pow­er­house, and smaller eu­ro­zone coun­tries like Cyprus and Greece are fre­quently laid bare dur­ing th­ese meet­ings, in­ter­nal doc­u­ments re­veal.

Mr. Wei­d­mann, the tough-talk­ing Bun­des­bank head, had long styled him­self as the in­sti­tu­tion’s bailout scold. The min­utes show him sharply op­pos­ing ECB-backed res­cues of the French-Bel­gian lender Dexia and smaller banks in Ire­land, Greece and Spain.

In Jan­uary 2013, just two months be­fore the Cyprus res­cue pack­age, Mr. Wei­d­mann re­peated his com­plaint that the ECB was putting it­self at risk in prop­ping up Cyprus Popular Bank — which sub­se­quently changed its name to Laiki Bank.

More­over, Mr. Wei­d­mann said that the value of the col­lat­eral posted at the cen­tral bank was in­flated - which, if true, would al­low it to se­cure more credit.

This was a pow­er­ful charge as it ques­tioned whether the Cyprus cen­tral bank, un­der its new gov­er­nor, Pan­i­cos Deme­tri­ades, was try­ing to play down the bank’s prob­lems in or­der to keep it alive.

To but­tress his claim, Mr. Wei­d­mann told his col­leagues that the ECB’s own risk an­a­lysts had con­cluded that the as­sets that Cyprus Popular had posted at its cen­tral bank were over­stated



at by about EUR 1.3 bln.

Mr. Deme­tri­ades re­jected the claim, ac­cord­ing to the min­utes, and said that his risk ex­perts had a bet­ter un­der­stand­ing of the as­sets in ques­tion than their coun­ter­parts in Frankfurt.

Christian Noyer, the head of the French cen­tral bank, said that he was “very much con­cerned” by the ag­gres­sive way that the Cyprus cen­tral bank was valu­ing the col­lat­eral, adding that it “dou­bled the risk” for the ECB

Klaas Knot of the Dutch cen­tral bank also chimed in, say­ing the col­lat­eral is­sue made him feel “very un­com­fort­able.”

“If ELA was pro­vided with­out ad­e­quate col­lat­eral, this would be a grave is­sue,” Mr. Wei­d­mann con­cluded, ac­cord­ing to the min­utes, as he pushed for the loans to be with­drawn.

Mr. Wei­d­mann asked what the gov­ern­ing coun­cil pro­posed to do about the is­sue, ac­cord­ing to the doc­u­ments. Not that much, it would turn out. Un­der a sec­tion in the min­utes called “sol­vency in­for­ma­tion,” the gov­ern­ing coun­cil noted that it had re­ceived a draft re­port from the as­set man­age­ment company Pimco that said the bank needed about EUR 10 bln in fresh cash - or about 10 times its cap­i­tal at the time.

There would seem to be lit­tle doubt that the bank was fin­ished, but the con­sen­sus was to keep the bank alive un­til an agree­ment could be reached on a broad res­cue pro­gram with the Cyprus gov­ern­ment.

The gov­ern­ing coun­cil de­cided “not to ob­ject”– in ECB par­lance - to the con­tin­u­ance of the life­line.

Two months later, the bank was fi­nally wound down as part of a bailout of EUR 10 bln euros, fi­nanced largely by a hair­cut im­posed on Cypriot de­posit hold­ers.

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