Europe’s Central Bank Defies Its Own Rules in Cyprus Bailout
Benoît Coeuré, a member of the E.C.B.’s six-member executive board, advised against the institution, Cyprus Popular Bank, using government bonds to secure more loans. Instead, he proposed an “alternative measure” that his Cypriot counterpart might “wish to consider.”
“The Central Bank of Cyprus has in principle the possibility to apply less stringent valuations and haircuts compared to the approach followed by the Eurosystem in credit operations,” he wrote in the email, a copy of which was reviewed by The New York Times.
As The Times reported last month, the central bank’s decision to approve such lending practices in Cyprus provoked a tense debate within its 24-member governing council.
Yet Mr. Coeuré’s email and related documents indicate that it was the E.C.B., and not Cyprus, that came up with the idea, a hands-on role that had not been previously revealed.
In effect, he was proposing that the central bank of Cyprus inflate the value of Cyprus Popular Bank’s collateral, so that it might funnel more emergency loans to the failing bank.
In so doing, Mr. Coeuré appeared to be violating the E.C.B.’s core principle: that it may not become involved in the rescue of a bankrupt bank — or a government, for that matter — by resorting to its printing press.
The E.C.B. defended its activities in Cyprus.
Michael Steen, a spokesman for the European Central Bank, said in a statement: “The executive board prepares and informs the governing council in its biweekly discussions on emergency liquidity assistance. This is so that the Governing Council can exercise its prerogative to object to E.L.A. if warranted by interference with monetary policy. The email you have is a reflection of this process.”
Almost two years after the Cyprus banking crisis, the E.C.B. is pushing to restore confidence in its banking system and revive the Continent’s economy while struggling to find consensus and follow rules that narrow its options.
Now, confidential communications from the central bank show how it has been willing to ignore its own bylaws and dictate policy to sovereign governments to prevent wider financial contagion in the eurozone.
This willingness was recently illustrated in documents from Ireland’s fiscal crisis in 2010. Letters that have emerged show the central bank threatening to cut off emergency financing unless Ireland entered an austerity program.
In the case of Cyprus, which like Ireland faced bankruptcy as a result of the failure of its banks, similar warnings went unheeded, prompting the E.C.B. to funnel more than 10 billion euros, or $12.5 billion, in last-ditch loans, via the country’s central bank, to its second-largest financial institution, behind the Bank of Cyprus, despite overwhelming evidence that it was failing.
President Nicos Anastasiades of Cyprus recently commissioned a study that examines in detail how the collapse of a single midsize bank could have such a devastating effect on the economy of Cyprus.
The 40-page report draws on thousands of pages of nonpublic documents and blames the previous government, the two governors of the central bank, Athanasios Orphanides and Panicos Demetriades, and to a lesser extent the European Central Bank for keeping a dead bank alive for more than a year.
As a result, a €17 billion economy was saddled with €10 billion in onerous short-term obligations.
The Times was provided with a copy of the report and some supporting documents.
When asked about the 2010 Irish correspondence, Mario Draghi, the president of the E.C.B., recently said: “It’s a very big mistake to look at past events with today’s eyes. You should go back and consider what was the situation at that time.”
Still, the questions now being raised about the bank’s actions in Cyprus and Ireland reflect deep divisions within it just as it seeks consensus on the most radical step in its 18-year existence: printing money to buy, in large quantities, the bonds of indebted countries, like Italy, Spain and Portugal.
As for Cyprus, the main question that divided the E.C.B.’s governing council from fall 2011 through March 2013 was whether Cyprus Popular Bank was solvent.
Rocked by bad loans and outsize losses from its Greek bond holdings, the bank was already hemorrhaging deposits in late 2011, when the European Central Bank approved a plan by the national central bank to provide it with short-term loans.
Throughout this period, the two governors of the Cyprus central bank, Mr. Orphanides, a well-known international economist who now teaches at the Massachusetts Institute of Technology and his successor, Mr. Demetriades, insisted that the bank could return to profitability, according to presentations they made to their colleagues in Frankfurt.
In March 2012, after Cyprus Popular Bank, which would change its name to Laiki Bank, reported a €3.3 billion loss for 2011 that wiped out its equity, Mr. Orphanides presented a last-ditch capital-raising plan for the bank, one that would be rejected by his skeptical colleagues,
Given the bank’s horrid finances, it was highly unlikely that such a sum could be raised from investors, the European Central Bank noted, according to minutes from a governing council meeting in March.
Executives also highlighted that more than half of the bank’s loan book was directed toward the sinking Greek economy. “The planned recapitalization may prove insufficient owing to the large exposure to the Greek private sector,” E.C.B. executives concluded, according to minutes from the meetings.
At a governing council meeting in Barcelona on May 3, 2012, Mr. Coeuré, the executive board member, took note of the bank’s large losses and pointed out, according to minutes, that by the bank’s own analysis, “the core Tier 1 regulatory capital ratio was negative.”
Nevertheless, documents show, it was decided to approve more emergency financing for the bank.
As the Cyprus Popular Bank’s figures deteriorated in spring 2012, senior officials at the E.C.B. began to worry that it was violating its own rules by approving loans to a bank that was virtually insolvent.
Among the most vocal in making that argument was Jens Weidmann, president of Germany’s central bank. Throughout 2012, he had railed against what he saw to be a backdoor bailout in Cyprus and persistently argued that loans to the bank should be withdrawn, given its financial distress.
Driving Mr. Weidmann’s frustration was the plan proposed by Mr. Coeuré in July 2012 to let the central bank of Cyprus inflate the value of Cyprus Popular Bank’s collateral to direct more loans to the failing institution.
Not only did Mr. Coeuré seem to be ignoring a bylaw decreeing that the E.C.B. keep its distance from emergency lending decisions by national central banks, he was pitching a plan that would have the Cyprus central bank secure loans on dubious collateral.
“If E.L.A. was provided without adequate collateral, this would be a grave issue,” Mr. Weidmann concluded, according to internal documents from governing council meetings.
Mr. Demetriades, desperate to keep the loans flowing, disregarded Mr. Weidmann’s concerns.
In a letter to Mr. Draghi, the president of the European Central Bank, in September 2012 he explained, in detail, how his staff had devised a system of increasing the worth of the collateral in question, without, he was careful to note, “extending the valuation beyond the appropriate levels of prudence.”
A few months later, with questions increasing in the governing council about this unorthodox approach, Mr. Demetriades wrote another letter to Mr. Draghi defending the collateral valuation techniques.
These emergency loans were “vital” not just for the bank but for Cyprus and neighboring Greece, the letter said. And he warned of a “catastrophic scenario” if emergency loans to such a “systemically highly important bank” were withdrawn.
In separate statements Mr. Orphanides and Mr. Demetriades rejected claims made in the report that they had approved loans to an insolvent bank.
Mr. Demetriades said that the collateral valuations carried out by the Cyprus central bank were “sufficiently conservative.”
Cyprus Popular Bank was finally wound down in March 2013. By then, the bank, and Cyprus, had accumulated €10 billion in short-term loans thanks in part to the collateral plan devised by Mr. Coeuré. And in the end it was the Cypriot bank saver that picked up the bill, not the European Central Bank.
Correction: November 19, 2014
An earlier version of this article misidentified who at the European Central Bank made the statement: “The executive board prepares and informs the governing council in its biweekly discussions on emergency liquidity assistance. This is so that the Governing Council can exercise its prerogative to object to E.L.A. if warranted by interference with monetary policy. The email you have is a reflection of this process.” It was Michael Steen, a spokesman for the E.C.B., not Benoît Coeuré, a member of the E.C.B. executive board, who said it.
By LANDON THOMAS JR. NOVEMBER 18, 2014 8:34 PM
November 18, 2014 8:34 pm 2
PHOTO: A branch of Cyprus Popular Bank in Athens last year. Credit John Kolesidis/Reuters
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