Implications of the shambolic co-op deal [Επιπτώσεις της χαώδους συμφωνίας για τον Συνεργατισμό],
[το πιο κάτω κείμενο δημοσιεύτηκε στην Cyprus Mail, και καταγράφει και από
την οπτική των mainstream οικονομολόγων τα προβλήματα διαπλοκής, την αμφίβολη νομιμότητα
της όποιας συμφωνίας, και τα προβλήματα που ενδεχομένως θα προκύψουν και για το
δημόσιο αλλά και για τον τραπεζιτικό τομέα γενικότερα. Μερικά βασικά σημεία υπογραμμίστηκαν
για αυτήν την αναδημοσίευση]
By Leslie Manison
The deal negotiated for the
Hellenic Bank to acquire the “good part” of the Cyprus Cooperative Bank (CCB)
and for the government to take over the “bad part” has generally been viewed as
very favourable for Hellenic Bank, but bad for the Cyprus tax-payer.
Although the fine details of
these arrangements have yet to be published and related legislation passed it
is still possible to explore in more depth some of the issues and consequences
that would most likely arise from a Hellenic Bank-Co-op Bank deal. In
particular how are the balance sheets and policies of Hellenic Bank and the
central government likely to be affected? And what could be the expected
repercussions of the deal on the overall financial system, on the behaviour of
the non-financial private sector, and more broadly on the macro-economy?
Questions on competence
The first issue that should
be stressed is that the deal has been put together in a shambolic, partly illegal, non-transparent,
uncompetitive and inequitable manner
following the failure of Finance Minister Harris Georgiades and his advisors to
privatise the CCB. The issue of development bonds of 2.35 billion euros
announced on April 10, 2018 and a later issue of one billion euros placed on
the balance sheet of the CCB and to be transferred subsequently to Hellenic
Bank as a key element of the deal violated public debt management laws in that
the House of Representatives was not informed about these bond issues.
Furthermore, a bill that
would enable the government to extend guarantees to Hellenic Bank for possible
impairment of certain assets acquired from the CCCB was not presented to the
attorney-general. Moreover, the proposed agreement between Hellenic Bank and
the CCB was not vetted by the attorney-general.
Indeed, the stealthy and
unprofessional way in which the deal has been prepared and managed not only
raises questions about the legality of the deal, but poses the issue of whether
the government was acting in the best interests of the public at large or was
just engineering things to especially favour the acquisition of the “good part”
of the CCB by Hellenic Bank, leaving the “bad” part of the CCB to be a
heavy financial burden on the law-abiding tax-payer for generations to come.
Moreover,
the government is paying to give a package of risk-free assets to Hellenic
Bank, a company whose major shareholders are connected closely with the ruling
political party and whose record in managing and productively deploying
financial assets has been poor.
Impact on Hellenic Bank
As a result of the
acquisition of deposit liabilities of 9.7 billion euro and certain assets
(government bonds of 4.1 billion euros, performing loans of 4.6 billion euros,
and cash of 1.6 billion euros) from the CCB the size of Hellenic Bank’s balance
sheet nearly trebles to over 17 billion euros. This purchase improves the
quality of Hellenic Bank’s asset portfolio in the sense that its NPLs are
reduced from 53 per cent to approximately 20 per cent of its gross loans.
In addition the balance sheet comprises 4.6 billion euros of “protected”
government bonds which should provide a steady interest income stream of around
115 million euros per annum.
It is debatable whether this
income together with revenue from performing loans will be sufficient to more
than offset the costs associated with a greatly increased number of employees
and with the provisioning related to new loans (IFRS 9 regulatory requirements)
and impairment of existing loans as well as interest expenses on deposits to
yield satisfactory profits for Hellenic Bank. Much will depend on whether the
bank can reduce substantially its NPLs and can extend new loans for
economically viable projects.
According to Hellenic Bank
and Central Bank personnel, if a deposit of a CCB customer is moved to Hellenic
Bank as a result of the deal and the total of his/her deposits at the bank then
is above 100,000 euros the excess will not be insured for protection. But
depositors in the three months following the deal becoming effective will have
the right to remove fixed deposits prematurely without penalty. If enacted
these proposed regulations for depositors could induce a considerable outflow
of funds from Hellenic Bank with deposits of individual customers moved to
other banks to keep below the 100,000 euro limit and also into cash. This loss
of deposits and cash if quite large (above two billion euros) could harm
Hellenic Bank’s liquidity position, but at the same time reduce its interest
expenses on deposits and on the holding of cash at the Central Bank.
There has been the misleading
viewpoint propounded by politicians, media commentators and even managers of
the Central Bank of Cyprus that your insured deposits of up to 100,000 euros
would be safer or at less risk if held at Hellenic Bank rather than remaining
at the CCB. However, for each bank it is the government that takes the risk in
providing protection if a bank cannot fund its insured deposits in the event of
its collapse. So in truth the deposit risk remains with the government and
ultimately with the tax-payer.
Impact on government
The deal could prove to be
very expensive for the central government and ultimately for the law-abiding
tax-payer.
The government has had to
issue Development Bonds totalling 3.35 billion euros to bolster the “good part”
of the CCB, raising its debt to GDP ratio from 97.5 per cent at end-2017 to
currently between 115 per cent and 120 per cent.
In addition, the government
has agreed to protect the assets of the Hellenic Bank by providing guarantees
which could eventually be very costly if exercised. Moreover, the deal between
the government and Hellenic Bank is imbalanced and one-sided with
built-in incentives for one party, that is, the Hellenic Bank, to call in the government’s
undertakings and guarantees if certain conditions are not satisfied.
Furthermore, the government
has agreed to take over the “bad part” of the Co-op Bank comprising mainly NPLs
of 8.3 billion euros, with the latter assets in turn to be managed by a Loan
Management Company set up by the government. In this connection the government
will incur considerable costs associated with the capital required for the
setting up of this company and of provisioning for the impairment of loans and
for losses on loans sold to third parties at a discount. Considerable costs
also are likely to be associated with the implementation of Estia, a scheme
aimed at helping vulnerable households and possibly businesses repay their
loans by subsidising their monthly instalments. Furthermore, the government has
agreed to make redundancy payments to the 1000 plus employees of the CCB who
are expected to be laid off as a result of the deal.
All these costs and
additional debt obligations will have to be met ultimately by law-abiding
Cyprus tax-payers. And with the surge in public debt arising mainly from
efforts to prop up the banks the government will have difficulty in borrowing
in international markets and will be forced to rely on tax revenue and/or
cutting back on traditional outlays to meet its new expenditure and debt
servicing obligations. It will have to raise tax rates and/or undertake real
serious efforts to combat tax evasion and aggressive tax avoidance in order to
substantially increase tax revenue. And with the government finances likely to
be severely strained, scope for outlaying funds for urgently needed
improvements to the health and education services and for environmental
protection as well as for productive infrastructure investments will be greatly
limited.
It is noted that at a time
when collecting tax income is and will be at a premium the chairman of the
House finance committee is submitting bills to provide tax relief to persons
who begin to service their non-performing loans. But it can be argued that such
measures are most likely to be counter-productive in encouraging and providing
incentives for more debt defaulting and tax evasion over the medium-term.
Impact on the real economy
From the expenditure side the
main driver of the recent fast growth of the Cyprus economy has been private
consumption. Buoyant consumption expenditures have been facilitated in part by
households and business entities not paying their debts, income taxes and other
obligations such as car insurance. However, if as a result of the Hellenic
Bank-Co-op Bank deal there is a substantial and necessary increase in tax
collections from the private sector and if new related legislation on
foreclosures and insolvencies as well as greater political will to combat
strategic debt defaulting prevail, then the growth of private consumption will
be curtailed significantly.
In addition with a return to
fiscal austerity as a consequence of the strains on public finances and
excessive adherence to EU fiscal rules domestic demand will be further reduced.
And with a considerable decrease in the growth of domestic demand entrepreneurs
will be more starved of private investment opportunities and are likely to
lower their capital expenditures. Accordingly, Cyprus is likely to enter a
recession in the coming years, the severity of which will depend importantly on
the extent of external demand stemming mainly from foreign tourists and
property buyers in offsetting the decline in domestic demand.
The providing of private
credit to finance economically viable projects is integral for healthy and
sustained economic growth. In the Cyprus context it is critical that its banks
have secure funding sources mainly in the form of deposits to finance such
projects. Thus, it is of concern that as a result of the gross mismanagement of
the large pool of funds of the CCB and the shambolic and failing efforts to
privatise the CCB that its deposits have been seriously run down in recent
months, with a considerable part of the deposit withdrawals being kept as cash
or deposited abroad, that is outside the domestic banking system. And as
mentioned above the proposed deal could lead to further outflow of funds from
the banking system as entities reduce their deposits with Hellenic Bank to
100,000 or less in the wake of the transfer of their deposits from the Co-op
Bank to their Hellenic Bank accounts.
And with the private sector
holding more cash the large underground economy of Cyprus involving more
untaxed cash transactions will be fuelled and fostered. Such a development
would run counter to the need for the government to substantially raise tax
revenue to finance the costly and extremely over-generous deal involving the
acquisition of the good part of the CCB by Hellenic Bank and the transfer of
the bad part to the government.
Is there an alternative?
Is there an alternative to
the Hellenic Bank-Co-op Bank deal that would be less costly to the tax-payer,
contribute better to financial stability, and provide an improved and sound
basis for productively using bank funds to generate economic growth?
Given these objectives and
the questionable motives of the main shareholders of Hellenic Bank in wanting
to acquire the cherry-picked assets and deposit liabilities of the Co-op Bank
on very favourable terms it is recommended that the government take over the
balance sheet of the good part of the Co-op Bank that was headed to Hellenic
Bank and in due course establish a new bank.
While retaining its retail
operations with households the mission and role of this new bank would be to
intermediate and utilise financial savings including its access to equity
funding to promote economic development. The managers of the new bank should be
competent professionals who should be supported by a staff of lawyers,
accountants, debt restructuring experts, financial analysts, economists and
other talented personnel selected on the basis of their capabilities rather
than their loyalty and connections with ministers and politicians. When in
place management and staff should begin directing the bank toward specialising
in development banking activities somewhat along lines suggested by Savvakis
Savvides in his recent paper “The Alternative Way to Deal with the
Cyprus Co-Op Bank”.
As this bank would be
government-owned with possible contributions to capital from international
organisations such as the European Investment Bank there would be little need
for costly guarantees and protection schemes aimed at making assets risk-free.
Deposits of CCB customers
would be automatically moved to the new bank upon its activation with those up
to 100,000 euros insured for protection by the government. Problems as
described above relating to financial outflows from banks arising from the
transfer of deposits of CCB customers to the Hellenic Bank that cause their
total individual deposits at a bank to exceed the 100,000 euro insurance limit
would thus be avoided.
Financial instability
reflected in runs on deposits usually emanate from the wasteful use and abuse
of bank funds by bankers in extending numerous loans to customers who do not
have the ability to repay and to those who are unwilling to repay as was the
case in Cyprus in the run-up to the 2012/13 crisis. Similarly, the run on the
deposits of the CCB during 2018 reflects the strong perception that the funds
of the bank are being mismanaged and abused, a view supported by the bank’s
prevailing extremely high level of NPLs and certain dubious lending of late.
In this connection it is this
writer’s opinion that the management of a new bank comprising competent
professionals will be able to use the balance sheet of the good part of the CCB
that was headed to Hellenic Bank much more prudently and productively than the
influential and politically-connected shareholders and management of Hellenic
Bank. And this greater competence of the new bank in deploying its loanable
funds would in turn help to restore some semblance of financial stability and
provide a stronger basis for bringing about the healthy and sustained recovery
of the Cyprus economy. That is a recovery after the inevitable economic
slowdown associated with the substantial increase in private savings required
to effect the large repayments of the huge amounts of household and business
debt and tax liabilities.
Leslie G Manison is
an economist and financial analyst, specialising in macroeconomic policy
analysis, bank viability assessments, and international financial relations. He
is a former senior economist at the International Monetary Fund, an ex-advisor
in the Cyprus finance ministry and a former senior advisor at the Central Bank
of Cyprus.
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