Book notes: A diary of the euro crisis in Cyprus

Panicos Demetriades, A diary of the euro crisis in Cyprus: lessons for bank recovery and resolution, Palgrave Macmillan, 2017

This book is about Panicos Demetriades’ tenure as governor of the Central Bank of Cyprus (May 2012 to April 2014), covering the banking crisis that hit the country, the banks’ resolution and the wider lessons learned from the event. Reading this book felt in some ways like a simultaneous reading of Gabriel García Márquez’s novel Chronicle of a death foretold and an economics-based thriller such as Murder at the margin by Marshall Jevons. While the book is entitled ‘a diary’, do not let the phrasing put you off. It is much more than a personal diary.

The book begins with Demetriades’ appointment as governor of the central bank. But you know from the beginning how it ends: he resigns as governor. The book’s focus is the challenge of central bank independence; in the case of Cyprus, the central bank’s independence was tested during the crisis through the governor’s ability to preside over the resolution of banks. In fact, writing this sentence already reveals one of the underlying issues: the only feature of a central bank’s independence enshrined in European treaties is the independence of the governor of the national central banks.

As Demetriades discovered, there are ways to limit the practical independence of the governor: appointing (or firing) deputy governor(s) and creating new executive director roles who have a seat on the board and whose roles are determined by the board rather than the governor; and requiring board approval for bank licensing and amendments to existing licences. These might look like arcane corporate governance issues, but they do matter, especially when independence is most needed. Interestingly, the European Central Bank and the European Commission witnessed these changes taking place at the Central Bank of Cyprus but had limited powers to intervene other than expressing concerns through legal opinions.

Demetriades also plays a detective role in his book, explaining how the crisis in Cyprus came about. It is interesting the origin of the crisis is traced back to the country’s business model – an offshore financial centre for wealthy Russians and eastern Europeans, supported by a network of lawyers and introducers to banks. Like many readers, no doubt, I have seen the term ‘business model’ applied to companies, but this was first time I have seen it applied to describe a country. This suggests to me that avoiding the crisis would have required a very tough regulatory stance and, without such action, the banking collapse would have happened sooner or later, regardless of the euro crisis.

Through his investigation, Demetriades identifies the crisis’s trigger. Interestingly for me, someone who works in risk management, the trigger identified is the decisions of Cyprus’s two main banks to invest most of their equity capital in Greek debt in the spring of 2010, when Greece was being downgraded. This resulted in losses in excess of €4 billion ($4.91 billion). As Demetriades notes, this decision ignored the fundamental relationship between yields and risk, and diversification of investments.

There were also challenges for international institutions in the troika. There are several references to the International Monetary Fund’s analysis of debt sustainability and the assumptions underpinning it. A debt-to-GDP ratio of 100% was assumed to be sustainable for Cyprus, compared with 120% for Greece. In Demetriades’ view, this made the bail-in for Cyprus larger than might have been necessary. 

Demetriades’ tenure as a governor of the central bank spanned a right-wing and a left-wing government. You might have preconceptions about which government would find the notion of an independent central bank more challenging, but in fact, both governments found it equally challenging because of national pride and voting considerations. These challenges weigh heavily on Demetriades, who concludes the book with a stark warning about the future of the euro, which is in fact relevant to all the members of the Eurosystem: “Populism, if left unchecked, can shake the foundations of the monetary union beyond the point of repair.”

Just as I did when reading Chronicle of a death foretold, I wondered if Demetriades could have done something to maintain the independence of the central bank and avoid the clash that led to his resignation. I could not identify anything.