28 Mar 2013

How Greece exported a bank default to Cyprus

For nearly a fortnight this island has been turned into a giant economic laboratory. A grand experiment has been carried out on the Cypriot people, involving trying to take part of their savings, closing their banks, and then essentially destroying their main industry.

Today draconian rules on withdrawing, exchanging, and exporting currency too. But the inside story of what led to this, is more remarkable, even than that.

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The fate of this nation has been determined at late night, often botched, negotiations in Brussels, where Cyprus was considered too small to have to bail out.

Chris Pavlou, a Cypriot and former leading British banker, was at the heart of financial discussions in Nicosia with the President, regulators, and the Troika.

Until last week he was vice-chairman of Laiki also known as Popular bank, Cyprus’s second biggest. He spoke to Channel 4 News exclusively.

Channel 4 News: “It does seem as if Berlin or Brussels or Frankfurt were very keen to communicate to Cyprus’ leaders that ‘you’re not systemic, in some ways you don’t matter, you have no negotiating power’.”

Pavlou: “Unfortunately that’s what they said, yes. Unfortunately yes. And it’s not very nice actually to see two or three people half your age, clever people, coming over there and shaking their hands at the President and saying ‘you have to do this, otherwise we’ll bring you down’.”

C4N: “30 year-olds?”

P: “Well 30-35 year-olds. It is very painful for somebody who’s just been elected to actually face that.”

C4N: “Humiliating?”

P: “At best.”

There is telling footage of a shocked Cypriot finance minister Michael Sarris in Brussels 11 days ago, as his 16 eurozone colleagues agreed a first botched bailout after 10 hour meeting.

That proposed bailout brought in cuts to all Cypriots and foreigners’ savings. hitting small savers was a Cypriot inititiative, though signed off by all, but it would have kept the main two banks including Laiki, alive.

However a week ago it was spectacularly rejected by MPs – amid euphoric protests, the opposition leader triumphant about facing down the troika when I spoke to him then, suggesting the troika had gone too far, and needed to learn a lesson. Celebrated at the time, it turned out to be a calamity.

PAVLOU: “The second time we went to Brussels, the government went to Brussels, and they came back with a situation that was twice, three times, 10 times worse than the original one we rejected.

C4N: “So the government has accepted a plan that was three times worse than the original plan?”

P: “Yes, everybody knows that, everybody knows that the one we accepted in Brussels a couple of days ago is many many times worse than the original one that they gave us and the House of Parliament rejected.

C4N: “But that would have hit small depositors?”

P: “Yes, it would have hit small depositors, but the amount that they would be forced to pay, it was something like one and a half year’s interest.”

So there’s sufficient blame to go around in Cyprus. There can be no doubt that the system became too dependent on Russian deposits. But looking at actual data rather than hearsay, innuendo, and never-published German intelligence reports, it is pretty clear that the sharp rise in “Russian” deposits over the past half-decade is nearly exactly matched by a sharp rise in deposits from within the Eurozone.

All roads lead to Greece.

A deal signed off this week saw the Greek subsidiaries of Cypriot banks snapped up by a lucky Greek bank, that has seen its share price rocket.

That’s not even the half of it. The key sticking point in troika negotiations was the status of these subsidiaries. Why? Because there were awful corporate loans in some of them.

Something odd happened.

The end result: Greece and its banking system were spared any sort of default or haircut, for losses arising wholly in Greece. Cyprus was left holding the baby. Greece exported its bank default to Cyprus. And the people running the Eurozone were left without yet another Greek headache in a politically sensitive year.

Mr Pavlou, the chairman of the Laiki audit committee, says he was shocked at what he found in the Greek subsidiary of his Cypriot bank. Billions were lost when the EU arranged a massive cut to Greek government debt. But as much was also lost in opaque lending by the Greek unit of the now defunct Laiki.

Pavlou: “In some of the loans in Greece, there was absolutely nothing behind it. Collateral was almost zero, and very low interest rates.

C4n: “So very low interest rates, we’re talking multi-million pound deals…”

P: “Multi-million pound deals, very low… ”

C4N: “Sketchy connections maybe, between the bankers and the recipients?”

P: “One could find evidence of some connections there, yes. A conflict of interest.”

C4N: “Would you say that that subsidiary was rotten?”

P: “I wouldn’t use the word rotten, because there was a lot of people working there.”

C4N: “There was a lot of rotten lending in that subsidiary?”

P: “In the UK we used to use the word ‘dodgy’. I think some of the lending there, some of the practices were very dodgy.”

C4N: “Yet this is the part of the bank, which was if you like, the cancer within the bank. Where have those losses ended up? Have they ended up in Greece?”

P: “They ended up in the bank. Greece was part of the bank. Yes. Some of the losses were taken, we have taken some 5.5bn euros worth of losses, and there were some other expected losses. And I understand that when the Greek parts of the Cypriot banks were sold to Greece, all the expected losses were covered by the Cypriot taxpayer. ”

As people continue to protest… helicopters buzzed around Nicosia. To police a riot? No.

Amazingly in four Green lorries, with armed and chopper-escort, the European Central Bank had delivered billions of euros for Cypriots to extract if they want to when banks reopen at some time today.

Just in time delivery. Incredible economic history in the making. Mainly, of the wrong sort.

Follow @faisalislam on Twitter.