Posts filed under Cyprus

A Better Way To Do The Cyprus Bank Bail-in

Inspired by reading this article that hints at Sarris's and the Cyprus's government's initial approach on how to bail-in depositors, I am going to run some rough numbers to see if it could work. Short Answer:  Yes, but it needs to be much more aggressive than the numbers shown in the article.  It looks like they were aiming for 3B, I ran the numbers on the 10.6B figure.

Let's say I accept all the conditions of the Troika as a starting point of the analysis:

1. The amount to be taken from bank creditors is 10.6B

2. It is proper to use creditors of other banks to protect the ECB / CBC from itself in its extension of ELA to Laiki

Let's give it a shot at how we find 10.6B in a much less destructive manner:

1. Wipe out bond holders and stockholders of BoC and Laiki.   That is probably good for about 1.5B of the 10.6B, leaving 9B.

2. Cyprus has 70B of deposits at the time of capital controls, so we need to somehow confiscate 12.8% of them (9B/70B)

3. This is a total guess, but let's assume 75% were in interest-bearing accounts (averaging 3.5%) and 25% were in non-interest bearing accounts.   I know for sure that as late as last year the competitive rates for time deposits were in the 3% to 4% range depending on amount and time of lockup

That would imply an average cost of deposit financing / interest earned of 2.625% or 1.8B euros per year.

In 4.8 years x 2.625% = 12.85% that you need.   Let's round it to 5 years

4. So, the tax comes in as follows:   100% of interest income for the next five years.    To prevent withdrawals, you also have an withdrawal / exit tax as follows:

Subtract March 1, 2013 balance from end of year of balance and multiply any reduction by the Exit Tax below so that the bank recap is revenue neutral on withdrawals.   You apply a 12.85% escrow on the initial balance of everyone's account to make sure the money is there if you need to tax it and you reduce the escrow by 2.625% every year.

Exit Tax 2013: 12.85% 2014: 10.23% 2015: 7.61% 2016: 4.98% 2017: 2.35%

By then you hope that there is a rational common banking union in place and the banks emerge into normalcy under that union.

5. You still resolve Laiki (as it is insolvent, not illiquid), rationalize bank staffing, branch networks and so on.   If there are bank assets like branch networks overseas that should be sold, that can be done in a logical commercial way trying to maximize the value to the bank selling them (and reduce the bail-in needs).

It seems to me that this satisfies all the Troika demands

1. Bank creditors pay for losses:  Check!

2. Resolve Laiki / Restructure Bank of Cyprus: Check!

3. ELA fully protected: Check!

4. Reduce Cyprus's attractiveness for foreign deposits:  Check! (I am not saying this is a VALID or LEGAL troika demand but it appears to be a troika demand)

But while having many more advantages relative to the current plan

1. To the average depositor this does not feel like 'theft' in the same way that haircut does.   I understand that in real terms it is the same thing, but no real person lives their financial life in real terms, they live their lives in nominal terms and their mortgages, car payments and so on are in nominal terms.   So, this does not feel like their current money is stolen, it just a high tax rate on future INCOME.

This is exactly what countries with real central banks have been doing since 2008 (US and UK).   They have suppressed interest rates and have been stealthily recapitalizing the banks that way which, relative to other solutions, is a very good idea.   Basically, nobody has complained or even really noticed a thing.   People just accept that right now, in the US or the UK, a bank is only useful for storing your money, not as a way to earn income.

This might be fair or unfair in some platonic sense, but it is certainly better than the 1930s-style Banking 'Supervision' that is currently happening in Cyprus.

2. For the same reason as number 2, I don't think it violates the deposit insurance guarantee.  Nobody is losing their principal balance.

3. It does not cause wildly unfair outcomes based on basically random factors such as 'which of the main banks in Cyprus you used' and 'how much cash on hand you had on day X'.   So the number of tragic sob stories will go from 'a lot' to 'zero'.

4. It does not crush business liquidity (which is the main catastrophe of the current plan) -- At worst, if a company needs ALL its liquidity in 1 year, it is a somewhat manageable 12.6% haircut.   But it is rarely the case that cash on hand will go up or down 100% so in practice most businesses will suffer very manageable or no haircuts

In the current model, business liquidity is going to be hit close to 100% for most businesses in Cyprus.   I cannot even imagine the drop in GDP / bankruptcies / increased unemployment / reduced tax revenue / reduced debt sustainability this is going to cause.   It is the most utterly moronic part of the current model and is what makes even the revised DSA an exercise in fantasy.    It is also so completely an own-goal for everyone involved, including Cyprus and its creditors (who will suffer bigger losses when the Cyprus economy collapses).

5. For the savers/pensioners/etc, you are telling them: 'hey, I am sorry, you won't have interest income for five years but sit tight and you won't lose a single euro of *your money*'.    It is a winning proposition under the circumstances.   It is also a perfectly good message to the Cypriots: "hey, we need you to keep the money in our banks for five years to support the country" which will play OK.

6. For the foreign depositors who are going to bolt at the first loosening of capital controls in the current plan, you provide a hard monetary incentive to sit tight.    It might not be enough, but it is certainly better than today's model where they have no incentive to stay.   And, OK, if they leave, great, we get revenues for the bank recap.     You could even make the haircut higher on them *if they leave* - it would not be the first time there has been hot money capital restriction imposed by a sovereign.

What are possible disadvantages?

1. Theoretically it spreads the moral hazard across all the banks instead of concentrating it where it belongs (Laiki and Bank of Cyprus).    In practice, I am not sure it is much different:

(a) The Troika already proposed a plan (the first one) that spread the pain across all banks so it can't be that much of a concern for them

(b) The current plan pushes losses from Laiki to Bank of Cyprus which makes no sense under any moral hazard reason

(c) The current plan is going to put the viability of other Cypriot banks in question anyway given the damage it is going to cause to the economy

(d) In any case, we are only talking about the moral hazard for depositors.  Laiki and Bank of Cyprus shareholders and bond holders should be wiped out in any plan.

I am utterly unconvinced by the theory being promoted by many parties, particularly the Germans, that anyone with >100K in a bank account earning 3% was 'gambling' and should be punished.

It is absolutely not the retail depositor's responsibility to be monitoring the balance sheets of banks and figuring out if they are illiquid or not.   That is why we pay our taxes to hire bank regulators and Central Bankers who are financial specialists whose main responsibility in life is ensuring that banks under their watch *don't* burn retail depositors.

If it gets to the point that it might be obvious to a retail depositor that a bank is in trouble, the regulators should have already stepped in to take corrective action.

I am not sure how anyone can say with a straight face that ECB is not at fault for giving these banks green lights as late as mid-2011 (EU Stress Tests) but retail depositors were supposed to figure out what the ECB did not figure out.  And all the losses that the banks have faced were already on the asset side of the balance sheet by mid-2011.

2. The other downside of this plan is that it does not absolutely decimate the Cypriot economy.   Possibly that is a flaw to some...


Posted on April 13, 2013 and filed under Cyprus.

Crimes Against Math And Logic: ECB HFCS Wealth Study Edition

(1) The Bundesbank released a study purporting to show that the Germans are well below average in household wealth in Europe (195K euros per household) and that the Cypriots are the 2nd richest (670K euros per household), despite the Germans having substantially higher GDP per head.   In general, it shows the South to be richer than expected and the North to be poorer. The study is here:

(2) First, let's break it down for basic macro-plausibility.

According to their table 1.1, household size is 2.64 2.04 in Germany and and 2.76 in Cyprus.    So assets per capita are 95K in Germany and 252K euros in Cyprus.

Taking the 81M person population in Germany and 800K in Cyprus and GDP of 2.5T for Germany and 20B for Cyprus, this tells us that:

German assets, in aggregate, are worth 3.1x GDP and Cyprus assets are worth 9.68x GDP -- an utterly implausible 3.01x more valuable per dollar of GDP than German assets.

(2) Some commentators note that the differences might be due to homeownership rates in the South (75-80%) vs Germany (44%).

Um, not really.

At some level, "homeownership rate" in all countries is 100% as SOMEONE owns the home.   And given the nature of residential real estate, that someone is almost always a domestic national and so should be showing up in the statistics (the mean, not the median)

If they are not, then this means: "we undersampled people who own >1 home"

It reminds me of my favorite trick math question:  "Do men or women have, on average, more sexual partners?" (Answer will be provided in a different post)

(3) Others have noted "well, the Germans pay higher taxes."   Also, unlikely to be relevant.   Think about where taxes actually go:

(a) Transfer payments (so that should not change average national wealth)

(b) Salaries of government employees, primarily to domestic nationals (so, again, a transfer of wealth that is solely internal to the country and should not impact household wealth)

(c) CapEx/Infrastructure (harder to measure, but, again, that wealth stays in-country)

Only foreign transfers would impact this calculation and I doubt they are big enough to matter

(4) The only variable that could account for these differences would be if Germans are pouring all their high GDP into consumption, not into savings/investment.

If so, the correct title of the study would be: "Italians, Spanish and Cypriots thrifty savers; Germans profligate consumers"

(5) However, #4, aside, I think the data is not accurate for the purposes it is being used.

Common sense from just walking around Cyprus/Germany tells you that the former is not 2.5x wealthier per-head than the latter.

Given the asset figures relative to GDP, it feels like the German numbers are deflated (aka, important sources of domestic wealth are excluded) and the Cypriot figures are inflated (probably some of those foreign assets in Cyprus are being counted as domestic assets).

Posted on April 10, 2013 and filed under Cyprus.

I am shocked, shocked there are Russians in Cyprus

I am writing this post so that I can stop having to repeat myself in email. (1) The Germans claim to be confused at why there is Russian money and Russian transit flow through Cyprus

(2) That is impressive that Cyprus could have gone through its EU accession in 2004 (a vastly tedious checking of everything in the country) and its Eurozone accession in 2008 (a through audit of its financial system) and somehow the Germans missed the fact that 45% of the economy was in banking and the associated professional services.    Cyprus also goes through the Council of Europe Anti-Money-Laundering assessment and regularly scores higher than Germany and Austria and a good chunk of the rest of the EU, but we will ignore that too.

(3) Cyprus is being pilloried as if it was a large player in offshore banking.   Let's go to the numbers, from the February 16th edition of the Economist.

Largest sites of offshore wealth
Switzerland: $2.2T
Britain, Channel Islands and Ireland: $1.9T
Caribbean and Panama: $1T
HK and Singapore: $1T
United States: $600B
Luxembourg: $500B

Cyprus has about $20-$40B in offshore deposits.   That would be less than 0.5% of the offshore banking wealth.

One might have an opinion about whether or not people should be allowed to keep money offshore and there will be many points of view on this topic.   But certainly if your point of view is that offshore banking should not exist, it hardly seems like Cyprus is your place to start...

(4) What Cyprus is for Russia is a transit destination.    In other words, Russian money that is outside of Russia or earned outside of Russia and Foreign Direct Investment is routed through Cyprus into Russia.

Why?   Partially because of tax reasons (the tax treaty rates are favorable, though taxes are fairly low in Russia too), but mostly because Cyprus provides a predictable legal framework that is derived from English law (it was a British colony until 1960), has tax treaties with practically every other country of note and is a fairly neutral jurisdiction for firms from different locations.   Cyprus has also built over the three decades an extremely educated legal and accounting profession to support these transactions.

Basically, until three weeks ago, you would be practically negligent not to route a transaction into Russia without using Cyprus.

(5) If there is a theoretical "victim" to Russian tax structuring through Cyprus, it is the Russian Treasury.  It certainly is not the Germans.    Russia, however, renewed the Cyprus-Russia tax treaty just a few months ago.

Is that because the mighty Cypriot army forced Russia to renew an agreement against its will?  Or is it because Russia sees more value in having this channel for investment than its theoretically lost tax revenue?

In any case, why in God's name does Germany care?   The Russian government finds the arrangement to be useful & from an EU perspective, Cyprus ought to be commended in taking its greatest asset (a well educated workforce) and finding a niche that brings tax revenue into the EU.

The closest parallel I can think of would be if somehow China shut down the Caymans (used by US hedge funds for their offshore clients) and the Bahamas (used by the US for reinsurance) and confiscated US money there and said "yes, I am protecting the US from itself"

It does not make the slightest bit of sense but the newspapers swallowed the narrative hook, line and sinker.

(6) It is beyond the scope of this post, but anyone who reads the newspaper can recall the dozens of money laundering scandals of the major Western banks involved in Iran sanction-busting, Latin American drug money laundering and so on.    Somehow that is brushed aside (HSBC laundered billions for both Iran and drug lords, covering all the bases, and yet the not a single person was found criminally or civilly liable), yet apparently any Russian who engages in any international commerce is an 'oligarch', 'mafioso' or 'money launderer'

Posted on March 31, 2013 and filed under Cyprus.

You Cannot Engage In Commerce Without Liquidity

As I predicted here, accepting the transfer of the 9B of Laiki ELA to Bank of Cyprus would be disastrous. The disaster has now appeared.   The latest Central Bank plan has the following to say about the large (>100K euro) depositors of the Bank of Cyprus:

(1) Loans outstanding to the bank netted against deposits.  Congratulations, you have now paid off your loans!   If you still have more than 100K of deposits, go to step 2

(2) 37.5% of amount >100K is converted to Bank of Cyprus equity senior to the existing equity.   In other words, we can consider this to be a 0.

(3) 22.5% of the amount >100K will be frozen for 90 days until a valuation of Bank of Cyprus assets is made, after which a decision will be made as to if it should be haircut or not.   In other words, you can consider this to be preferred stock, series A.    Note that I am not sure how one assesses bank assets when you simultaneously withdraw all liquidity from the system.   About 20% of Bank of Cyprus loans were non-performing two weeks ago.   It is hard to imagine that 100% of them won't be non-performing in 30 days from now.   If you are one of the very fortunate people to have some liquidity right now in Cyprus, would your first thought be to use it to make your loan payments???

(4) 40% will be frozen for an indefinite period (claimed to be short, but let's get serious) and will be returned to you when bank results merit it.    There is a word for financial instruments with this payoff schedule and it is called preferred stock, series B.   It is certainly not a checking account!

So, in the best-case scenario, this is a 37.5% haircut.   In the worst case scenario, this is a 100% haircut.

My more immediate concern however is liquidity.   In ALL scenarios it is a 100% liquidity haircut.   You will not be able to access a single euro above 100K on Tuesday morning.    Laiki and Bank of Cyprus are the two money center banks in Cyprus and the core of the local payment infrastructure, used very heavily by local businesses for their operating, payroll and working capital accounts.

The Cyprus market could probably operate (with a lot of random, unfair pain) with the Laiki acccounts being lost.    It seems inconceivable to me that the market can operate with both Laiki and Bank of Cyprus being frozen.   They must be the bankers for 70% of Cyprus firms.  Hundreds of firms will miss payroll, not be able to pay suppliers, etc in this scenario.   I am really at a loss as to what is going on.   It is like taking a century of knowledge about how banking supervision is supposed to work and throwing it out of the window.

I hope this is the Central Bank of Cyprus off in outer space as it has been several times last week  (e.g. they wanted to open the banks without capital controls) and some adult supervision will enter the picture, otherwise this is going to be a very, um, interesting few weeks.    If these restrictions last for, say, a month, there is a large likelihood Cyprus is back on the CYP, whether they want to or not.

Posted on March 31, 2013 and filed under Cyprus.