Thursday

17th Oct 2019

Analysis

Cyprus 'business model' was no mystery to EU

  • Cyprus joined the euro only five years ago (Photo: ec.europa.eu)

Be it the German finance minister, European Central Bank (ECB) officials or the head of the Eurogroup - they all agree on one thing: Cyprus must scrap its "unsustainable business model" based on low taxes and attracting large amounts of bank deposits from abroad, mainly Russia.

The Cypriot banking sector, relying largely on deposits, is more than seven times the size of the island's economy - which means that if the banks go bust, the state cannot cover their losses.

Read and decide

Join EUobserver today

Support quality EU news

Get instant access to all articles — and 18 year's of archives. 30 days free trial.

... or join as a group

And if Cyprus wants help from its fellow eurozone countries, Russian and local depositors will have to take a hit.

"The banking sector in Cyprus simply has no future in its current form. Everyone in the Eurogroup agreed on this," German finance minister Wolfgang Schaeuble told public broadcaster ARD earlier this week.

"The Cypriots' hope they could continue like this, attracting capital with low taxes and lax regulation, and then others should pay for it when the model doesn't work any more - this is unfortunately an illusion and the ones in charge should explain this to their population," he added.

Speaking in the European Parliament on Thursday, Eurogroup chief Jeroen Dijsselbloem also said that Cypriot banks "have to be downsized and rebuilt on a healthy and sustainable business model."

But the Cypriot business model is not something that they all discovered just now.

In a so-called convergence report dated 2007, one year before Cyprus joined the eurozone, the ECB mentioned the large influx of capital.

"Much of the financing of the deficits in the combined current and capital account over the past two years has also come from capital inflows in the form of 'other investment,' comprising non-resident deposits and loans," the report says.

"Other investment inflows amounted to a sizeable 11.3 percent of GDP in 2006. Since capital inflows exceeded the current and capital account deficit between 2004 and 2006, Cyprus experienced an accumulation of official reserve assets in this period," it adds.

One data chart on foreign deposits published on the ECB website shows that the inflows of foreign deposits increased to a peak of over €19.2 billion in 2011, €1 billion more than the size of the overall economy.

"The ECB did know about the Russian money flowing into the island. Technically it's impossible not to know it," says Yasen Iliev, an investment banker with New Europe Corporate Advisory, a Sofia-based consultancy.

"Large imbalances in the GDP components, such as the oversized Cypriot banking sector, were an obvious time bomb easily noticeable to students in macroeconomics, let alone central bankers," he told this website.

He said the main reason why nobody said anything at the time was political.

"I believe the Cypriots somehow thought the party will go on indefinitely. The rule of thumb in Brussels and Frankfurt was to 'let go,' probably because of [Cyprus'] dispute with Turkey or maybe because the island's economy was too small to care about. As a consequence, the Cypriots grew up like kids who know their parents will get angry at them from time to time, but they will never kick them out of the house," he added.

For his part, Peter De Keyzer, chief economist with BNP Paribas bank in Brussels, agrees that letting Cyprus into the eurozone had less to do with economics than politics.

"Ten years ago, Cyprus was not even an EU member. Then it joined the EU, the eurozone, it even held the rotating EU presidency last year. This was clearly a political process," he told this website.

"And it strikes me that with Latvia potentially joining the euro next year - with all due respect to what they've been through and accomplished - it is again a political decision that has nothing to do with economics," he added.

Pressed on how much the German government knew about the business model in Cyprus over the past few years, government spokespeople in Berlin say that the flaws became evident only after the financial crisis.

"The crisis has uncovered weak spots in the business models that were built on very thin ice," said Martin Kotthaus, the spokesman of the German finance ministry.

"We now have to deal with the situation as such. It is not a reproach, each country is free to set their own taxes as they please. But then nobody can claim that a state that has chosen low taxes on purpose, should be completely financed with the tax revenues of other states," he added.

Cyprus struggling on bailout Plan B

With no firm offer from Russia, Cypriot officials are scrambling to find alternative money to secure a €10 billion EU bailout.

Cyprus rejects bailout deal

The eurozone plunged into uncertainty on Tuesday after the Cypriot parliament rejected its EU bailout plan by an overwhelming majority.

Eurozone agrees Cyprus bailout 2.0

Cyprus' Laiki bank is to be wiped out. Depositors in Bank of Cyprus will also take a hit under a new bailout deal. But details remain sketchy.

Cyprus MPs pass bank laws, start bailout talks

Cyprus edged back from the brink of bankruptcy on Friday after MPs agreed to a series of emergency reforms - including capital controls - in a bid to avoid financial meltdown.

Column

These are the crunch issues for the 2019-2024 EU commission

These developments will largely determine who will be running the world in the coming decades and perhaps generations. If the Europeans can't find an answer over the five years, they will be toast. And we haven't even mentioned climate change.

Magazine

The changing of the guards in the EU in 2019

The four most powerful EU institutions - Commission, Parliament, Council and Central Bank will all have new leaders in the coming ten months. Here is an overview.

Stakeholders' Highlights

  1. Nordic Council of MinistersBrussels welcomes Nordic culture
  2. UNESDAUNESDA appoints Nicholas Hodac as Director General
  3. UNESDASoft drinks industry co-signs Circular Plastics Alliance Declaration
  4. FEANIEngineers Europe Advisory Group: Building the engineers of the future
  5. Nordic Council of MinistersNew programme studies infectious diseases and antibiotic resistance
  6. UNESDAUNESDA reduces added sugars 11.9% between 2015-2017
  7. International Partnership for Human RightsEU-Uzbekistan Human Rights Dialogue: EU to raise key fundamental rights issues
  8. Nordic Council of MinistersNo evidence that social media are harmful to young people
  9. Nordic Council of MinistersCanada to host the joint Nordic cultural initiative 2021
  10. Vote for the EU Sutainable Energy AwardsCast your vote for your favourite EUSEW Award finalist. You choose the winner of 2019 Citizen’s Award.
  11. Nordic Council of MinistersEducation gets refugees into work
  12. Counter BalanceSign the petition to help reform the EU’s Bank

Stakeholders' Highlights

  1. UNICEFChild rights organisations encourage candidates for EU elections to become Child Rights Champions
  2. UNESDAUNESDA Outlines 2019-2024 Aspirations: Sustainability, Responsibility, Competitiveness
  3. Counter BalanceRecord citizens’ input to EU bank’s consultation calls on EIB to abandon fossil fuels
  4. International Partnership for Human RightsAnnual EU-Turkmenistan Human Rights Dialogue takes place in Ashgabat
  5. Nordic Council of MinistersNew campaign: spot, capture and share Traces of North
  6. Nordic Council of MinistersLeading Nordic candidates go head-to-head in EU election debate
  7. Nordic Council of MinistersNew Secretary General: Nordic co-operation must benefit everybody
  8. Platform for Peace and JusticeMEP Kati Piri: “Our red line on Turkey has been crossed”
  9. UNICEF2018 deadliest year yet for children in Syria as war enters 9th year
  10. Nordic Council of MinistersNordic commitment to driving global gender equality
  11. International Partnership for Human RightsMeet your defender: Rasul Jafarov leading human rights defender from Azerbaijan
  12. UNICEFUNICEF Hosts MEPs in Jordan Ahead of Brussels Conference on the Future of Syria

Join EUobserver

Support quality EU news

Join us