The basics of the Cyprus bank problems

We talked yesterday about what could be done in order to mitigate the inevitable – and rather deep – recession or depression that Cyprus is going to go through in the near future however, today we thought about offering a bit more context for those who are yet to grasp the basics of why this is happening in the island nation.

The problem started due to the exposure of Cypriot banks to Greece, the island’s neighboring economy, both on the commercial side of things, must more importantly and more critically because the Greek Government Bond EU restructuring, which Cyprus signed up for in the spirit of EU/Greek solidarity. Now this restructuring will account for about 40-50% of capital needs in Greece.

At that time it was understood that there would be some sort of protection in exchange for this solidarity otherwise, Cyprus should’ve taken a much harder line like ensuring that the Greek branches within Cyprus get covered by the Greek bailout.

We should also make it clear that this is not true for all banks, and Cyprus has two money-centre type banks: Laiki (Popular) Bank and the Bank of Cyprus.

A while back, Laiki was purchased by a Greek vehicle backed by money from the Gulf and this caused a shift in the bank’s policy. From being a fairly conservative local bank it turned into one very open to Greece, which made it exposed to Greece’s problems as well. Now Laiki is insolvent and has to be restructured.

On the other hand while Bank of Cyprus proved to be more conservative in its deals with Greece it is still exposed to the troubles even if less so than Laiki, it could survive without restructuring but that remains to be seen.

These are the two main bank in Cyprus, there are of course smaller banks which either have a much smaller exposure to Greece or none at all, so those will be relatively fine. These considerably more local-oriented banks were exposed to the local real estate market bubble which burst in 2009, but they’re recovering slowly from that.

These are the bare-bone basics of what’s happening in Cyprus, there would be more to talk about of course, and we’ll do so in future posts.