Pinning the blame for the collapse of the Cypriot banking system (and the country itself) on the shoulders of one man may seem harsh but Laiki Bank's chief risk officer Dimitris Spanodimos represents the tip of the spear of mass delusion that encompasses most (if not all) of Europe. Cypriot banks had been swamped with deposits courtesy of their cozy relationship with Russia and this left them with, in Spanodimos' words, "comfortable liquidity and capital position to deepen selectively some highly profitable and highly promising client relationships." In short, they had so much excess that they had to invest it somewhere and given the regulators light tough (which gave the banks a clean bill of health through 2011), they bought Greek government debt and extending huge amounts of mortgage loans (in Greece and Cyprus). So, as the WSJ reports, while everyone else was purging, Spanadimos had swallowed the red pill and decided his banks' gorging on extremely risky investments was tolerable - until of course the EU pulled the plug with the haircuts from the Greek bailout. These losses, and the need for new capital, is why Cyprus needed a bailout - so who is to blame...
So a combination of zero-risk-weighting for Greek government bonds (and their juicy yield), huge deposit inflows, abysmal regulatory oversight, and a risk-manager devoured by the mass delusion that Europe (and more specifically Greece) was all going to be ok (who decided to pull a 'Corzine') - is why the Cypriot banks collapsed - and why the Cypriot people now stand in the street looking for handouts...
In August 2010, Greece's economy was tumbling into depression amid angry street protests and a €110 billion bailout. Dimitris Spanodimos, the chief risk officer of Cyprus's second-largest bank, remained bullish.
Mr. Spanodimos boasted on an Aug. 31, 2010, conference call with analysts that the bank was expanding faster than rivals in Greece and bulking up on residential mortgages. "We have used our group's comfortable liquidity and capital position to deepen selectively some highly profitable and highly promising client relationships," he said.
His bank, Cyprus Popular Bank PCL, is now ruined. Its destruction—and the near-failure of its larger peer, Bank of Cyprus PCL—was the result of poor choices by bank managers and of a European regulatory system that gave both banks a clean bill of health as their infections festered.
An examination of regulatory documents, conference-call transcripts and financial filings shows that both banks gorged on Greece while nearly everyone else was purging.
In late 2010, even after German and French leaders had openly agreed that creditors of fiscally weak governments should take losses on future bailouts, the two Cypriot banks appeared nonchalant about their exposure to Greek government bonds.
By the end of the year, according to European regulators, the two banks had a combined €5.8 billion ($7.5 billion) of Greek government bonds—€1 billion more than they had held just nine months earlier, and a sum equivalent to about one-third of Cyprus's annual economic output. By comparison, over the same period, Barclays cut its Greek government exposure by more than half.
Both Cypriot banks passed Europe-wide stress tests in 2010, relieving them of pressure to change course. They passed again in 2011.
"Their regulator was clearly signaling it was OK to go on" expanding in Greece, said Christine Johnson, a bond-fund manager at Old Mutual Global Investors in London, referring to Cyprus's central bank and European banking regulators.
Cyprus Popular and Bank of Cyprus have booked combined losses of €4.3 billion on their Greek government-bond holdings.
For a while, the Greek business was good, as both banks pursued business with their fellow Hellenophones. The 2006 annual report of Bank of Cyprus speaks of its "dynamic expansion in Greece" and plans for more branches. By the time Greece began to teeter in late 2009, both banks were in deep.
In July 2010, a pan-EU regulator conducted "stress tests"
Cyprus's two main banks passed easily, with a total of €572 million of surplus capital. The Central Bank of Cyprus declared "deep satisfaction" with the results, which it said "demonstrate the ability of the domestic banking sector to withstand shocks under adverse scenarios."
In 2010, after getting that all-clear, ... Both banks also expanded their portfolios of soon-to-be-toxic Greek government bonds.
In February 2011, Cyprus Popular's then-CEO Efthimios Bouloutas said "we're extremely comfortable" with the bank's capital levels, which he predicted would rise as Cyprus Popular churned out profits."We don't have any rush to strengthen them," he said. He couldn't be reached to comment.
Also that month, Mr. Spanodimos, the risk officer, told analysts during a conference call that he didn't think Greek or Cypriot loans would go bad at an increasing clip.
Around the same time, a top executive at Bank of Cyprus told analysts that the lender was "selectively and cautiously expanding its business in Greece," and noted the bank's capital position "remains strong."
In 2011, the European Banking Authority ordered more stress tests. Like the ones the previous year, they didn't contemplate losses on government bonds. The two Cypriot banks were again found to have plenty of capital to withstand a deteriorating economic environment.
Less than a week after the results came out, European leaders reached a deal for a new Greek bailout that included losses on Greek bonds. That plan was never executed—another plan,which saw steeper losses, eventually was—but now the specter of such losses was out in the open.
Three months later, Cyprus Popular executives said they were racing to downsize their Greek government-bond holdings. Mr. Bouloutas told analysts in late November 2011 that the bank was seeing some customers pulling their deposits as a result of "all this adverse publicity," but expressed confidence the trends would quickly stabilize. A week later, he resigned as CEO.
That year, the banks realized huge losses on their Greek government bonds. Both were left with lower capital levels than Cypriot regulators required. Bank of Cyprus scaled back its lending to individuals and small businesses in Greece, but its loan portfolio there stood at about €10 billion. Nearly 12% of the loans were classified as nonperforming.
Bank of Cyprus's estimated deficit was €1.56 billion and Cyprus Popular's was €1.97 billion. The banks had until June 2012 to come up with the new capital.
They couldn't raise enough, and Cyprus needed a bailout.