The financial crisis of 2012-13 constituted a “wake-up call” for Cyprus. While many other countries have adopted legal provisions giving their bank supervisory authorities the ability to restructure severely troubled banks, appoint special administrators or conservators, arrange purchase-and-assumption transactions and so forth, Cypriot banking legislation did not contain any such provisions until March 2013.
Laiki Bank, also known as Cyprus Popular Bank1, was the second largest bank in Cyprus, behind the Bank of Cyprus (BOC). Its shares were listed on the Cyprus and Athens Stock Exchanges. It had a network of more than 295 branches in Cyprus, Russia, Ukraine, Romania, Serbia, the UK and Malta, and had applied to open a representative office in Beijing. As of September 2012, Laiki Bank held a 16 per cent share of the market in loans in Cyprus and a 14.4 per cent share of deposits.
Prior to and during the Greek financial crisis, Laiki Bank made a series of large loans, many to Greek companies. What followed has been described as “billions handed out in bad loans [which] created a financial time-bomb.”2 After the bank collapsed, it was rescued by the Cypriot government, which took 84 per cent ownership on 30 June 2012. However, as the bank’s condition deteriorated further, it was resolved as part of the Cypriot government’s efforts to stem the 2012–2013 Cypriot financial crisis.
On 15 March, 2013, Laiki Bank and BOC were closed by the Central Bank of Cyprus (CBC) until further notice. The following day, a tentative €10 billion bailout agreement was reached between Cyprus and the European Commission, the European Central Bank and the International Monetary Fund. As a condition for the bailout, Cyprus would have imposed a one-time levy (tax) of 6.7 per cent on bank deposits up to €100.000 and 9.9 per cent on higher deposits, with account holders being compensated with shares in their banks in equivalent amount as the amount of the tax.
The banks also froze the moneys representing the prescribed levy on all accounts to be levied. The Cypriot Parliament, however, rejected these terms. On 25 March, an alternative agreement was reached, preserving all insured deposits up to €100,000 without a levy. A revised €10 billion bailout deal, which was eventually approved by the Cypriot Parliament by a margin of just two votes, consists of four principal components:
- The Greek operations of three Cypriot banks – Laiki Bank, BOC, and Hellenic Bank – were sold to Piraeus Bank, a large Greek bank;
- Laiki Bank was permanently closed and its Cypriot operations were split into a “good bank” and a “bad bank”, with uninsured deposits being converted into equity in the bad bank;
- Laiki’s good bank, along with its insured deposits, was merged into BOC;
- Up to 60 per cent of BOC’s uninsured deposits are to be converted into equity in order to recapitalise it. At the time of this writing, BOC had converted 37.5 per cent of uninsured deposits into “class A” shares, with an additional 22.5 per cent being held as a buffer for possible conversion in the future. The remaining 40 per cent are temporarily frozen for liquidity purposes. Many of these uninsured deposits are held by wealthy citizens of other countries, particularly Russia, who use Cyprus as a tax haven.
Because Cypriot banking legislation in existence at the time the crisis exploded did not allow for a resolution along the lines just described, it had to be enacted quickly3. In point of fact, the legislation had been under preparation for quite some time, although it took the crisis to spur parliamentary action4. The new legal framework is contained mainly in two pieces of legislation: the Law on the Resolution of Credit and Other Institutions 2013 (the “Resolution Law”) and amendments to the Banking Law. This article will provide a brief overview of the new resolution regime and will offer some observations.
The resolution process
Under the Resolution Law, the CBC is designated as the “Resolution Authority” (RA). “Resolution measures” are defined as measures aimed at achieving the following objectives:
- ensuring continuity in the provision of critical banking or financial services;
- preventing the creation or propagation of risks, which could have possible adverse effects on the stability of the financial system, within Cyprus or elsewhere;
- safeguarding public confidence in the stability and smooth operation of the financial system;
- protecting public funds by discouraging affected institutions from depending on public support for their sustenance;
- protecting depositors covered by the Deposit Protection Fund;
- minimising the costs of resolution for the taxpayer;
- safeguarding the public benefit and serving the public interest.
Resolution measures may include mandatory capital increases, sale of operations, transfers of assets, rights and/or liabilities to a bridge bank; transfer of assets and rights to an asset management company; and various “bail-in” measures (in essence, ensuring that shareholders and uninsured creditors are the first to suffer losses in connection with a bank resolution).
The decision to institute resolution measures regarding an “affected institution”5 must be taken jointly by the RA/CBC and the Ministry of Finance (MOF)6. Under section 6(1) of the Resolution Law, resolution measures may only be undertaken if all of the following cumulative conditions are met:
- (a) The institution is no longer viable or is likely to no longer be viable, based on the assessment of the RA/CBC, thereby giving rise to a credible risk that the affected institution may not meet its obligations and/or continue to operate as a going concern;
- (b) In the absence of resolution measures, any other actions that could be taken within a reasonable period of time by the affected institution or by the competent supervisory authority would, according to the assessment of the RA/CBC, be insufficient to enable the institution to observe its capital adequacy and/or liquidity requirements, and
- (c) a resolution measure is necessary to safeguard the public benefit or to serve the public interest.
While point (a) may appear to set a very high bar at first, the list of circumstances that could give rise to such a determination do, in fact, give the CBC and MOF a considerable “margin of appreciation” within which to make a decision. The Law contains 10 sub-points that may be taken into account in making this determination. These include, among others:
- failure or likely failure to meet capital or liquidity requirements; and
- fundamental shortcomings in the institution’s business plan or breach of the terms of the institution’s license.
Still, points (b) alternative measures not likely to enable the institution to meet its capital and/or liquidity requirements and (c) the public interest or public benefit test need to be satisfied. And in order to satisfy point (c), it is necessary for the CBC/MOF to determine that liquidation would not serve the purpose equally well.
In the event that liquidation is determined to be the best option, the CBC may apply to the Court for a liquidation order. According to the Banking Law, a bank may be liquidated in one of two ways: via the general liquidation process laid out in the Companies Act (with some particular provisions relating to banks), or via “special liquidation”. Irrespective of the provisions of the Companies Law, the CBC may apply to the Court for a liquidation order relative to any bank whenever the CBC has revoked the bank’s licence. The Court may appoint a temporary receiver or liquidator for the bank only after hearing the opinion of the CBC. The Banking Law provides that in general, the winding up of a bank is subject to the provisions of the Companies Law7. In an ordinary liquidation situation, the court appoints the liquidator, who exercises authorities subject to the oversight of the court8.
The Banking Law also provides for a “special liquidation” procedure for banks9. The law authorises the CBC to file an application with the court for a special bank liquidation order to be granted and for a special liquidator to be appointed where all three of the following conditions are met:
- (a) the bank’s licence has been withdrawn by the CBC on grounds provided in the Banking Law, or the bank has voluntarily handed over its licence;
- (b) the bank is holding insured deposits; and
- (c) the special liquidation of the bank concerned is in the public interest.
The special liquidation application may be granted ex parte. The bank has a maximum of three days to appeal to the court to show why the order should cease to apply. Assuming the court grants the CBC’s application, the court will appoint a “special liquidator”, who is recommended by the CBC, must meet certain “fit and proper” criteria and is subject to the supervision and control of the CBC. The CBC is authorised to make recommendations to the special liquidator as to how to best achieve the objectives in the Banking Law, and the special liquidator is obliged to comply. There are also reporting requirements of the special liquidator to the CBC. The provisions of the Companies Law apply to special liquidations to the extent that they do not conflict with the Banking Law.
The Banking Law also provides that the CBC may request the court to institute “reorganisation measures” with respect to any bank, in order to preserve or restore the financial situation of the bank. Such measures may include the possibility of a suspension of payments, suspension of enforcement measures or reduction of claims of creditors or shareholders of the bank, as well as the measures provided for in relevant sections of the Companies Law.
The new legal provisions clearly represent a welcome upgrading of Cypriot banking legislation, and bring the country’s bank resolution regime into closer harmony with evolving international standards. The following points are offered as items that the Cypriot authorities may wish to consider in the future.
First, the requirement that resolution measures be jointly agreed between the CBC and the MOF is somewhat curious. Included in the list of resolution measures is a mandatory capital increase, which, it would seem, should be a standard supervisory tool and should be routinely imposed whenever a bank fails to meet any capital requirement without requiring the involvement of the MOF. For example, in the United States, the “Prompt Corrective Action” regime becomes applicable automatically when a bank fails to meet any required capital benchmark.
On this point, the interaction between the Resolution Law and the Banking Law is a source of potential uncertainty: the Resolution Law requires a joint decision between the CBC and MOF on the imposition of resolution measures, of which a mandatory capital increase is one type; the Banking Law, on the other hand, gives the CBC the authority to impose various enforcement and corrective measures, including an increase in share capital, without mentioning the involvement of the MOF and without a determination that the three prerequisites for “resolution measures” specified in the Resolution Law are met. Query, then, what are the pre-conditions for a mandatory capital increase, and the procedure that must be followed?10
Second, while special provisions for bank liquidations are clearly a good idea, Cyprus has not completely severed the judicial “umbilical cord” when it comes to winding up or otherwise resolving the affairs of severely troubled banks. Generally, in international practice, there are two principal models for bank resolution. Under the first, found in the United States and some other countries, special procedures are administered by the bank regulator or the deposit insurer, with the court performing only a judicial review function, which only happens if the bank chooses to pursue such a review.
The only questions for the court are whether at least one ground for license revocation/appointment of the receiver were present at the time the action was taken, and whether any required procedural steps were followed. By contrast, in much of Europe, where bankruptcy proceedings are court-administered, there has traditionally been a reluctance to transfer certain “judicial” functions to another authority, even in cases involving such highly specialised institutions as banks. Recently, this has begun to change and there has been a discernible trend towards giving financial supervisory authorities a much greater role in bank resolution and winding up proceedings.
For example, Germany’s Bank Restructuring Act (effective January 2011) allows the Federal Financial Supervisory Authority (the BaFin), to wind up systemically important banks. Switzerland took a similar decision in 2003, via amendments to its Federal Law on Banks and Savings Banks. This is in recognition of the fact that bank supervisors and deposit insurers have greater expertise than judges to deal with the special circumstances that arise when the defunct entity is a bank11. Those, like this author, who are used to a completely administrative mechanism for resolving failed banks, probably would have preferred to see the Cypriot parliament follow a similar path12.
The vast majority of things that happen in a typical bank resolution are not inherently “judicial” and do not require the involvement of a court. Examples include reviewing and approving expenses, reviewing proposed asset sales, approving a list of undisputed claims, disbursements, etc. Where court action is contemplated, the real issues are:
- whether it is a truly judicial issue that is being decided (that is, a legitimate legal dispute that only a judge has the expertise to decide)
- whether it would stall the resolution process unnecessarily.
Next, special liquidation procedures, which entail the appointment of a special liquidator acting at the direction of the CBC, can only be undertaken if certain conditions are met. It is possible that not all insolvent banks will meet the conditions that will qualify for special liquidation treatment. Those that do not meet this test will continue to fall under the provisions of the Companies Law, with a few different twists involving banks. And even in cases of special liquidation, the provisions of the Companies Law apply to the extent that they do not conflict with the provisions of the Banking Law.
The Resolution Law also contains some provisions regarding priorities of claims in liquidation proceedings involving a bank that is under resolution. Parsing through the Banking law, Resolution Law and Companies Law in the course of a winding-up proceeding may prove cumbersome. It would seem that a neater and cleaner approach would have been to adopt a purely administrative system, such as described above, under which the CBC could revoke a bank’s license, appoint a receiver, which could be the CBC itself, the deposit insurer, or simply a person acting at the direction of the CBC, and allow the receiver to implement any reorganisation or restructuring scheme deemed appropriate, subject to the oversight of the CBC and the deposit insurer. The courts would only become involved in the event that judicial review became necessary.
The above issues may well be revisited in future cases of bank failures in Cyprus. Hopefully, such failures will be few and far between. In the meantime, Cyprus has taken welcome steps to give the CBC greater authority to resolve failed or failing banks quickly and expeditiously without taxpayer funding.
- Laiki is the Greek word for popular.
- BBC Broadcast, “The Bank That Brought Down Cyprus”, http://www.bbc.co.uk/programmes/p016tlqr.
- Benjamin Fox, “Cyprus MPs pass bank laws, start bailout talks,” EU Observer, 23 March 2013.
- “Cyprus’ Resolution Law on Financial Institutions,” The New Athenian (22 March 2013), http://www.thenewathenian.com/2013/03/cyprus-resolution-law-on-financial.html.
- An “affected institution” may be a bank, a parent financial holding company, a cooperative credit institution, or the Housing Finance Corporation. This article will assume that the institution is a bank.
- Resolution Law, section 3(1).
- Banking Law, section 33A
- In Cyprus, insolvency proceedings involving companies are handled under the Companies Law. Bankruptcy proceedings involving individuals are handled via the Bankruptcy Law.
- Section 33Bbis
- The Resolution Law provides that the CBC may order an institution under resolution to increase its capital, unless section 30A of the Banking Laws or section 12C of the Cooperative Societies Laws (which also authorise mandatory capital increases) has already been successfully activated. It is unclear how these provisions fit together.
- See Eva K. Hupkes, “Dealing with Distressed Banks – some insights from Switzerland”, Journal of International Banking Law, Vol. 17, No. 6, 2002.
- Note, however, that even in Germany, court approval is still necessary for certain aspects of the resolution process. See Deutsche Bundesbank, “Fundamental Features of the German Bank Restructuring Act,” Deutsche Bundesbank Monthly Report (June 2011) (noting the role of the Higher Regional Court in recovery and reorganisation procedures).