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Friday 23.03.2018 | Name days: Mirdza, Žanete, Žanna

BL: Latvia's Eurozone membership has nothing to do with Cyprus

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Аuthor: PantherMedia/SCANPIXThe current Cyprus matter believably illustrates potential problems that could be related to the growth of large financial centres in countries with small economies. The banking sector is the fundamental reason for Cyprus’ current problems, not the non-residents’ business servicing model, Bank of Latvia economist Denis Titarenko says.

According to statistical data of the European Central Bank for 2012, assets of Cyprus’ banks (which form nearly 90% of the national financial system) were more than 7.4 times larger than the country’s GDP. The size of Cyprus’ banking system in comparison to GDP is notably larger than that of Britain (5.2 times), France (4 times), Germany (3.2 times) and the average of the European Union (3.5 times).

“Cyprus has a long way to go until it reaches the level of Luxembourg, where bank assets exceed the total amount of the country’s economy 22 times. Nevertheless, it should be added that Luxembourg’s banking system is nearly completely made up of branches of foreign banks. Also according to statistics, Luxembourg’s banking sector’s profitability and asset quality have been significantly better than that of Cyprus in the last several years”, – the economist said.

Results of economic surveys suggest that the large financial system can stimulate economic growth in a short-term perspective. In a long-term perspective, however, this creates notable risks. During the period from 2000 to 2008, Cyprus’ service export was mostly made up of such services – an average of 42% of GDP, compared to an average of 8% across Eurozone (Barclays Research data). This became Cyprus’ main engine for economic growth. However, it had also set up a large dependence on foreign demand and funding.

“The specifics of the Cyprus banking sector, compared to that of other EU countries, shows notable dependence on funding in the form of deposits. The increase of deposits in the Cyprus banking sector was especially rapid during the pre-crisis period and increased only in the last two years’ time. As a result – the volume of attracted deposits at the end of 2012, according to the data of the Central Bank of Cyprus, reached 70.2 billion EUR or 390% of GDP. It should be noted here that a significant increase in the Cyprus banking system began much earlier than the country’s joining of Eurozone in 2008. This is why the statements that were recently voiced in the Latvian media about the risks of the country becoming the next Cyprus after joining Eurozone are especially absurd”, – the banking expert explains.

Another Cyprus banking sector’s specific trait is a very large exposition toward Greece’s economic turmoil. Last year, nearly four billion EUR were given to Cyprus banks for the resolution of the Greek debt crisis.

It should be admitted, however, that the situation with Cyprus looks very similar to that of many other countries. Excessive increase of banking assets at the expense of attracted funds, dependence on foreign funding, rapid increase of investments in the real estate sector and a relatively low level of capitalization are the problems that are characteristic not just for Cyprus, but for many other European and global banking sectors.

An unreasonable increase of credits issued by banks contributed to the investment boom in the real estate market and the formation of the price bubble. During the crisis, the large exposition toward the real estate market and rupture of the price bubble had led to the increase of bad credits (the current proportion of such credits in the balance of three largest banks of Cyprus, according to Barclays, is an average of 18% to 27%).

“So it can be concluded that the current problems of Cyprus’ banking sector mainly come from an aggressive and unreasonable investment policy. The worsening of the credit portfolio and the write-off of Greece’s assets cost Cyprus 7.6 billion LVL in the three quarters of 2011 and 2012 (International Monetary Fund data). A relatively low percentage of capitalization limits the ability of Cyprus’ banks to absorb such large losses. This brings up the matter of their insolvency”, – says the economist.

According to him, the development of not only the banking sector, but the economy as a whole before the global crisis and during the crisis was largely unbalanced and led to a significant internal and external imbalance. This is believed to be possible to explain this with the significant increase of the current account deficit (16% of GDP in 2008, according to Barclays data). A beneficial tax regime contributed to the rapid influx of foreign capital. Cyprus’ life in debt is reflected not only in the banking sector’s statistics, but also in that of other sectors of its national economy. Cyprus has the third largest private sector’s debt level in the EU – 280% of GDP.

Currently, Cyprus’ economic future is in the hands of the creators of the country’s domestic policy. The country should shift its attention from seeking the guilty, and start carrying out reforms of the national economy, which will allow Cyprus to avoid making the same mistakes in the future, all to allow the economy to return to long-term development, Titarenko says.


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  1. Ilmars says:

    Politically things have changed in the last few weeks in the EU.
    The major European powers are fed up with the antics of small wanna be financial centres like Latvia, who dont understand the economic, political or moral consequences of being a haven for laundered money.
    An explicit warning was given by the Germans to Latvia not to take hot Russian money. The French President yesterday called for all tax havens to be “eradicated”.
    Latvian membership of the EU will very likely have new conditions regarding laundered money from Russia.
    Latvias eurozone membership has everything to do with Cyprus.

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