Financial crisis in Cyprus: Can it happen in Sri Lanka?

There were recent write-ups citing current problems in Cyprus and questioning if there is a possibility of a similar financial crisis hitting Sri Lanka. Having seen the happenings at close quarters during stints in Brussels and later in the Czech Republic, I would like to express my views on the subject as it is most important for all to keep our calm.

Presently, in Cyprus, customers are limited to withdrawing € 300 a day, € 1,000 in cash for travel abroad and no more than € 5,000 a month on debit or credit cards. Anything above requires approval of their Central Bank.

What went wrong in Cyprus?

Before the crisis struck Greece in 2010, Cyprus was seen to have a healthy economy, with high growth, low unemployment and sound public finances. In fact, for many Sri Lankan expatriate workers it was a preferred destination with good salary levels and better working conditions.

During the good years, the island’s banking sector grew rapidly. By 2011, the IMF reported that their assets – including all the loans they have made – were equivalent to 835% of GDP. A chunk of that was by foreign-owned banks, but Cypriot banks alone had made loans to Greek borrowers worth 160% of Cypriot GDP.

When Greece became engulfed in crisis in 2010, Cypriot banks were hit hard, and the Government did not have the money to bail them out itself. Government finances were further weakened by slow economic growth and international lenders stopped offering loans.

On the contrary, bank lending in Sri Lanka never went above 50% of GDP, not too high for a developing country, and our Central Bank deserves credit for identifying expansionist trends in time and taking action through macro and micro controls to keep it in check. There are also prudent single borrower limits placed on each bank in Sri Lanka linked to capital.

For one thing, the people of Greece and Cyprus never had the strong work ethic or the willingness to pay their taxes and dues as done by the Anglo Saxons in Germany, Holland, UK and France. Structurally too, Greece and Cyprus were different, mainly reliant on tourism and agriculture without an industrial backbone as in most other EU countries.

In retrospect many are of the view that Greece and Cyprus should have kept out of the Euro sticking with their own currencies, Greek Drachma and Cypriot Pound while enjoying membership of the European Union similar to UK, Poland, Denmark, Hungary, etc., all of which are far bigger than Cyprus.

With it, those two countries could have devalued their currencies out of the present trouble while independently adjusting interest rates without having to go through bank closures and bankruptcies.

In Sri Lanka, we still enjoys this comfort and it is something future governments in Sri Lanka should not surrender giving into pressures to have a common currency with India and some South Asian nations.

The levy on bank deposits in Cyprus became necessary when the multilateral lending organisations and foreign governments wanted Cypriots themselves to contribute towards the solution by raising funds themselves, supplementing the international bailout. The levy on bank deposits was designed to mobilise that money.

There was a political aspect too. Banks in Cyprus also had large amounts of Russian-owned money parked to evade money laundering and tax avoidance investigations. The ECB was concerned that any high cost rescue of depository would have benefited Russian oligarchs and the mafia holding most of these off shore deposits in Cyprus. Once again, we don’t face that risk in Sri Lanka thanks to the strong AML and Anti Terrorist Financing regulations diligently enforced by the Central Bank in Sri Lanka.

In these circumstances chances are remote of a Cyprus style contagion affecting Sri Lanka but the Central Bank and State and private sector commercial banks should be constantly guarded against too many politically-motivated lending decisions, disregarding ultimate repayment, mismatch of maturities and prudent capital adequacy requirements.

Prof. SBM