22 March 2013

Could We Be the Next Cyprus?

Back in 2010 the drive for austerity was driven by a fear that we could all go the way of Greece. The country's high level of government debt led to a crisis in which government could not raise funds from the market and was forced to accept an EU-IMF bailout with harsh terms and savage cuts.

Of course we in Britain, and most of Europe, were in a very different position from Greece. A financial crisis has caused the economic crisis and countries were badly affected even if they had low public debt before 2008. (Ireland and Spain had lower debt than Britain which was less indebted than Germany or France.)

Despite the fact that the problem lay in the banks, the narrative turned to public debt with Greece as the exemplar. The banks are still the problem and fixing the finance sector should be the priority.

Cyprus presents us with a new model. A small country whose banking sector towers over its economy. The aggregate balance sheet of the Cyprus banks is some 800% of the country's GDP. When the banks hit trouble can a small country cope?

Instead of worrying whether Britain could go the way of Greece, is this an opportunity to ask could we go the way of Cyprus? The aggregate balance sheet of banks in Britain is over 500% of GDP.

During the crisis the last government took action to stabilise the finance sector, recapitalising some major banks forcing others to recapitalise themselves and providing guarantees to keep them solvent. Since then the pace of reform has slowed. Each proposal has been compromised from the outset by fear of the power of the financial sector. Each proposal has been watered down further by financial sector lobbying.

Yet still the banks have failed to recognise the bad loans on their books, to raise their capital to a safe level, or to separate the activities which government should underwrite from those which should be at the risk of investors. Could Cyprus be the wake up call?

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