The banks of Cyprus and the pursuit of integrity

The bail out of the troubled banking sector in Cyprus has taken on serious political overtones as the crisis deepens. During the past few weeks Cyprus has been accused of failing to combat money laundering and fraud and that Russian oligarchs seek refuge for their money in this “tax haven” country.

Cyprus central bank, Nicosia

Now the strongest members of the European Union want a tax on Cypriot bank deposits to pay for part of the bail out. This news has not only enraged many Cypriots, but more importantly it has also brought the focus back to Cypriot banks. The anger stems in part from the belief that the euro zone has a role in creating the crisis. In particular, euro zone leadership is blamed for playing a part in the decision to slash the value of Greek debt – a major holding of Cypriot banks, and precipitating the Mediterranean island’s banking crisis.

Still, among the contributing factors to the problems facing Cyprus is a lack of integrity in the financial sector – a central failure in the global banking system that created a fertile environment for the financial crisis of 2008.

Cyprus is not alone, but it illustrates the devastating effect that this lack of integrity can have. Like Ireland and Iceland before it, Cyprus must come to terms with a banking system that is devouring its economy.

For too long senior executives at the banks of Cyprus ignored the long term public interest in favour of short term, personal (or corporate) financial gain.

This is why the banking sector grew to be at least five times the size of Cyprus’ GDP. In a March 16 statement on the agreement, the Eurogroup — an informal body of euro zone finance ministers — said the “current fragile situation of the Cypriot financial sector” was linked to its large size relative to the country’s GDP.

Banks’ obligations to society derive from the fact that they are licensed by the government. Let us not forget that it is a privilege, not a right, to operate a bank. They are licensed precisely in recognition of the fact that they play a critical role in the smooth functioning of the economy.

That leads to the next question: Where were the regulators whose job it is to ensure the safety and soundness of the banking system?  No one is talking about how they failed in their jobs.

Cyprus is clearly not the first country to face such criticism, which is why Transparency International has the following recommendations for the global banking industry:

  • Forge a new management culture:  the behaviour of bank employees is not hardwired. They are responding to a set of short-term incentives and skewed values that are reinforced at every step of the career ladder, from initial recruitment to golden parachutes. Banks must put in place a sustainable management and leadership culture, together with the systems that underpin it (e.g. compliance monitoring, coaching, whistleblowing procedures, remuneration policies )
  • Sunshine is the best disinfectant: banks can vastly improve their transparency, particularly public disclosure of their business models, their policies towards customers, relationships with governments (payments, lobbying, political party contributions) and the measures taken internally to deal with unethical behaviour.
  • Accountability, accountability, accountability: What has changed? What corrective action has been taken? At every step of this process of reform, banks need to communicate the answers to these questions to all those who have a stake in their proper functioning. This means not only the “cosy fireside chats” with their supervisors, but with investors, customers, employees and civil society more widely.

These recommendations will not solve the problems of Cyprus overnight, but they can begin to address the deeper issues. It goes without saying that cultural change will require a large investment of time and resources.

Carousel image: Financial destrict skyscrapers Nicosia Republic of Cyprus. Copyright: Wikimedia Creative Commons/ Tofabuilding

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Karen Egger

About Karen Egger

Karen Egger is Senior Programme Manager in Transparency International's Private Sector Team.

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14 Responses to The banks of Cyprus and the pursuit of integrity

  1. Mario 20 March 2013 at 11:04 pm #

    Dear Karen,

    I have three questions to raise:

    1. You mentioned the big size of the banks as being the major contributor to their collapse. Why should this be a problem for a country specializing in the financial services industry provided the banking sector is rightly administered? And why don’t you show the same sensitivity for the size of the banking sector in Luxemburg?

    2. Does any rumours for lack of accountability or integrity justify the unethical and probably illegal imposition of a hair cut of deposits of innocent civilians both Cypriot and foreigners violating the security and reliability that the EU promotes all times? I believe people forget that Cyprus is a European member state and not a corrupted third world country.

    3. The major hit that forced the banks in Cyprus to request a recapitalization was the haircut of the Greek bonds which came from the Eurogroup and which cost a loss of 4.5 billion to the Cyprus banks. Until that time the European Central Bank rated any bonds of an EU member state as a risk free investment and urged all EU member states to invest in such investments.

    I believe that Transparency International should intervene and stop this unethical victimization of Cyprus which take place as a result of the intense competition in the industry of financial services between various EU member states.

  2. Chris Sanders
    Chris Sanders 21 March 2013 at 5:35 pm #

    Many thanks for your comment, it is very much appreciated. Maybe some countries can handle banking sectors that become many times larger than the economy, but that also means the banks themselves quickly become ‘too big to fail’. Once this happens, they can quickly become too big to regulate and too big to manage. It also makes high levels of transparency and accountability harder to attain.

  3. Erik P 27 March 2013 at 3:46 pm #

    What happened in Cyprus is much fairer than what happened in Greece and Portugal, but not necessarily fair: Cyprus was a tax haven for wealthier people. Europe knew that money was being laundered there, and did not act (so the EC is in part to blame). Banks MUST be allowed to fail if they undertake risky operations. By doing so, the market regulates them i.e. cautious people avoid banks that have high risk. Bondholders and shareholders of banks should also suffer through a ‘buy-in’ (I presume they will if the banks are closed). Basically, if people take high risks with their money, they should be prepared to loose it. As far as the high penalty, I think it does lack justice (the EC should have actually investigated the laundering charges long ago). However, they benefited from the tax haven, and the high risk, so they should loose the money in preference to tax payers who don’t have accounts with them.

    In addition, using ‘austerity’ to pay for banks simply allows high risk banks to continue at the expense of the tax payer, and indeed results in a ruined economy. I doubt if the loss of money will have any affect on Cyprus (although a following back run would). Unfortunately, Cyprus as a country was gambling on its financial future to pay for the current wealth, and they have lost. Cyprus must thus now develop means of generating wealth that are less risky than the finance industry.

    Bank workers complaining about lost jobs make me very angry. Pure selfishness. They worked in an industry that they knew was paying them out because of it being a tax haven, and assisting to create this problem. They definitely SHOULD loose their jobs. (especially in preference to workers in unrelated industries).

  4. Mario 27 March 2013 at 9:24 pm #

    Dear Mr Eric,

    I know we have the freedom to express our comnents and views. However the TI’s space is an area where only decent, valid and professional comments are welcomed that aim to combat corruption and promote transparency on valid grounds. Otherwise TI will lose its credibility.

    Your comments lack completely of any reasoning and validity. Such unsubstantiated and abusive comments should better be avoided unless you have specific facts to support them.

  5. Frank Vogl 27 March 2013 at 11:50 pm #

    Cyprus should have been hurled out of the European Union years ago because of its determined efforts to serve as a prime location for international money laundering and thereby assisting criminals from many nations to secure their ill-gotten gains.

    The EU as a whole, as well as the 17-nation Eurozone, has long ignored Cyprus’s illegal activity and now it is paying the cost. it is an activity that goes back a very long time – I recall, for example, that in the 1990s there were reports that then Serbian leader Slobodan Milosevic had accounts in Cyprus (for example, see The Observer (UK), article by Yvonne Ridley, June 27, 1999).

    The cost to decent people in Cyprus and to the Eurozone more broadly as a result of the EU failing to act against Cyprus years ago has been, and continues to be, formidable. This should be a lesson for the EU’s leaders – it is high time they cracked down on tax evasion and corruption in Greece and in Italy (which are causes of the crises in both of these countries), and placed anti-corruption values at the center of their policies.

    Frank Vogl

  6. Melvin Joseph 28 March 2013 at 6:23 am #

    Good explanation on Cyprus crisis. Thanks

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