Why cyprus banks failed

These terms are in effect a form of contribution by the creditors to state coffers. The finance ministry said the measures were about protecting Iceland's balance of payments rather than extracting money from creditors, mostly hedge funds that bought into the debt after the collapse of the three key banks.

The main impact was psychological on people, but it didn't really stop the circulation of money," she said. Cypriot authorities are in the second year of an EU and IMF mandated reform program in return for 10 billion euros in bailout funds, and expect to exit the program in early Cyprus returned to growth in the first quarter of this year for the first time since , and officials say they may not need all the bailout money.

Cypriots reacted more maturely," said Sarris. For you. World globe An icon of the world globe, indicating different international options. Get the Insider App. Click here to learn more. A leading-edge research firm focused on digital transformation. Good Subscriber Account active since Shortcuts.

Account icon An icon in the shape of a person's head and shoulders. It often indicates a user profile. Log out. US Markets Loading Money has poured in from Russian oligarchs and mobsters looking to avoid taxes back home, and that Russian money has bloated Cypriot banks to a size far beyond the government's ability to bail out.

In other words, almost all of the foreign money is in uninsured accounts, and 68 percent of all uninsured accounts come from abroad. So, what did Cyprus banks do with all of this money? Well, they invested it where they thought they had a competitive advantage: Greece. After all, southern Cyprus is ethnically Greek the northern half is occupied by Turkey , and the Greek economy, which is 12 times larger than the Cypriot one, looked like an ideal place to expand. It wasn't. Cypriot loans to the Greek government and businesses have opened black holes on bank balance sheets.

Here's how it works. Suppose you run a euro bank desperately short on cash, collateral, and confidence. In other words, you need more money, but you so obviously need more money that nobody will lend it to you except on a secured basis -- and only then against top-notch collateral, which you don't have.

Well, this is what lenders-of-last-resort are for, assuming your bank is illiquid and not insolvent. You can take your slightly crappy collateral to the ECB, and get a loan subject to a haircut.

Technically-speaking, the worse your collateral, the higher the interest rate the ECB charges you. But suppose your collateral isn't just slightly crummy; say it's really crummy. Well, don't worry, you're still in luck! Welcome to the wonderful world of " emergency liquidity assistance " ELA.

Now, this sounds confusing and that's probably the intent behind it , but it's really not. It's the same idea as before, only with crappier collateral and higher interest rates.

Remember, the ECB sets monetary policy for every euro member, but those members retain their own central banks, which carry out the ECB's policy decisions. These national central banks can basically accept any collateral -- really, anything -- as long as they apply more severe haircuts and get the okay from the ECB.

The only other big difference here is the national central banks, not the ECB, are on the hook in case of default. Cypriot banks have stayed alive by gorging on this ELA funding. Notice it gets a third of its capital from the central bank.

That's, um, a lot. This dependence on central bank financing leaves Cyprus quite open to, shall we say, ECB persuasion. This, ladies and gentlemen, is what we call "foreshadowing". Merkel doesn't want to bail out Russian gangsters in an election year. There are two ways a broke government could still come up with this money. First, it could force its own creditors or the banks' creditors to take losses. But, as Joseph Cotterill points out, the Cypriot government can't logistically force losses on its foreign lenders, and its domestic lenders are mostly its banks.

In other words, the only losses the government can force on its bonds would make the banks' problems all the worse. That leaves the banks' creditors. Most banks fund themselves with three classes of lenders: junior bondholders, unsecured senior bondholders, and secured senior bondholders, including insured depositors. If the bank goes bust, the secured senior bondholders are at the front of the line for whatever's left, and so on.

But Cypriot banks are almost entirely funded with deposits and ELA money. Despite the success of the country's bailout, non-performing loans NPLs remain a thorn in the side of the Cypriot banking system with the latest data from the country's central bank showing the total number of bad loans is around 27 billion euros. Read More Bad loans a 'challenge' as Cyprus exits bailout. Cyprus can now demonstrate an enviable growth with its economy expanding 0. However, euro zone watchers have learnt to that guarded optimism is the best course of action in a region with low inflation, essentially low growth as a whole and sticky unemployment in many countries which is often a truer test of business confidence and recovery — in Cyprus, for example, Likewise, the Eurogroup held no illusions that Cyprus could now take its eye off the ball.

While Cyprus' banking system had gone through what it called a "deep transformation," it said work must continue with determination to secure the reduction of the non-performing loan ratio "to healthier levels. The Eurogroup also said that Cyprus should complete the privatization of the Cypriot Telecommunications Authority, what it said would be "another growth-enhancing step.