Cyprus, a Mediterranean island nation, has experienced its share of banking turmoil. As an international bank creditor, understanding the complexities of the Cyprus banking law, bank failure definition, and resolution measures is vital to safeguard your interests. Banking law in Cyprus is governed by several legislative acts, including the Cyprus Banking Law of 1997, the Central Bank of Cyprus Laws, and various directives issued by the European Union. These laws dictate the regulation, supervision, and resolution of financial institutions in Cyprus. Bank failure in Cyprus is defined as a situation where a credit institution is unable to meet its obligations or maintain adequate capital levels. This can result from insolvency, liquidity issues, regulatory breaches, or systemic risks.

The determination of a bank failure in Cyprus is a multi-step process. It involves an assessment of the bank’s financial situation, regulatory compliance, and risk exposure. The Central Bank of Cyprus (CBC), as the national supervisory authority, in cooperation with the European Central Bank (ECB), is responsible for this assessment. They monitor key financial indicators, such as capital adequacy, asset quality, management effectiveness, earnings, and liquidity.

The CBC and ECB, following a rigorous evaluation, may conclude that a bank is failing or is likely to fail. The legal mandate of these bank supervisors includes ensuring financial stability, protecting depositors and other creditors, and maintaining public confidence in the banking system. They possess the authority to impose corrective measures or initiate resolution actions if necessary.

Post-failure Processes

Bank supervision and resolution planning aim to preserve the critical functions of a bank and ensure its continuation during financial distress. The CBC and ECB employ rigorous supervisory practices to identify vulnerabilities early on and require banks to maintain robust risk management frameworks. Resolution planning enables a swift response to minimize the impact on the broader financial system.

Recovery Planning: A bank must develop and maintain a comprehensive recovery plan outlining measures to restore financial stability during a crisis. This plan is regularly reviewed and updated by the bank and the supervisors.

Resolution Planning: The CBC, in coordination with the ECB, prepares a resolution plan that includes strategies and tools to resolve a failing bank while minimizing public costs and systemic risks.

Succession Planning: If a bank’s failure leads to its dissolution, a succession plan ensures an orderly transfer of assets, operations, and customer accounts to a viable successor institution.

Bank Failure in Cyprus

Bank failure occurs when a financial institution becomes insolvent and unable to meet its obligations to depositors, creditors, and other counterparties. In the case of Cyprus, the country experienced a severe banking crisis in 2012-2013, which saw the collapse of its two largest banks, Laiki Bank and the Bank of Cyprus. This crisis was caused by a variety of factors, including excessive lending, poor risk management, and a high level of exposure to the Greek debt crisis.

Bank failures in Cyprus are typically attributed to the following factors excessive risk-taking and poor lending practices, inadequate corporate governance and internal controls, overexposure to foreign markets and currency fluctuations, insufficient capital and liquidity buffers, and regulatory infringements:

Regulatory Violations: Regulatory violations can cause bank failure in Cyprus when financial institutions fail to comply with the rules and requirements set forth by the Central Bank of Cyprus (CBC). Non-compliance with these regulations can lead to issues such as insufficient capital buffers, inadequate risk management, and improper governance practices. Consequently, banks become more vulnerable to economic shocks, financial instability, and loss of depositor trust, which can ultimately result in bank failure and damage to the overall financial system.

Excessive Lending: During the years leading up to the financial crisis, Cypriot banks engaged in excessive lending, primarily to the real estate sector. This rapid expansion of credit fueled an unsustainable property bubble, which eventually burst, leading to significant loan defaults and a sharp decline in property prices.

Poor Risk Management: The banks failed to maintain adequate capital buffers and risk management practices, which left them vulnerable to economic shocks.

Greek Debt Crisis Exposure: Cypriot banks had a high level of exposure to Greek government bonds, which were severely devalued during the Greek debt crisis. As a result, the banks faced massive losses, further eroding their capital base and solvency.

The main concern of bank failure is the disruption of the payment system ultimately followed by a reduction in production. To avoid escalation and irreparable damages to the Cypriot society and taxpayer, the resolution authority in Cyprus follows these steps when a bank within its jurisdiction fails:

  • Declare the bank as failing or likely to fail.
  • Assess the need for resolution and the available resolution tools.
  • Coordinate with relevant authorities, such as the ECB and the European Banking Authority.
  • Implement the chosen resolution strategy, which may involve bail-in, bridge institution, asset separation, or sale of business.
  • Ensure a fair and transparent resolution process, and adherence to established legal and regulatory frameworks.

Following the failure of a financial institution, the resolution authority may decide to reorganize, recapitalize, restructure, or dissolve the entity.

Reorganizing: Implementing changes to the bank’s management, business model, or organizational structure to restore financial stability.

Recapitalizing: Injecting new capital or converting debt into equity to strengthen the bank’s capital base.

Restructuring: Modifying the bank’s balance sheet, liabilities, or operations to improve its financial health and resilience.

Dissolving: Liquidating the bank’s assets and distributing the proceeds to creditors in accordance with the legal hierarchy.

Account deposits and other creditor interests in Cyprus are protected by law through the Deposit Guarantee Scheme (DGS) and the Investor Compensation Fund (ICF). The DGS protects individual deposits up to €100,000 per depositor and per institution, while the ICF covers investments up to €20,000 per investor. These schemes provide a safety net for depositors and investors in the event of a bank failure.

The local DGS in Cyprus is activated when a bank is declared insolvent or unable to repay its depositors. The Central Bank of Cyprus, in its capacity as the resolution authority, triggers the DGS to ensure the timely compensation of eligible depositors.

Orderly Exit of Non-viable Financial Institutions in Cyprus

To ensure the orderly exit of non-viable firms in Cyprus, the following measures are implemented:

Early intervention by supervisory authorities to address emerging risks and prevent insolvency.

Prompt corrective actions, such as capital injections, management changes, or operational adjustments.

Resolution planning and execution to minimize disruptions to the financial system and protect depositors and creditors.

Orderly Liquidation: The orderly liquidation of a bank in Cyprus is a well-structured process aimed at winding down the bank’s operations and minimizing losses for depositors and creditors. It involves the appointment of a liquidator by the Central Bank of Cyprus (CBC) or the court, who is responsible for taking control of the bank’s assets, settling its liabilities, and distributing any remaining assets to the relevant stakeholders in a fair and equitable manner. The liquidator must also ensure compliance with all legal and regulatory requirements, safeguard the interests of depositors, and strive to maintain financial stability and public confidence throughout the process. The liquidation procedure concludes with the finalization of the bank’s accounts, the termination of its legal existence, and the revocation of its banking license.