Cyprus' Resolution Law on Financial Institutions

The Law on the Resolution of Financial Institutions was not composed over the past week. It is based on an ECB directive other eurozone members have harmonised and which, bankers tell us, has been under preparation in draft form long before the February election. 

It gives the Cypriot central banker sweeping discretionary powers to resolve any financial institution on evidence of unviability or lack of solvency or mismanagement. This suggests that authorities may believe the central bank might have to resolve a number of institutions, not just the two largest banks. It also hands the central bank complete discretionary power to transfer or sell an institution's assets, manage the institution and be legal guardian of it for up to five years. 

The central bank's two basic priorities are a) to ensure that the public interest is served and b) the institution is worth more through the restructuring than through outright breakup and sale. In other words, the institution's business activities should preferably be preserved. 

A statement released by Andros Kyprianou, the head of the communist Akel party, on Friday, to the effect that the government has not accepted or honoured its contributions and that the party is prepared to help but washes its hands of the outcome - suggests that it is preparing for a confrontation in parliament. It also ominously adds that it has eyes and ears behind the scenes - a warning to the ruling party that it is prepared to defend its corner stoutly with hitherto undeclared hostility if the government calls it on its contrariness. 

Here are the basic provisions of the law:

• It allows the central bank to act as a resolving authority 
• it stipulates that any losses stemming from resolution must be smaller than those that would stem from outright closure
• The first to suffer the costs of resolution are the shareholders, then come those who've lent to the institution, and finally depositors 
• Senior management will be penalised according to seniority and responsibility for the institution's insolvency 
• The central bank can fire managers, has complete access to balance sheets, files and offices, and can issue directives, in effect taking over management of institutions 
• The central bank may proceed to resolve an institution if it believes the institution is insolvent or has reduced access to liquidity, its assets have fallen below the value of its liabilities, it is unable to meet obligations, it is in need of public financial support or may damage the public interest if it is not resolved - it is the central bank that makes the judgment call in all cases 
• The central bank can ask a troubled institution to sell a part of its activities or assets or seek additional financing in order to save itself, but is also the judge of whether these measures are successful 
• The central bank can set up an intermediary bank (which is considered the good bank), transfer assets to it and ask it to maintain the activities of the bank. In the case of Laiki, one lawmaker tells us, the good bank will receive all deposits up to 100K plus performing loans. The central bank may operate this for an initial period of three years, extendable to five. It must then sell it or liquidate it. 
• Nonperforming loans and all deposits above 100K - apparently amounting to five billion euros - would remain in the rump Laiki, or bad bank. This would be liquidated. 
• The central bank has the right to transfer any assets into and out of this 'bad' bank if the public interest is served. This essentially means that the central bank can sell what it wants in order to cover the liabilities and costs of liquidation to the state. 
• Any remaining assets after liabilities are satisfied revert to the bad bank, or the good bank, at the central bank's discretion 
• The central bank has full control over the shareholder structure of the new vehicle, or good bank - it can split or reissue shares or recapitalise the bank. This means that majority shareholders at the beginning of the resolution might no longer be in control at the end 
• The central bank can appoint an auditor to assess the value of assets in the good and bad banks, but has ultimate control over the outcome of those evaluations. In other words, it can act as liquidator and auction off assets on its own terms. 
• The central bank essentially enjoys immunity from prosecution in the discharge of these duties, unless a plaintiff can prove breach of good faith.