Analysis: Euro zone bank troublespots don't come down to size

Sun Apr 14, 2013 5:16am EDT
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By Carmel Crimmins and Sinead Cruise

DUBLIN/LONDON (Reuters) - Though the implosion of Cyprus's bloated banking system has put other euro zone economies with outsized financial sectors such as Luxembourg and Malta in the spotlight, loan quality is the real litmus test of a country's financial stability.

Attracted by low taxes, high interest rates and light regulation, foreign deposits, largely from Russia and other former Soviet states, pumped up the Cypriot banking sector to nearly eight times annual economic output, more than double the European average of around 3.5 times.

Stripping out Russian banks and other international lenders, the three Cypriot banks for which the state was liable had assets amounting to more than five times Gross Domestic Product (GDP), a huge proportion for an island of just 800,000 people.

What caused the problem, however, was that Cyprus's two main banks used the gush of deposits to gamble on the Greek economy, leaving them horribly exposed when Europe imposed losses on Greek sovereign bonds. The implosion of the Greek economy rotted their loans to that country.

"Banks don't fail because they are big. Banks fail because they make bad lending decisions," said Frank Gill, director of European sovereign ratings at Standard & Poors.

"It is important to understand that the Cypriot banking crisis was born on the asset not the liability side of the balance sheet."

Bank of Cyprus's BOC.CY non performing loans shot up to 17 percent of its total book at the end of September last year. Cyprus Popular Bank CPBC.CY, known as Laiki, which is being shut down as part of the Cypriot bailout, almost quadrupled its loan loss provisions to 400 million euros in the third quarter of 2012.


A worker paints a wall above a branch of Bank of Cyprus in Bucharest April 1, 2013. REUTERS/Bogdan Cristel