Greg Clark MP: Lessons for Britain from the Cyprus debacle

Greg Clark is Financial Secretary to the Treasury and MP for Tunbridge Wells.  Follow Greg on Twitter.

Last weekend, George Osborne and I represented the United Kingdom at the European Finance Ministers summit in Dublin. Before the summit began, the finance ministers of the Eurozone countries met to approve formally their agreement to give financial support to Cyprus.

The chaotic handling of the Cyprus episode should be a wake up call for Europe’s financial regulators. It revealed that five years after the financial crisis no thought-through and predictable response was ready to deal with the difficulties of two banks which, while large for Cyprus, are tiny in European terms. Instead, policy morphed and uncertainty persisted while the banks had to go on an extended holiday. Just imagine the chaos if this had happened for bigger banks in larger eurozone member states.

I draw four main conclusions from the Cyprus affair. The first is that it demonstrates starkly what can happen if you lose control of your currency, lose control of your banking system and lose control of your public finances. It underlines how crucial it is for the UK to be committed to keeping our currency, bringing our banking system back under the supervision of the Bank of England and pulling our public finances back from the verge of ruin.

Second, it is essential to put it beyond doubt that the guarantee of savers’ deposits under EU-wide deposit protection schemes will always be respected. Commitments given in advance to depositors underpin public confidence in a financial system. They must be honoured both to the letter and to the spirit in which they are made, even when – in truth, especially when – the pressure is on. George Osborne and I argued at Dublin that it should be made crystal clear in the EU’s proposed Resolution and Recovery Directive that insured depositors will be preferred creditors – which is exactly what we are doing in our own Banking Reform Bill.

Third, it must be clearly – and urgently – set out who is responsible for recapitalising failed banks should they require it. This needs to be done in advance of any crisis, not in the middle of one. The EU should adopt clear rules that state that holders of debt, as well as equity, should be ‘bailed-in’ to support a troubled bank so that insured depositors do not lose their savings, and to avoid taxpayers having to ‘bail out’ banks. The ad hoc, work-it-out-as-we-go-along approach that was used in Cyprus must never again be all that is available.

Fourth, more must be done to strengthen the underlying resilience of banks across Europe. In the UK the Financial Policy Committee of the Bank of England has recommended that British banks set aside a further £25 billion of capital by the end of this year. The UK has been one of the main advocates of robust EU-wide stress tests to discover how solid banks are. This is not just about banks holding more capital – we must ensure that banks are calculating their risk-adjusted assets in a consistent, transparent and realistic – rather than optimistic – way. The best foundation for growth in the real economy is to strengthen confidence in the resilience of the financial system, without which markets will be fragmented – as the imposition of exchange controls in Cyprus illustrates.

We in Britain have great sympathy with the people of Cyprus. Cyprus has long been a staunch ally of this country, a valued member of the Commonwealth and many of our citizens and theirs have chosen to live in each other’s country. The choices that its new government – led by a sister party of the Conservative Party – faced were invidious. To put it into context, the money that needed to be injected by the eurozone was nearly two-thirds of the GDP of Cyprus, even excluding the main bank recapitalisations. That is the equivalent of the British government needing to borrow, in an emergency, £1 trillion. When you need that kind of money, and quickly, your options are few.

Although Britain is not part of the eurozone and, therefore, not part of the negotiations, we offered immediate technical assistance to our ally, and a team of officials, led by the Treasury’s second Permanent Secretary, worked hard in Cyprus to share our experience. And with 15,000 depositors in UK branches of the Cyprus Popular Bank, which is being wound up, we moved quickly and successfully to agree with the Cypriot authorities that their deposits would transfer without loss to the UK subsidiary of the Bank of Cyprus, which is regulated by the British authorities and covered by the UK Financial Services Compensation Scheme.

The months and years ahead for Cyprus will be tough. Cyprus has had to ensure a period of deep uncertainty in recent weeks that has made a bad situation worse. It is crucial that Europe learns the lessons of how this should have been done better and applies them now with urgency and rigour.