The Fruitless Search for the “Next Cyprus”

Ever since the dramatic decline of the Cypriot banking sector the world has been trying to find “the next Cyprus.”  Across the EU and beyond many regional banking hubs exists to serve niche markets.  Some have developed recently in reaction to new markets opening up and the fall of the Soviet Union, while some have existed for hundreds of years. 

While it is easy to look at a large banking sector in a small country and get worried, most of these countries have well regulated, transparent, and modern banking practices and serve an important role in global trade.  As the world becomes flatter, and economies more intertwined, the global banking system has become exponentially more important and necessarily more complicated. Regional banking hubs serve a more crucial role now than ever before, which makes the recent trend of cavalierly labeling countries “the next Cyprus” dangerous to the system as a whole.

The most recent banking sector to draw close scrutiny from economic observers is Slovenia. A recent report by the OECD warned of a “severe banking crisis, driven by excessive risk-taking, weak corporate governance of state-owned banks and insufficiently effective supervision tools.” Yields on government bonds have shot up, raising fears that the government will soon be unable to refinance its debt. Non-performing loans now make up 14 percent of Slovene banks’ portfolios, and the government has estimated a potential capital shortfall upwards of €1 billion.

To avoid a crisis Slovenia will need to sell its viable state-owned banks and allow those that are not viable to fail. This is no surprise to those who follow Slovenia – in fact, cleaning up its banking sector has been the number one priority for the government over the past year.

This is a reason for optimism. Speaking in Brussels, Slovenia’s new Prime Minister Alenka Bratusek reiterated the message that has been coming out of Ljubljana for months – that they would not in fact require an international rescue to shore up the teetering banking system.

A plan is already in place to create a “bad bank” for the troubled assets and install a new government agency to oversea the rapid privatization of many State owned assets in all sectors, including banking, energy, tourism, and transportation.  All that Slovenia needs now is the political will for its fiercely divided political parties to come together and move the plan forward.  If the political parties do come together, Prime Minister Bratusek believes most of the financial sector restructuring could be done by June of this year, with the privatizations happening quickly afterwards.

While Slovenia certainly has problems in its banking sector that need to be addressed, it is clearly not the next Cyprus. In fact, comparing any country to Cyprus, no matter how troubled their banking sector, is unfair. In Cyprus, bank assets were above 700 percent of GDP. In Slovenia, that number is a mere 1.4 percent.  Cypriot banks were over-invested in bad Greek bonds and supported businesses crippled by the economic situations in Greece and Italy. A history of poor regulation and political interference created a bloated sector that became too unruly for the Cypriot government to reign in once they realized the scope of the problem. 

Instead of making clumsy arguments about which banking capital will fail next, international policy wonks would be better served spending intellectual capital on how we can better regulate the globally interconnected banking sector to prevent the kind of vulnerabilities that led to the Cypriot crisis in the first place.  These solutions need to cross borders and include both small and large banks.  Ideally, the upcoming IMF spring meetings will be a good place to start this discussion in earnest.