In 2002, the late mortgage payments recorded the highest value in the recent history of Europe. The first sign of a financial crisis appeared in the EU zone alarmed the policy makers and called for an urgent European crisis management framework. Nevertheless even by the end of year 2009 formulating of such an effective crisis management framework had been inadequately progressed. The currently unfolding banking crisis in Cyprus can be considered as the latest stage of EU zone banking crisis.
Fragility of the Cypriot Banking System: Situation before the Bailout
The following chapter presents existing literature regarding the problems of banking system in Cyprus. Gunsel, 2007, defined bank failure as “a situation in which banks were closed because of financial difficulties.” Accordingly during the period of 1999-2002 the rate of banking failure in North Cyprus had been as high as 32.4 percentage proportion of the total banks in the country. The number of total banks in North Cyprus declined from 37 in 1999 to 25 towards end of 2002. Example: the Cyprus Credit Bank Ltd., Cyprus Liberal Bank Ltd., Everest Bank Ltd., Kibris Yurtbank Ltd. and Cyprus Finance Bank Ltd., were closed due to bankruptcy in 2001. Moreover, the Cyprus Commercial Bank Ltd., Yasa Bank Ltd., Tilmo Bank Ltd., Asia Bank Ltd., and Cyprus Industrial Bank Ltd. were taken over by the Saving Deposit Insurance Fund (SDIF) of the country during the same time period. Estimated cost of banking failure in year 2000, amounted approximately 200 trillion TL, (almost 50 percentage proportion of the national GNP of previous year) in the Turkish Republic of Northern Cyprus. Banking sector comprised of 6.3 percentage proportion (568.4 million TL, in 1977 prices) of the country’s GDP in 1999. It steadily declined reaching 4.8 percentage proportion (416.1 million TL, in 1977 prices) by 2002. The global economic crisis is recognized as the leading cause of this deteriorating. In 1999 the banking sector provided employments to approximately 3.5 percentage proportion of the total working population in Northern Cyprus. Contribution of the financial for providing employments to the Cypriot economy severely dropped after closing of the banks. In 2002 only 2.6 percentage proportion of the country’s employments were provided by the financial institutions. Further, the other sectors in the economy showed slight recovery from the economic crisis towards the end of year 2002 however, financial sector remained unrecovered. The failure of the system was evident in the revoking of banks from operation and taking over by other banks (Safakli, 2003). Failure of the Banking System: Root Causes Gunsel, 2007, revealed that inadequate capital, poor asset quality, high interest expenses, low profitability, low liquidity and small asset size are significant variables that determine the likelihood of bank failure in North Cyprus. Black, 1995, revealed that poor risk analysis by the banks especially during the expansion phase of the business cycle can trigger banking crises. Inefficient internal credit control systems may fail to monitor the amount and quality of bank loans. Hoenig, 1999, revealed that connected lending or lending to the companies or development projects connected with the bank owners or managers despite their limited profitability as a major cause of bankruptcy in the region. Banks which lack capital assets are more susceptible to the shock of an economic downturn. According to the Bank for International Settlements (BIS) a minimum of 8 percentage proportion capital to risk weighted assets ratio is required for all international banks. High leverage can affect