Panicos Demetriades was Governor of the Central Bank of Cyprus from 2012 – 2014. Before and after his Governorship he was a Professor of Financial Economics at the University of Leicester. Diary of the euro crisis in Cyprus is his account of the crisis, apparently written after the event: it isn’t a diary in the usual sense of the word. It is very well written and extremely clear.

Professor Demetriades was appointed by the left-wing government of President Christofias, which was in office from 2008 - 2013. His predecessor, Athanasios Orphanides, formerly a well-known Federal Reserve economist, had been appointed in 2007 by the previous centre-right government of President Papadopoulos. This is relevant because Professor Orphanides has written his own account of the crisis (What happened in Cyprus?’, IMFS Working Paper Series no 79, Goethe University, Frankfurt-am-Main, 2014), which puts a different spin on events.

Cyprus, a member country of the euro area, endured a severe banking crisis in 2011 – 2013, in which the leading commercial banks were obliged to find new capital. Had they not done so, the European Central Bank would have cut off emergency liquidity assistance, and they would have failed, causing chaos and disruption, and the departure of Cyprus from the euro area. Demetriades blames the commercial banks and their friends in the government for causing the crisis; he also blames Orphanides for not restraining the banks’ expansion sufficiently strenuously: in 2011, private sector indebtedness had reached 286% of GDP. He largely exonerates the government’s fiscal policy.  Orphanides, for his part, blames fiscal policy, and largely exonerates the banks. So the causes of the crisis are disputed; predictably, the Governor chosen by the centre-right blames the government and the one chosen by the left blames the banks.

The problem that confronted Demetriades on the day of his appointment, 3rd May 2012, was the restructuring of Greek government debt, in which Cypriot banks had invested heavily and which caused them correspondingly heavy losses, equivalent to nearly a quarter of Cyprus’ annual GDP. Whatever view one takes about the other causes of the crisis in Cyprus, it is impossible not to regard the Cypriot banks’ large holdings of Greek government debt, and the decision of the Basel Committee on Banking Supervision to assign them a zero risk weight for the purpose of capital adequacy calculations, as recklessly irresponsible.

The main interest of the book, however, lies in its detailed account of events during the crisis. The Greek election held on 6th May 2012, three days after Demetriades’ appointment, was inconclusive. There was a serious risk that Greece would leave the euro area, and deposits were withdrawn from banks in Greece lest they be forcibly redenominated and devalued: euro banknotes were safer. Laiki Bank, which had branches in Greece, lost 10% of its deposits in two months. It urgently needed new capital but the Cyprus government was not sufficiently creditworthy to borrow in the bond market. Although Russia had lent Cyprus €2.5 billion in 2011, it proved unwilling to lend any more. Cyprus had no alternative to applying for official assistance from the IMF and the EU.

The German representative on the ECB executive board was curious and deeply suspicious about the large amount of Russian deposits in Cypriot banks, and more generally about the commercial relationships between Cyprus and Russia. Demetriades usefully explains the origins of the financial relationship between Cyprus and Russia. Suspicions about the Russian depositors, and reluctance to finance their bailing-out, appear to have been an important influence on the ECB.

The IMF estimated initially that the capital needs of the commercial banks were €13.5 billion, nearly 80% of Cyprus’ GDP. Later, the estimate was revised to €10 billion. Both estimates were hotly disputed. The IMF’s calculations showed that the Cypriot government could not afford to recapitalise the banks out of its own resources. It would be necessary to impose a ‘deposit levy’ – in other words, write down the value of deposits in Cypriot banks. The EU authorities did not distinguish themselves in the negotiations. Initially, the Eurogroup – representing the finance ministries of the Euro area countries – agreed on a deposit levy of 9.9% for deposits over €100,000 and 6.75% for deposits under €100,000.

They evidently forgot that deposits under €100,000 were protected by mandatory deposit insurance under EU law, and soon backed off. Shortly afterwards, the ECB threatened to end emergency liquidity assistance if a recapitalisation plan were not implemented within four days.

The eventual solution was to close Laiki Bank. It was split into a good bank and a bad bank. The bad bank was to be run down over time and the good bank was merged with Bank of Cyprus (a commercial bank, not the central bank). Deposits under €100,000 were transferred to Bank of Cyprus, but larger ones were frozen, alongside other creditors’ claims, pending resolution. The Bank of Cyprus was also put into resolution, and uninsured deposits over €100,000 were frozen until the bank was recapitalised. A loan of up to €10 billion was provided by the ‘troika’, not to be used for recapitalising Laiki or Bank of Cyprus; emergency liquidity assistance was continued; Cyprus remained in the euro area; and there were restrictions on daily withdrawals from bank accounts and a ban on premature withdrawals from time and savings accounts. Russian depositors lost a lot of money, and the Russian Prime Minister Medvedev commented that ‘In my view, the stealing of what has already been stolen continues in Cyprus’, hinting that the Russian deposits in Cyprus had been illegally placed.

Demetriades gives a vivid and fascinating account of the profound and extensive repercussions of the crisis within Cyprus, and of the fractious interaction between politics and finance. Anyone who believes that central banks can be independent should read it. So should anyone who is interested in the practical management of financial crises, and in the strange ways in which the euro area sometimes works. Not to mention anyone who is considering an invitation to become Governor of the Central Bank of Cyprus.