Financial crises in Iceland, Ireland and Cyprus have in common, besides their geography, a hypertrophied banking system at the outbreak of the crisis: seven times the GDP in Ireland and Cyprus, ten times for Iceland compared to three times in Spain, which is approximately the EU average.
This bank growth based on foreign deposits (somewhat lower in Ireland), prevented, during the financial crisis, the government to have the resources to take on debt. But the solutions adopted were very different.
In Iceland there was discrimination against foreign depositors, leading to complaints from British and Dutch authorities. The crisis was deep, with a strong devaluation, debt restructuring and establishing control of capital, which is in force even now, four years later.
The court EFTA (European Free Trade Association) recently ruled in favor of Iceland in the dispute that it has with the Netherlands and the UK, although it is not clear to what extent this verdict was made according to the case law.
In Ireland the decision was to extend the guarantee not only for all deposits, but also to bond holders. The state was charged with the bank debt, which questioned the sustainability of public debt.
In Cyprus, there was a huge slowness in crisis management and communication, but eventually the solution adopted seemed to be more consistent with the banking crisis resolution as discussed in Brussels. After the hesitating initially, the lenders were safeguarded and the guaranteed deposits were protected. However, establishing a capital control, if it’s not strictly temporary, it’s risky for the monetary union.
There is a need of clear rules in solving the banking crisis in Europe to avoid using taxpayers’ money, ensure maximum protection of deposits, allow the proper functioning of financial markets and prevent healthy banks to be pulled down by banks with problems.
A coherent framework for solving the financial problems is critical to advance to a banking union, which would break the link between bank risk and sovereign risk, making possible for the recapitalization mechanism to operate whenever necessary.
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