Introduction: Banking failure - A case study of Laiki Bank

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Introduction

This first chapter is a prologue of ‘An empirical study of banking failure: A case study of Laiki Bank’. It provides the background of the study; it presents the purpose, the problem, and relevant contextual information. At the end of it, it outlines the structure of the dissertation.

Background

Nowadays, the term ‘bank collapse’ or ‘bank failure’ is commonly used and it concerns everybody. You do not need to be extremely rich to start worrying about the money you have at a savings account in a bank or the money you have invested in bonds and securities. Due to the recent events that happened in Cyprus, there is proof that even people with low-savings account have suffered by losing their money, through a direct or an indirect way. The last decade, media have been talking about the phenomenon of ‘bank collapse’ and its disastrous results in the whole world. The term ‘bank failure’ can be, defined in different ways but the most usually accepted one is by saying that a financial institution, also known as bank, it is no longer solvent to meet its credit obligations. The bank might not have enough liquidity to pay back its depositors, to pay out its creditors or give out loans. The result that a bank failure can cause, it might be very limited as to affect only the bank’s activities and its customers, nevertheless, it can result to disastrous costs, not only to the clients of the particular bank, but also to a whole nation and its banking system. The Federal Deposit Insurance Corporation (FDIC) is a bank supervision corporation, which has been, created in 1933 after the 1920s continuing failing banks system in USA. FDIC is now one of the most valid websites where you can get information about the number of banks that have failed, and it keeps its records up to date. The phenomenon of bank’s insolvency has started to be increasingly common in 1970. The great depression though has happened few years ago, which raised a massive number of issues and problems, like the closure of a large number of banks as well as the suffered of large losses of companies and individuals. The particular crisis was not, eliminated into one nation but it has been, expanded and affected various countries. The effect on different countries was even worse as it reduced the GDP, the value of currency has fallen, the educationally development of countries etc. Even now, you are still able to recognise the consequences from the great depression since 2008.

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The first bank collapse in Cyprus happened this year. Laiki bank, also known as Cyprus Popular Bank, was the particular bank that failed and affected other banks of the island. Due to this collapse, all Cyprus people had, suffered and still suffer, as there was a serious wound on Cyprus banking system. Laiki was the second biggest bank in the whole island and it has been, first called as a limited company in Cyprus, during 1901. Laiki started its activities on the banking sector but during 1970s and 1980s, it extended its activities to investments and consulting services. The bank was getting bigger and stronger, acquiring branches in other countries. One of the main branches was holding, was in Greece. In 2006, Marfin Investment Group, which was, managed by Andreas Vgenopoulos, bought shares in Laiki Bank. That merger found Laiki under a new re-arranged greek management and it had been renamed to ‘Marfin Laiki Bank’. The bank continued its growing career and in 2010, it became the biggest bank in Cyprus, having a capital more than €43 billion, and at the same time, it was the fifth biggest bank in Greece. Its growth was so remarkable and the famous magazine of Financial Times ‘The Banker’ chose Marfin Laiki Bank as the Bank of the Year for Cyprus. Nevertheless, the successful path came into an end when the new management of the bank decided to invest a massive amount of money in Greek bonds, in 2009. No matter the bad economic situation of Greece due to the crisis, Marfin Laiki Bank spent money on their bonds, expecting bigger returns. The interest rate for the Greek bonds market was very attractive and the Cypriot bank decided to take that expansion. As the time went by, the decision of investing in those bonds appeared to be a disaster as Europe agreed to restructure Greek sovereign bonds. At that time, the Cypriot bank suffered losses of €2.3 billion by holding investments of €3.1 billion in Greek bonds. The Cyprus government could not let its second biggest bank to default so it bailed out Laiki with €1.8 billion. Government’s next step was to set up its own directors in order to save the bank. The collapse of Laiki could affect the whole Cyprus banking system and it was an emergency for the government to save it. However, following reports and rumours on a possible levy on accounts a small number of Laikis bank depositors started exit the bank. Most of its customers were loyal and trusted people in that bank, so they kept their money in Laiki. The only way for Laiki to raise money and starting breathing again, was to sell its assets. For their bad luck and by extension, bad luck for the people holding accounts in Cyprus, Laiki sold its assets at as 15% discount, which did not help to raise the necessary fund to even, stand on its knees. The bank was still in trouble. The Cyprus government could not, help anymore and when it has been, asked from the European Central Bank to allow Laiki to draw down €9 billion of liquidity assistance, it refused. Cyprus economic situation was so serious due to the fact, that it could cause many problems not only in the island particularly but also to the rest of the countries in Eurozone. At that time, Eurogroup and Troika have been, asked to involve in the economic situation and find a solution. For a week or even more, all banks in Cyprus were, closed. People could not get their money and they did not know what it could happened to their accounts. The whole banking system had freeze and people were doing strikes, complaining and shouting in the media about the situation. The facts that followed were even worse for people holding deposits accounts in Cyprus as they have all been, affected in a way. Eurogroup and Troika concluded their decisions for Laiki as to bail-in in depositors over €1000.000 so it could cover its losses. It sounds like it did not affect people who owned lower than that amount in the bank or people from other banks, but in an indirect way that situation created problems to all people in Cyprus and people who are non-resident in Cyprus but holds accounts there.

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The recent findings of Laikis collapse in Cyprus proved that a failure of a bank could cause disastrous problems. In 2008, ‘the Economist’ (cited in Imad A. Moosa, p.12, 2010) has stated ‘if banks suffer, we all suffer. Nevertheless its bad consequences, and not talking particulary about the Cypriot bank, there are people like Lindgren et al who believe that the failure of a bank is not necessarily bad. They support their argument by saying that when a particular weak bank collapse and be removed from the banking system of a country, it enhances the maintenance of keeping a banking system strong (1996, 114-115, cited in Benton E. Gup, p.11, 1998).

Purpose of the study

For long time, Laikis failure and by extension the default of Cyprus banking system was in headlines around the world and it is still in Cyprus. It is the subject that I found the more interesting for me at this time to look for and find more information about what really happened, who do people blame, why and get a better understanding in general of the real facts for the bank collapse. The fact that people lost massive amounts of money, the collapse of the banking system in Cyprus and in general the financial instability of the country, makes it even more interesting for me.

Aim:

Examine the key factors that resulted to the failure of Laiki (Cyprus Popular Bank) Ltd.

Questions:

What are the main reasons that lead to a bank collapse?

What are the key factors that resulted in the failure of Laiki Bank?

Objectives:

  1. To consider the main factors that led to a bank collapse
  2. To identify the factors that resulted in the collapse of Laiki Bank
  3. To recommend how the Cyprus banking system can prevent or eliminate bank failures

Outline of the dissertation

This study is, divided into five main chapters, introduction, and review of literature, methodology, research, and analysis of results and conclusion and recommendations. The first chapter of the study is the prologue where it explains the background of the study and the purpose of writing it with an outline of the thesis at the end of it. The following chapter is is the review of literature, which consists theories that are relevant to the study research. The third part explains the methodology that have been followed to produce the the dissertation, the challenges that have been faced and the philosophy of the study. At the forth chapter of the study there is an analysis of the results that have been collected based on Laikis collapse. The last chapter provide and analyse the conclusion of the study. It also gives recommendations and suggestions for further research.