EC’s Cyprus ‘failure’ undermined Eurozone central bank independence – Demetriades

The failure by the European Commission (EC) to take enforcement action against the Cypriot authorities in 2013 for allegedly violating Central Bank of Cyprus (CBC) independence has created a “systemic” risk to the Eurosystem, according to Panicos Demetriades.

Demetriades, governor of the CBC from 2012-2014, claims in a Central Banking journal interview that the decision by former EC president José Manuel Barroso not to take legal action against Cyprus in 2013 – despite apparently receiving a strongly worded letter from European Central Bank president Mario Draghi advising such an approach in November 2013 – has damaged the reputation of the ECB and emboldened other Eurozone governments to circumvent central bank independence rules that are meant to be protected by EU treaty.

Draghi was forced to intervene after the authorities in Nicosia took a series of actions over a period of many months in 2013 that Demetriades says were designed to undermine his authority while in office. This included removing a respected Cypriot deputy governor, diminishing the central bank’s power as a resolution body (including appointing directors of resolved banks) and re-designating the CBC’s board of directors in a manner that weakened the governor’s ability to run the central bank.

Demetriades said that instead of taking formal action, Barosso – who created an ethics debate when he took a senior role at Goldman Sachs shortly after leaving public office – just had “a quiet word” with Cyprus president Nicos Anastasiades, who, like Barosso, is part of the European People’s Party. Barosso did not reply to an emailed request seeking comment on the allegations made in this article.

Demetriades said one of the reasons that he managed to stay on in office in 2013 despite what he claims were repeated government attempts to remove him was “due to the ECB”, where he was also a member of the governing council. Members of the ECB’s governing council are protected by the Statute of the European System of Central Banks (ESCB) and the European Central Bank, and the Treaty on the Functioning of the EU. 

“Neither the ECB nor the national central banks, nor any member of their decision-making bodies, are allowed to seek or take instructions from EU institutions or bodies, from any government of an EU member state or from any other body,” the ECB states on its website. “EU institutions and bodies and the governments of the member states must respect this principle and not seek to influence the members of the decision-making bodies of the ECB (Article 130 of the Treaty).”

ECB initially listened to then ignored

Demetriades said that after “Draghi sent a letter to parliament and to the president” earlier in 2013 informing them that they had “to respect the independence of the central bank” and reminding them that there “has to be a process” for governor removal “that is subject to a European court agreement”, the Cypriot authorities “backed off… for a while”.

But the government then “came back with a vengeance”, he claims.

Lawmakers in Nicosia decided to change the Cyprus central banking law to introduce two new “executive directors” to the CBC board that Demetriades said undermined his authority as governor. This elicited another response by Draghi in the form of a “very strongly worded” legal opinion, according to Demetriades. 

“The ECB considers that the draft law is unclear with regard to the nature of the executive directors’ powers and the division of competences between the board and the governor,” Draghi said in the legal opinion sent on June 5, 2013. “The governor should not be influenced by an executive director or the members of the board in the performance of ESCB-related tasks which, under national law, are assigned exclusively to the governor.”

“There was the expectation in the ECB and the governing council that people would read that legal opinion and say: ‘Wow, we really need to be cautious with that’,” said Demetriades. “No, they didn’t – they just ignored it!”

The episode in Cyprus highlighted that “the ECB has no legal power to do anything – it’s the EC that should protect the independence of the central bank”, said Demtriades. But the EC’s response after Draghi had urged action was “completely ineffective”, the former CBC governor says: “The ECB was asking for legal action, it wasn’t asking for a quiet word.” The ECB did not immediately respond to an email seeking responses to the allegations made in this article. 

Lasting damage for the Eurosystem

Demetriades believes the Cyprus debacle has had a lasting negative impact on the credibility of the ECB’s opinions with other governments.

“At the end of the day, [the ECB] published something in which infringements of independence are named and shamed,” says Demetriades. “But we have to recognise with politicians in this day and age – generally internationally, and with populist politicians in particular – they just shrug their shoulders and get on with it.”

Demetriades also believes the EC’s inability to draw a line under what was going on in Cyprus has emboldened others to such an extent that this is having a negative impact on central bank independence, creating a systemic problem for the Eurosystem.  

“People may have thought it was just Cyprus, it won’t happen anywhere else. But, unfortunately, it has happened,” Demetriades said. Demetriades, now a professor of financial economics at the University of Leicester, points to what he believes are related problems in Slovenia and Latvia.

“When the Slovenian central bank governor had to take action on a number of banks… he found himself in all kinds of trouble… and [facing] police investigations, etc,” says Demetriades. “While I don’t know enough about the details… I do know that in the end he had to also step down.”

In Latvia, meanwhile “governor Ilmārs Rimšēvičs effectively was removed from office without due process”, the former CBC governor says. “Although it’s a very different case – there are allegations of corruption there that I don’t know if they are true or not – nevertheless, what we can see is that there has been no due process. One judge decided that Rimšēvičs couldn’t go back to his job, and effectively, he hasn’t been back to his job for several months, and this could be until the end of his term,” Demetriades adds.

Given his experiences Demetriades is sceptical about the future viability of central bank independence in the Eurozone – something that was viewed as of central importance by the architects of the Monetary Union: “I don’t think that the current levels of independence offer enough protection, even in Europe where the monetary union is at stake.”