John Hourican, Bank of Cyprus’ former CEO, explains the Cypriot economic renaissance, the re-engagement of investors with the island’s largest bank, and the importance of continuing to take advantage of the reform opportunities that the 2013 banking crisis catalyzed.
In the context of the Greek crisis, Cyprus has become quite a role model for recovery given its willingness to undergo tough structural reform and an unprecedented bail in to ensure that they are on the right track at the earliest time. You came to Cyprus in the immediate aftermath of the turmoil, what has been your perspective on the recovery thus far?
Cyprus had a massive cardiac arrest in March 2013, and the one thing that the banking system requires was removed from it – confidence. It suffered the indignity of capital controls and the destruction of wealth of the depositors being bailed into the equity of the banking system. That was, in my opinion, the most destructive event to the country and to the confidence of the nation in terms of its ability to trust its savings and wealth preservation system.
The unintended positive consequences of what happened in March 2013, was that the banks in Cyprus were entirely ring fenced from its linguistic and cultural motherland Greece. Now, even if it was intended to ring fence Greece away from Cyprus, it actually did the opposite. There is a fundamental difference between Cyprus and Greece: in Cyprus, the government had the conviction to recover, and was willing to make hard and immediate choices. Cyprus had a fiscal legislative and reform agenda that actually was consistent with a desire to recover, rather than just talk about recovery.
The mechanisms that exist in Cyprus are more Anglo-Saxon than they are Mediterranean, in the sense that there is a tax collection system that works, a legal system based on British common law, and not some arcane way of dispensing legal prerogative. All of these things create the conditions for a more lubricated and rapid recovery than some of our near neighbors.
However, even with these positives, Cyprus has been hampered by what I would call parliamentary chicanery. So for the government, as a non-parliamentary majority, to achieve what it has achieved, is quite a something. They have done a really good job of restoring Cyprus on the international market. Now, that’s not to say everything went well; the changes in laws around foreclosure for example, were delayed for a year, and that has delayed our recovery.
Now, are we recovered? No, we are not. Do we have the conditions for recovery? Yes we have. Are we beginning to run the risk of wasting the crisis? Yes. So I think we still need more legislative reform, welfare reform and labor law reform. We need a concerted plan for the country so that we can get the whole country behind a multi-year strategy of what we are going to try and do.
We need more fiscal incentives for entrepreneurs to bring FDI to the island. We raised a billion euros of equity for the banking system, which was the largest ever FDI into Cyprus since 1960 (6% of GDP). However, that is not enough, we need more. So when you don’t have the on-shore capabilities to find those funds, you need to attract a confident investor to Cyprus by incentivizing them.
What Cyprus has to recognize is that it is not just competing for capital in Cyprus, it’s competing for attention on the world stage. It has to be compelling to put your dollars to work here, so you have to understand how the law works, you have to understand that the employees behave in a certain way, that the governance policy and approach is a certain way, and you have to understand that the environment is consistently stable through your investment horizon. All of those things matter as you disaggregate the economy into its components and as you set the tone for tax and labor.
When I look at Cyprus today, I see an economy that is not yet fully using its productive resources. You have a tourist season that is too short; you have a tourist arrival number that is too small. You compare it to Crete, which has a million and a half more tourists than Cyprus a year, you compare it to Mallorca, where the tourist season is legitimately short because of the climate, they have 11 million visitors, and Cyprus has 2 million. There is, in my view, an absolute underutilization of that sector.
There are other sectors: we have the potential of a hydrocarbon downstream business; we have the potential to reduce the energy cost of the island and to create actually productive business. We also have the casino that is to be built, which will change the nature of tourism. There is an emerging and high quality education sector and an emerging and potentially large convalescence in the medical industry. Finally we have the services industry and the banking sector that actually has a very high level of education and significant potential. We need to create an environment where the regulation here has little red tape. I would say that we still have far too much red tape to accelerate the pace of change.
If Cyprus is to move forward, they need to take full advantage of the structural reforms, and with the troika still conducting regular reviews of Cyprus, where do you see the main challenges in the finance sector?
If you look at what we have achieved, we have worked with the government to lift domestic and international capital controls early, we have got deposits growing again and we have been deleveraging our balance sheet by 6% of GDP every quarter, which is enormous.
To support this deleveraging we have been selling off overseas operations and compressing loans and deposits, doing all of the things you naturally do in a recession environment. We have combined the two largest banks on the island, and we have shared 35% of the cost, 25% of the staff, combined the IT platform, and taken 70 of the 200 branches. Basically, we have been busy, busy doing normal M&A corporate finance stuff, which if you do it as a job, you get used to doing it, but it feels like a shock to any institution.
The biggest thing to create confidence was to go out and bring in new international investors who validated the Cyprus banking recovery story and therefore validated the Cyprus story itself. Wilbur Ross describes the banking system in Cyprus as a warrant on the economy, which means that if you believe Cyprus will recover, the best place for you to play that recovery is through the banking stock, because it itself is levered and it is a proxy for the economy.
As a Cyprus ambassador speaking around the world, I have been saying that, we are not Greece, and in fact, it’s a year to the day that we were out on our road show raising equity. I said to people, if I were investing, I would go short Greece, long Cyprus. Cyprus is perfectly capable of being competitive and nimble, so when you look at Cyprus and its debt to GDP and you look at how you are actually going to fix that, and create some wealth for the future, ignoring the hydrocarbon discoveries, you can actually grow Cyprus out of its metric issues. So if you look at the debt to GDP, it was meant to be at 126%, now it’s 107%, and it can be much lower, because if you look at the GDP per capita of Cyprus, and you look at what Cyprus has to offer, the GDP is too low. This economy is too small for the capability in it, so we need to set an ambition that really is ambitious. There is no reason why Cyprus can’t double its GDP.
There are a lot of things that Cyprus is just not utilizing, and that is my frustration as a banker wanting to support the growth in the economy. I am watching a wasting of the natural resources of a country and not just its hydrocarbon, but its intellect, human capital, connectivity, law, time zone, its proximity to disturbed nations. All of these things create opportunities for Cyprus and it needs to be monetized.
Bank of Cyprus has brought in people such as Josef Ackermann and Wilbur Ross, in many ways to ensure that the culture of Bank of Cyprus is changed as well as ensuring confidence in the bank. Where are you focusing to get that confidence back in the banking system?
Confidence is built through action, not through rhetoric. Rhetoric creates mood, and confidence is created through the actions and the institutions and people around it. We set a very deliberate strategy where we effectively declared war on all fronts at the same time, and I put pace into every component of that strategy. This meant we had to do, and then we could talk. So when we announce things, and if you look back on our press releases that we did, not one of them says, we are going to do something, it says, we have done it. Some of how you run a company and change the culture is really simple; it’s the nature of how you approach a problem.
I see this banking crisis and the country’s problems as a Lego set, lots of little things. One thing on its own doesn’t make much sense, but the collective will create something strong, a basis from which we can build prosperity. To do this in our bank we sold our Ukraine business, sold our largest exposure of NPLs in Serbia, and sold off Romanian assets. We have been trying to build confidence and become really important to Cyprus again, to reverse what I would describe as the international managerial tourism of the past, and to return to what we can be good at and should be good at, because the basics of business are about being dominant in things you can be good at, in places you know.
This banking sector had lent badly into bad law. If you lend badly, that’s a sin, into bad law, that’s a multiple sin. So what we had to do was encourage the law change, in order to position the bank to be safer so that we could then talk to our investors, and also our depositors and ensure they understand that we are doing what we can to repair your bank and we believe that this bank can recover to some value.
There are also the inconvenient truths of this crisis, which are that the bond holders and equity holders of the past have lost their money; it’s gone and will not be recovered. This constant need to give hope to people that have no hope is a problem in Cyprus. We need to be more honest with our population, their money is gone, but if they get behind the bank, the economy, and their kids, then we will build a country that we can be proud of again.
Do you think that the government is succeeding in getting public opinion behind that vision, specifically in your sector?
No, I think this is a really slow recovery. In Cyprus, one of the things I hear a lot when I’m out talking to customers is, “we are glad that you are here and that you are not Cypriot.” Over time, there has been a lack of trust, of themselves and the hierarchy and social structures in Cyprus. Since I came to Cyprus as an Irishman who trained in London, I wasn’t at all connected and refused to be connected to this superstructure that is Cyprus. Over time, that has worked well because they recognize I cannot be influenced in perhaps the way the island nation used to do over decades of the past. I have used that very deliberately to the advantage of the bank, because I am saying we are going to do everything properly, we will treat everyone in the same way. There will be no favors done for anyone and that works well, because people begin to believe and trust that it is the right way to behave.
We used to be in love with collateral in this bank. We lent against the value of the thing, even though collateral is what you look at only after you have exhausted the cash flow; it’s not what you look at to lend.
Show me the cash, show me how you will repay me, then show me if you can repay me, or whether I can recover through the foreclosure regimes. That was double amplified as a sin, because the foreclosure regime itself wasn’t strong enough and was entirely in favor of the borrower and not the lender. That’s changing now; it’s very important to create the moral hazard for a functioning banking system in a recovering economy, because we can’t provide credit to an economy that doesn’t have the legal basis on which we can recover in a rapid way.
Securitization laws have been passed, the ability to sell loans, the basis of how you foreclose and how your receivers can act and all those things are essential to the recovery. It’s more essential than I think even some of our politicians realize, because it creates the conditions for an international business environment. That, and red tape reduction and fiscal reform and labor law reform are the absolute keys to rapid recovery.
You have been recognized quite recently as Euromoney’s “Global Banker of the Year” and also Bank of Cyprus itself has been awarded. You have been recognized for your remarkable achievements in a short space of time, but you are leaving by the end of August. Reflecting on your time with Bank of Cyprus, where do you see the main achievements?
I’m very pleased with what we have been able to do in Cyprus, but it is about unlocking the potential in the team you find. All the people here are people I found, I only brought one person with me. Sometimes, how you run a business and how you set an agenda creates the energy and stimulus for the company to succeed or fail. I feel like I have been able to create some spark that has allowed others’ excellence to come out, and when you receive an award, you receive it on behalf of your team. You don’t receive it for yourself, however sometimes it embarrassingly manifests itself in a personal award.
It is pleasing to say that we have been working with the supernational agencies, the government, and the parliament to actually make a difference. Could we have gone faster? I think if the legislative agenda had been one pace faster, we would be making much more progress on our non-performing loans. Other than that, I think we have performed ahead of everything we thought we would. It’s mostly about setting an ambition beyond what everyone thought we could achieve, and then overachieving it. Particularly in the banking sector, you don’t get the luxury of time; you only get the opportunity at a point in time to repair. Confidence is in a leveraged environment, so if you don’t restore it, you will just die. That is what worried me most about Bank of Cyprus, the confidence was so badly interrupted that restoring it was going to be quite a challenge and I wasn’t sure we could, but it has been really pleasing to see people start to reengage with the bank and recognize what we do as good.
This bank has been recapitalized twice in the last two years. First time with depositors’ money, although I quite quickly realized that wasn’t enough. We went and raised another billion in capital to take us to 15% common equity, and we passed the ECB stress test with a slim margin. So the bank is appropriately capitalized for the risk it runs, but it is not excessively capitalized. There is still a lot of work to do, to confirm that this country and this bank are back. But I sit here two years into the role and think the team has done a pretty good job. We could not have done it without that symbiotic cooperation with troika, the government, the regulators, the team and really being forcefully programmatic in our reform agenda.
In 2013, as you mentioned, significant damage was done to investor confidence and the Cyprus brand. As the country recovers, the government, the private sector, and the country are rebuilding that brand. From your perspective, as a relative outsider, how should Cyprus be branded?
The important thing about branding is that you don’t rename something as a new brand. You have to actually change the nature of what it is, what constitutes the brand. I think the key thing about Cyprus is that it is a small, open economy, the most eastern country in the European Union and I would regard it as an eastern gateway to the EU and all that has to offer. Cyprus differentiates itself from the rest of the Mediterranean belt, because it should operate very similarly to the westernmost nations in Europe because it has similar law, similar language and hopefully similar bureaucracy supported by a highly attractive tax and fiscal regime, and a highly educated and available workforce.
However Cyprus hasn’t yet put its full resources to use. And that, to me, is the challenge for chapter two. Let’s get this economy to become more meaningful and bigger, let’s stop the lazy reliance on industries that should be more productive, and geographies that perhaps should be a smaller percentage of the economy. For the future generations, Cyprus needs to get excited about its future; they need to understand that they have built the foundations for prosperity, through austerity.