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Blaming Europe’s Central Bank

Milos Bicanski | Getty Images News | Getty Images

There are certainly plenty of people who could be blamed for the economic crisis in Cyprus that caused worldwide anxiety last month. The potential culprits include Cypriot bankers who bet too heavily on Greece and a communist-led government that dithered as the losses piled up.

But increasingly, people on the financially stricken island nation are focusing their anger on another institution, one that is more accustomed to praise for its handling of the euro zone crisis: the European Central Bank.

Throughout much of the euro zone's financial crisis, the bank has faced criticism for not doing enough — not printing enough money or not buying enough bonds or not cutting interest rates fast enough. In Cyprus, though, the bank is accused of doing too much.

When the bank's governing council meets on Thursday, the hopes of recessionary Europe are pinned to its doing something to stimulate the regional economy — even if that is only the largely symbolic step of reducing its already historically low benchmark interest rate a quarter-percentage point, to 0.5 percent.

Some hold out hope that the bank and Mario Draghi, its leader, might soon take even bolder stimulus steps — although just what remains unclear.

In coming months and years, the euro zone plan is for the central bank to play an even more central role in overseeing European banks — acting as the master supervisor and, eventually, wielding the rule book by which failing banks would be banished from the field.

All of which is why complaints from Cyprus, the latest euro zone country to sustain a banking collapse, sound like either a startling indictment or a sore loser's excuse, depending on one's point of view.

"The big question is, did the E.C.B. help Cyprus or did it make things worse?" asked Nicholas Papadopoulos, chairman of the Committee on Financial and Budgetary Affairs in the Cyprus Parliament. Expressing a view widely shared in the country, he said, "My opinion is that it made things worse."

Critics in the Cypriot government that replaced the communists in February say the central bank broke its own rules by enabling Cyprus's central bank to keep the country's second-largest lender, Laiki Bank, on life support long after it was insolvent. That made the nation's banking collapse worse than it might have been otherwise, critics say.

The new Cypriot president has recently exchanged harshly worded letters with Mr. Draghi. But even as Cyprus levels its criticisms, much of Europe still wants the European Central Bank to ride to the rescue.

Central bank officials declined to comment in detail for this article, but they said that the Central Bank of Cyprus had taken the lead on crisis measures.

The European Central Bank's defenders say it is unfair to blame it for a larger policy blunder by European political leaders.

"The big mistake was not forcing negotiations in 2012 when it was obvious Cyprus was in trouble," said Nicolas Véron, a senior fellow at Bruegel, a research organization in Brussels. "But I wouldn't single out the E.C.B. It's really a collective failure of European institutions."

Still, the suggestion by a euro zone member, even crippled Cyprus, that the central bank committed serious policy missteps illustrates the hazards lurking as the bank heads further outside the realm of conventional monetary policy in hopes of keeping the euro zone intact.

As Cyprus demonstrates, the European Central Bank risks being sucked into the quagmire of local politics by measures intended to help struggling banks and prevent financial shocks. The hazard of such political entanglements, and the potential to make mistakes, might only grow as the bank begins assuming control of supervising euro zone banks in July.

Cypriot critics say the central bank acted as an enabler by acquiescing as the Central Bank of Cyprus provided low-cost financing to keep Laiki Bank afloat long after it should have been left to fail. The delay in dealing with problems at Laiki raised the cost of the bailout for taxpayers in Cyprus and the large depositors who will bear much of the cost, critics in the government say.

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The testy exchange of letters this month between the president of Cyprus, Nicos Anastasiades, and Mr. Draghi illustrates how easy it is for the central bank to be drawn into the infighting of national politics.

Mr. Draghi wrote to the government in Nicosia expressing concern about what he perceived as an attempt to remove the governor of the Central Bank of Cyprus, Panicos O. Demetriades — who in that capacity is a member of the European Central Bank's governing council.

Mr. Anastasiades, with obvious annoyance, implied in his reply that the European Central Bank had been complicit in an effort by Mr. Demetriades to delay a painful cleanup of Cyprus banks until after elections in February. Mr. Demetriades was appointed to the central bank post in 2012 by the previous president, Demetris Christofias, a communist whose party failed to retain power in the February vote.

Mr. Demetriades denied political motives in taking a deliberate approach to the crisis, saying through a spokesman that he merely followed the recommendation of European Union officials. If Laiki had been denied emergency central bank cash, "there would have been a disorderly default," Mr. Demetriades's spokesman said in an e-mailed statement. "This would have resulted in losses for both insured and uninsured depositors as well as contagion to other banks."

The controversy in Cyprus has also focused attention on a measure that the European Central Bank, under Mr. Draghi, has adopted as a crisis response, known as emergency liquidity assistance. The assistance provides emergency cash to banks in the euro zone that no longer have enough collateral to borrow money under normal terms from the central bank.

Analysts point out that the central bank has continually eased the terms for euro zone banks to borrow money at the rock-bottom official interest rate. It has, for example, also allowed the emergency liquidity to flow to Greek banks that were clearly in deep trouble.

"The concept of an 'insolvent' bank has been very fuzzy during the crisis," said Dimitris Drakopoulos, an economist at Nomura.

The European Central Bank argues that local central banks are responsible for deciding which banks are solvent or not and which are eligible for the assistance.

"We acted exactly within our mandate," Mr. Draghi said at a news conference on April 4. "We would have been acting politically if we had not done this."

Contact Europe: Economy

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