Sigrún Davíðsdóttir's Icelog

A small island, with a banking sector eight times its GDP, weak supervision, foreign money flowing in and some Russian connections. Iceland or Cyprus? Both.

With Cyprus now struggling to finalise bailout terms it is interesting to reflect on how similar the two islands are. In early October 2008, as the Icelandic banks were crashing, the Governor of the Icelandic Central Bank David Oddsson (leader of the conservatives 1991-2005, prime minister 1991-2004, CBI Governor 2005-2009, now editor or Morgunbladid) stunned the nation and the international community by announcing that Iceland did not need to turn to the IMF – Russia was willing to lend Iceland, apparently enough to pull the country out of financial quagmire.

Interestingly, this loan never materialised nor was it clear how or why the offer was made. Apparently the Russian ambassador did mediate the offer but then did not have the backing in Kremlin he either had understood or misunderstood he had. There is no lack of rumours as to why Kremlin might have been interested in bailing out the Icelandic government and who stood behind this. It is only safe to assume that the offer is unlikely to have been a fabrication of the staunchly conservative Oddsson but does indeed indicate some Russian interests in the Icelandic banks.

With Cyprus, Russian money flow and it is clear that there are huge Russian interests at stake. The Russian interests materialised in December 2011 when Russia lent Cyprus €2.5bn, maturing in 2016. Until last autumn, Cyprus seemed to hope for further €5bn from Russia but it now seems clear – at least for the time being – that more is not forthcoming from that part of the world.

The island has, through close contacts for many decades, been the chosen port into Europe for Russian money – also the money rising from dodgy privatisation deals and the oligarchs. Among those who made use of Cypriot money route are Bjorgolfur Thor Bjorgolfsson and his father Bjorgolfur Gudmundsson, who used money made in Russia in the ‘90s to buy Landsbanki; father and son have had companies registered in Cyprus.

It is clear that Cypriot supervision of the financial sector was more than lacking when it comes to supervising the flow of money from Russia and elsewhere. It seems fair to assume that there is money in Cypriot companies whose beneficial owners are unknown and money in Cypriot banks untested by the “know your customer” rule.

The key programme objective number 1, according to the Memorandum of Understanding is:

to restore the soundness of the Cypriot banking sector by thoroughly restructuring, resolving and downsizing financial institutions, strengthening of supervision, addressing expected capital shortfall and improving liquidity management;

But there is nothing specific on how this should be done, what is the target and how this will be verified. And there is nothing about the corruption thought to hover over the Cypriot banks, enabling the flow of dirty money into the tiny island economy. After all, why do funds float to countries like Cyprus – and for that matter Luxembourg – if not to do something that cannot be achieved in the more mature economies of Europe (though it is an uncomfortable thought why rich Russians are now so prominent in London)?

I have earlier stressed the correlation between the Eurozone crisis and corruption. Cyprus fits the case. It is an uncomfortable thought that the European Union might – yet again – close its eyes to corruption and deal with the Cypriot banks as if they were all about cricket and fair play.

Fortunately, most articles on the Cyprus bailout mention the Russian money, lastly articles in NYTimes, by Thomas Landon and James Kanter, who quotes Olli Rehn saying that a precondition for aid is that Cyprus needs to adopt “new laws against money laundering.”

If the EU insists on something more than just constructing some Potemkin villages, a bailout will hardly happen any time soon. Even after the next presidential election in February – a term now often mentioned – seems too soon. The euro was put in precarious conditions when EU postponed for two years to deal properly with Greece. Cyprus, with a GDP of around €20bn, is a much smaller problem and postponing a bailout there will hardly have Greek-portioned consequences.

Corrupt money is not just about ethics and morale but about the lethal effect of corrupt money management. If nothing is done now regarding the Cypriot banks, it is yet another victory for evil forces, which ultimately distort competition and crowd out healthy companies.

*An earlier Icelog on Cyprus is here, with links to documents such as the Memorandum of Understanding and IMF data on Cyprus – and here is an earlier blog, linked to an article of mine on Le Monde Diplomatique English website, on the correlation between crisis and corruption.

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