Economic rehabilitation programme and the existence of implicit deposit insurance in North Cyprus.

Abstract

Purpose--The purpose of this paper is to investigate the role of implicit deposit insurance in North Cyprus Banking Sector during the period 1984-2002.

Design/methodology/approach--A multivariate logit model is an empirical methodology that identifies the probability of bank failure. The model links the probability of banking problems to a set of bank-specific factors, macro-environment and structural weaknesses that may have exacerbated the internal troubles of the financial institutions.

Findings--The empirical findings suggest that in addition to the microeconomic variables, high credit expansion to private sector, implicit deposit insurance, existence of economic rehabilitation programmed, financial liberalization, weak regulation and supervision played an important role in the escalation of the 2000-2002 banking distress in North Cyprus.

Research limitations/implications--For further research, this paper may extend the time period and include other macroeconomic variables such as inflation, exchange pressure that may have a direct effect on bank failure in North Cyprus.

Practical implications--This paper presents a practical application of the deposit insurance policy as a main determinant of bank failure, which would help bank examiners, investors and regulators in their decisions to alert management in time, to prevent bank failure. The ability for early detection of any structural or financial weaknesses in the country will help to minimize financial costs of the island that brought about by financial instability.

Originality/value--Overall, the empirical results that are obtained by logit model analysis are quite robust. The logit regression results reveal that the predicted values, i.e. the potential risk levels for Mediterranean Bank was very high in this analysis. Towards 2005 Mediterranean Bank had to dose, which prove that the model is robust.

Keywords Cyprus, Banks, Business failures, Regulation, Insurance

Paper type Research paper

1. Introduction

This paper presents a practical application of the determinants of bank failure, which would help bank examiners, investors and regulators in their decisions to prevent bank failure. The ability for early detection of any structural or financial weaknesses in the country will help to minimize financial costs of the island that brought about by financial instability.

The North Cyprus economy has experienced two banking sector distress periods. The first took place in 1994 and the second took place between 2000 and 2002, which coincided with the deteriorating economic fundamentals in Turkey. During these periods there was a continuing devaluation of the Turkish Lira (TL), which resulted in a serious currency crisis. As there is a close monetary and economic link between Turkey and North Cyprus, as a consequence of the financial distress experienced in Turkey in 1994, banks in North Cyprus were also affected. In 1994, two banks (namely, Everest Bank Ltd and Mediterranean Guarantee Bank Ltd) were placed under the control of the TRNC Ministry of Finance. Later, these banks had to be bailed out by the Government. Mediterranean Guarantee Bank Ltd became a public bank and the Everest Bank Ltd was taken over by a private owner.

During the period of 2000-2002, ten financial banks were forced by the Government of North Cyprus to suspend their operation. In 2000, five banks, namely the Cyprus Credit Bank Ltd, Cyprus Liberal Bank Ltd, Everest Bank Ltd, Kibris Yurtbank Ltd and Cyprus Finance Bank Ltd, were put under the Saving Deposit Insurance Fund (SDIF), and then these banks were closed in the year 2001. The bankruptcy of these five banks started a serious banking crisis in North Cyprus. Criminal investigations have been conducted to investigate the management, and the total loss of these five troubled banks was reported to be around 112 trillion TL (Radical Newspaper, 2002). Another four banks, namely Cyprus Commercial Bank Ltd, Yasa Bank Ltd, Tilmo Bank Ltd and Asia Bank Ltd, were put under the SD1F in 2001, and Cyprus Industrial Bank Ltd was put under SD1F in 2002. Furthermore, Finba Ltd was taken over by Artam Bank Ltd in 2000 and Med Bank Ltd and Hamza Bank Ltd were taken over by Seker Bank Ltd in the years 2001 and 2002, respectively. During 1999 there were 37 surviving banks in North Cyprus. However, towards the end of 2002 ten of these banks were revoked from operation, two banks were taken over by other bank, and only 25 banks remained. The increase in the failure of commercial banks in North Cyprus increased attention on efforts to investigate the determinants of bank failure.

2. Economic rehabilitation programmed

Following the banking sector distress that the North Cyprus economy experienced between the years 2000 and 2002, a three-year economic rehabilitation programmed was formulated and executed by the Central Bank of the TRNC on 4 October 2000, in an effort to gain public confidence in the banking system (Figure 1). The aim of the programme was to slowly upgrade the financial system to an intemafional standard, in which the modification of the regulatory structure advanced broadly on the schedule. The proposed new banking law in 2000 replaced the banking Act of 1976 and the Establishment Law of 1987[1]. The new banking law was based on the banking Law of Turkey, and was particularly considered to be an improvement on the 11/1976 Banking Law implemented in 1976 (Safakli, 2003). This new act sought to provide stricter prudential controls and a mechanism of tighter regulatory control of banks. In this regard, the economic rehabilitation programmed led to major improvement of the banks' regulation and supervision. Some of the implementation of the economic rehabilitation programmed is discussed below.

First, a full coverage deposit insurance fund was implemented in 2000. Before 2000, an explicit limited coverage scheme covering the domestic bank deposit only amounted 7,000 [pounds sterling]. However, after 2000, in order to prevent the adverse effects of a bank run from spilling over from a few banks to the whole financial system, the Government issued an urgent state guarantee covering all bank deposits in 2000. In the case of bank failure, insurance scheme are placed to ensure that any investment in the banking system is secure. The purpose of this was to increase confidence in the banking sector and to prevent the banking system from bank runs and financial panic.

[FIGURE 1 OMITTED]

In addition, in 2000 the SDIF founded in North Cyprus aimed to compensate the depositors of insolvent banks. The treasury was authorized to liquidate or to rehabilitate unhealthy banks. The head of the SDIF (North Cyprus) was the Governor of the Central Bank, and all administrative decisions should have been approved by the central banks. The names of banks transferred to the SDIF (North Cyprus) are listed in Table I. As is illustrated in the table, before 2000 the TRNC Economy and Finance.

Ministry was responsible for regulating banks in North Cyprus. However, later in 2001 this responsibility was given to the Central Bank of North Cyprus.

The third amendment was on the minimum capital requirement[2]. One of the major problems with the 11/1976 Banking Law was that the Government allowed for the creation of a new bank with minimum capital requirements of 50 billion TL (120,000 US dollar). (US value is calculated on the exchange rate of 30 June 1999). However, just after the banking sector distress in 2000, under the Law …