Opinion of the European Central Bank of 15 November 2011 on the management of financial crises and the setting up of an independent financial stability fund (CON/2011/93)
Date: 2011-11-15
Institutions: European Central Bank
Subjects: Cyprus, State aid, financial institution, financial solvency, financial stability, monetary crisis, national law

EN 

ECB-PUBLIC 

OPINION OF THE EUROPEAN CENTRAL BANK 

of 15 November 2011 

on the management of financial crises and the setting up of an independent financial stability fund 

(CON/2011/93) 

Introduction and legal basis 

On 20 October 2011, the European Central Bank (ECB) received a request from the Cypriot Ministry of 

Finance  for  an  opinion  on  two  draft  laws.  The  first  relates  to  the  management  of  financial  crises 

(hereinafter  the  ‘draft  law  on  financial  crisis  management’)  and  the  second  establishes  an  independent 

financial  stability  fund  to  support  the  stability  of  the  financial  system  (hereinafter  the  ‘draft  financial 

stability fund law’). On 9 November 2011, the Cypriot Ministry of Finance submitted revised versions of 

the two draft laws. 

The ECB’s competence to deliver an opinion is based on Articles 127(4) and 282(5) of the Treaty on the 

Functioning of  the  European  Union  and  the  third  and  sixth  indents  of  Article  2(1) of  Council  Decision 

98/415/EC  of  29 June 1998  on  the  consultation  of  the  European  Central  Bank  by  national  authorities 
regarding draft legislative provisions1, as the draft laws relate to the Central Bank of Cyprus and to rules 

applicable  to  financial  institutions,  insofar  as  they  materially  influence  the  stability  of  financial 

institutions and markets. In accordance with the first sentence of Article 17.5 of the Rules of Procedure of 

the European Central Bank, the Governing Council has adopted this opinion. 

1.  

Purpose of the draft laws 

1.1  The  draft  law  on  financial  crisis  management  aims  at  enabling  the  Cypriot  Ministerial  Council, 

following  a  proposal  of  the  Central  Bank  of  Cyprus  and  taking  into  account  the  opinion  of  the 

relevant  supervisory  authority,  to  take,  at  times  of  financial  crisis,  measures  addressing  liquidity 

and/or  solvency  problems  in  the  financial  system  and/or  to  enhance  the  capital  base  and/or  the 

balance sheet of financial institutions in Cyprus, in a manner consistent with Union State aid rules 
and the Laws of 2001 to 2009 on State aid control2. These include (i) government loans to financial 

institutions; (ii) government guarantees for loans to be taken by financial institutions and/or bonds 

issued  by  financial  institutions  for  an  appropriate  price;  (iii)  the  provision  of  capital  to  financial 

1  
2  

OJ L 189, 3.7.1998, p. 42. 
Law 30(I)/2001,  Episimi Efimerida tis Dimokratias No 3481, 16.3.2001. The Laws on State aid control transposed the 
State  aid  acquis,  entrusting  the  Office  of  the  Commissioner  for  State  aid  control  with  monitoring  its  correct 
implementation in Cyprus. 

 
 
 
 
                                                 
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institutions in return for a corresponding participation in their ownership structure; (iv) government 

loans or guarantees for an appropriate price and/or a grant for the Deposit Protection Schemes to 

cover any deficit that may arise in the pay-outs to depositors, in the event of their activation; (v) 

government loans or guarantees for an appropriate price and/or a grant for the Financial Stability 

Fund to assist it in fulfilling its mission. 

1.2  The draft financial stability fund law aims at establishing an independent, self-financing fund (‘the 

Fund’)  to  enhance  the  current  crisis  management  and  resolution  framework  in  Cyprus  and 

contribute  to  financial  stability.  The  objectives  of  the  Fund  are  to  (i)  support  and  fund  the 

resolution  of  ailing  credit  institutions,  avoiding  the  use  of  public  funds,  and  (ii)  maintain  public 

confidence  in  the  financial  system  while  minimising  moral  hazard  in  case  of  the  Fund’s 

intervention. 

2. 

General observations on the draft law on financial crisis management  

2.1  Member  States  have  already  consulted  the  ECB  on  numerous  national  measures  adopted  in 

response to the global financial crisis. Given the broad scope of the support measures envisaged in 

the draft law, the consulting authority is invited to take into account the ECB’s opinions on similar 
draft legislative provisions in other Member States3. 

2.2  The  ECB  stresses  that  it  is  of  the  utmost  importance  that  support  operations  conducted  by  the 

national authorities do not interfere with the conduct of the single monetary policy and/or with the 
Eurosystem’s  refinancing  operations4.  Given  the  interdependencies  of  the  Member  States’  policy 

responses  to  the  financial  crisis,  previous  ECB  opinions  have  also  drawn  attention  to  the 

importance  of  a  concerted  approach  throughout  the  Union  to  restore  confidence  in  the  financial 
markets5.  

3.   General observations on the draft financial stability fund law 

3.1  The  setting  up  of  bank  resolution  funds,  financed  by  levies,  has  already  been  addressed  by  the 
European  Council’s  Conclusions6  and  by  the  European  Commission,  which  proposes  that  all 

Member States set up ex ante resolution funds as part of the planned Union crisis management and 
resolution framework7. 

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4   
5  
6  
7 

All ECB Opinions are available on the ECB’s website at www.ecb.europa.eu. 
See, for instance, paragraph 3.4 of ECB Opinion CON/2008/52. 
See paragraph 3.7 of ECB Opinion CON/2008/81.  
See Conclusions of the European Council of 17 June 2010. 
See  European  Commission,  Communication  from  the  Commission  to  the  European  Parliament,  the  Council,  the 
European Economic and Social Committee and the European Central Bank, ‘Bank Resolution Funds’, COM(2010) 254 
final,  26.5.2010  and  European  Commission  Communication  from  the  Commission  to  the  European  Parliament,  the 
Council, the European Economic and Social Committee, the Committee of the Regions and the European Central Bank 
‘An EU Framework for Crisis Management In the Financial Sector’, COM(2010) 579 final, 20.10.2010.  

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3.2 

In line with Opinion CON/2011/29, the ECB reiterates that the primary purpose of resolution funds 

is to mitigate the effects of a bank failure for the different stakeholders, including customers, the 

real economy and taxpayers. In particular, this implies that resolution funds should not be used for 

any form of bailout or to avoid a bank’s insolvency. As the existence of resolution funds may raise 

moral hazard concerns, stringent conditions for their use need to be defined, including no automatic 

correspondence  between  the  pay-in  and  pay-out  to  the  fund,  with  decisions  about  the  use  of  the 

funds taken by independent and accountable public authorities. The ECB also reiterates that, when 

adopting  resolution  tools  for  financial  institutions,  Member  States  should  act  in  a  coordinated 

manner to avoid significant differences across the Union.  

4.  

Specific observations on the draft law on financial crisis management  

4.1  Underlying principles and triggers for the activation of the national support measures  

4.1.1  Section 5 of the draft law on financial crisis management defines the general principles underlying 

the  measures  in  Section  4  to  be  taken  by  the  Cypriot  Ministerial  Council.  Following  Opinion 

CON/2009/12,  the  consulting  authority  has  (i)  expressly  provided  that  any  government  support 

measures will be of limited duration and the draft law itself is of temporary duration, (ii) expressly 

excluded  inter-bank  deposits,  subordinated  loans  and  collateralised  liabilities  from  the  scope  of 

application of the government guarantees provided for in the draft law, (iii) covered the pricing of 
government guarantees consistently with recommendations by the ECB’s Governing Council8, (iv) 

stipulated that government guarantees for loans to be taken by financial institutions and/or bonds 

issued by them are to be consistent with the monetary policy of the Eurosystem, and (v) stated that 

the proposed arrangements comply with Union State aid rules.  

4.1.2  Under Section 4(1)(a)(ii) of the draft law, the Cypriot Ministerial Council may issue government 

guarantees for loans taken out by banks, while, under Section 5(b), government support measures 

may also be taken vis-à-vis financial institutions facing or likely to face ‘insolvency problems’. The 

ECB reminds the consulting authority that the aims of government guarantees of bank debt should 

be to: (i) address the funding problems of liquidity-constrained but solvent banks by improving the 

functioning of the market for bank debt of longer term maturity; (ii) preserve the level-playing field 

amongst financial institutions by avoiding market distortions; and (iii) ensure consistency with the 

management of liquidity by the Central Bank of Cyprus.  

4.1.3  Second,  the  ECB  reminds  the  consulting  authority  that  it  is  important  to  ensure  that  financial 

institutions benefiting from government support measures do not profit from the undue use of their 

guaranteed status to engage in a heightened level of activities, distorting the market and facilitating 

abnormal  balance  sheet  growth.  In  this  regard,  the  ECB  reiterates  the  importance  of  establishing 

appropriate safeguards such as limits on the marketing of financial products or on the expansion of 

8  

See  the  Recommendations  of  the  Governing  Council  of the European  Central Bank  on  the  pricing  of  recapitalisations, 
20 November 2008 (hereinafter the ‘ECB’s recommendations’). 

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their activities on the basis of government guarantees. The ECB recommends amending the draft 

law on financial crisis management to include such safeguards. 

4.1.4  Third, as regards government recapitalisation measures, the ECB draws the consulting authority’s 

attention  to  the  ECB’s  recommendations.  The  aim  of  recapitalisation  measures  should  be  to 

strengthen  the  capital  position  of  fundamentally  sound  financial  institutions.  The  ECB’s 

recommendations  stress  that  the  pricing  conditions  for  recapitalisation  measures  should  be  risk-

based  and  market-oriented,  taking  into  consideration  the  specific  risk  of  both  the  specific 

instrument  chosen  for  injecting  capital  and  the  institution  concerned.  Specific  features  of  the 

instruments  for  capital  injections  should  be  appropriately  chosen  so  that,  while  being  consistent 

with capital adequacy requirements and encouraging an early end to the State’s capital support of 

banks,  these  do  not  result  in  an  excessive  increase  in  the  cost  of  capital.  The  ECB  draws  the 

consulting authority’s attention to the need to ensure that the State’s shareholder role as a result of 

a  possible  future  recapitalisation  under  the  draft  law  is  limited  in  time.  In  this  respect,  and  in 

accordance  with  the  ECB’s  recommendations,  the  Cypriot  authorities  should  consider  setting  out 

terms for the redemption or conversion of the instruments, either on the basis of a fixed period of 

time  or  depending  on  market  conditions,  to  preserve  the  temporary  nature  of  the  State’s 

involvement  and  to  discourage  financial  institutions  from  relying  on  such  involvement  for  an 

extensive period of time. 

4.1.5  Fourth,  regarding  the  triggers  for  the  activation  of  the  government  support  measures,  the  ECB 

understands that these are to be deduced from a combination of the definition of the term ‘financial 

crisis’ in Section 2 of the draft law, and Section 4(2) and Section 5 on the general principles for the 

support measures. The ECB recommends amending the draft law to specify that access by financial 

institutions to that framework is activated in emergency cases only.  

4.2   Beneficiary financial institutions 

Pursuant to Section 2 of the draft law on financial crisis management, its provisions are to apply to 

the ‘financial institutions’ referred to in it, provided that these have been established and licensed in 

Cyprus.  The  ECB  understands  that,  with  the  exception  of  branches  of  banks  and  other  financial 

institutions registered outside Cyprus, the draft law applies to all financial institutions in Cyprus, 

including  the  Cyprus-based  subsidiaries  of  foreign  financial  institutions.  The  ECB  welcomes  the 

non-discriminatory  application  of  the  draft  law,  which  is  conducive  to  the  equal  treatment  of 

domestic  and  foreign  financial  institutions,  and  in  line  with  the  Commission’s  guidance  on  the 
eligibility criteria for beneficiary institutions9. 

4.3   Central bank involvement in the support measures 

4.3.1  The  ECB  notes  that,  pursuant  to  Section  4  of  the  draft  law,  the  Cypriot  Ministerial  Council  will 

decide following a recommendation by the Central Bank of Cyprus whether to support a domestic 

9  

See  paragraph  18  of  Communication  from  the  Commission  -  The  application  of  State  aid  rules  to  measures  taken  in 
relation to financial institutions in the context of the current global financial crisis (OJ C 270, 25.10.2008, p. 8). 

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financial institution or to exercise any of the other powers conferred on it. The ECB expects that 

the involvement of the Central Bank of Cyprus would not extend beyond such a recommendation 

and to otherwise comply fully with the monetary financing prohibition laid down in Article 123(1) 

of the Treaty. In particular, the ECB expects that the support measures envisaged in the draft law 

will  be  exclusively  financed  from  the  State  budget  and  that,  to  the  extent  that  their  funding  may 

require  State  borrowing,  this  will  not  include  pre-financing  or  refinancing of  the  State  budget  by 

the Central Bank of Cyprus.  

4.3.2  The ECB also expects that the Cypriot Ministerial Council will use its powers in connection with 

State  support  measures  in  a  manner  fully  compatible  with  the  institutional  and  financial 

independence of the Central Bank of Cyprus, thereby safeguarding the proper performance  of its 

tasks  under  the  Treaty  and  the  Statute  of  the  European  System  of  Central  Banks  and  of  the 

European  Central  Bank.  The  reference  in  Section  16(a)  of  the  draft  law  to  the  Laws  of  2002  to 

2007 on the Central Bank of Cyprus is welcome. 

4.4  Additional measures in Sections 7 to 10 of the draft law on financial crisis management 

Sections 7 to 10 of the draft law on financial crisis management provide for a number of powers 

vested  in  the  Cypriot  Minister  for  Finance  to  be  exercised  when  the  measures  laid  down  in 

Section 4(1)(a) are taken, and by way of derogation from the Law on Companies and the Law on 

cooperative  credit  institutions.  These  powers  include  (i)  restrictions  in  the  exercise  of  the  voting 

rights  attaching  to  shares  or  the  voting  rights  possessed  by  the  shareholders  of  the  beneficiary 

financial institution; (ii) appointment of the majority of the members of the Board of Directors of 

the  beneficiary  financial  institution;  and  (iii)  increase  of  the  share  capital  of  the  beneficiary 

financial institution. The ECB notes that, unlike the measures set out in Section 4 of the draft law, 

the  above  measures  may  be  ‘recovery  and  resolution  measures’,  to  be  taken  by  the  resolution 

authority  in  the  context  of  a  comprehensive  bank  recovery  and  resolution  regime.  The  ECB 

understands that the inclusion of these measures in the draft law is temporary, until such time as an 

operational  recovery  and  resolution  framework  has  been  established  in  Cyprus,  and  that  the 

consulting  authority  will  reconsider  in  the  future  their  interplay  with  the  recovery  and  resolution 

framework that is to apply, in the future, to financial institutions operating in Cyprus, and on which 

the ECB expects to be consulted.  

4.5  Section 15 of the draft law on financial crisis management provides for a number of deviations in 

its  application  to  cooperative  credit  institutions.  The  ECB  notes  that,  without  prejudice  to  the 

separate  supervisory  regime  to  which  cooperative  credit  institutions  are  subject  in  Cyprus,  these 

qualify as fully-fledged credit institutions for the purposes of the banking legislation. Moreover, the 

risks to which they are exposed, or those to which they may expose the domestic financial system, 

are  not  qualitatively  different  from  those  of  non-cooperative  credit  institutions.  It  follows  that 

cooperative credit institutions should be treated, also for the purposes of the draft law, in a manner 

that  guarantees  a  level  playing  field  for  them  and  non-cooperative  credit  institutions  (banks) 

operating in Cyprus. The ECB recommends amending the draft law accordingly. 

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5. 

Specific observations on the draft financial stability fund law 

5.1  Section 4(2) of the draft financial stability fund law, on the Fund’s purposes, should be amended to 

include, among its objectives, the maximisation of the value of the good assets of an ailing or failed 

credit institution and the facilitation of the quickest possible return to their productive use, as part 

of its mitigation of the effects of a bank failure on different stakeholders.  

5.2   Section 16(1) of the draft financial stability fund law, on the use of the Fund’s resources, does not 

specify the different resolution measures that the Fund will cover. The ECB understands that this is 

because  a  dedicated  recovery  and  resolution  framework  for  financial  institutions  operating  in 

Cyprus has yet to be established. Besides, the conditions subject to which the funds collected are to 

be  used  are  not  clearly  specified  except  by  an  implicit  reference  in  Sections  16(1)  and  (2) to  the 

Management Committee’s discretion to decide whether to make disbursements on a case-by-case 

basis. 

5.3  Several of the provisions of the draft law confer on the Fund’s Management Committee public law 

decision-making  powers  that  are  neither  necessarily  consistent  with  its  management  tasks,  under 

Section 23 of the draft financial stability fund law, nor with its responsibilities. For instance, the 

Management  Committee  may  exempt  credit  institutions  from  making  contributions  to  the  Fund 

(Section 5 of the draft law), impose sanctions on anyone breaching the provisions of the draft law 

independently  from  the  competent  supervisory  authority  (Section  18(3)  of  the  draft  law),  and,  as 

mentioned  above,  take  discretionary  decisions  as  to  whether  or  not  to  make  disbursements  to  a 

credit institution (Section 16 of the draft law). The ECB notes that such decisions should be taken 

by the appropriate resolution authority, rather than by the Management Committee, and invites the 

consulting authority to reconsider the scope of the powers conferred on it, some of which are more 

appropriate for a resolution authority. 

5.4  Section  22  of  the  draft  financial  stability  fund  law  addresses  the  issue  of  the  Fund’s  governance 

structure. The ECB is satisfied that the draft law provides sufficient guarantees for the Management 

Committee to operate as an independent body and for the statutory enshrinement of its functional 

independence  from  the  Government.  However,  the  ECB  continues  to  stress  the  need  for  the 

authorities in Cyprus to ensure that the proposed bank resolution fund’s management is entrusted to 

those national authorities that would be de jure or de facto responsible for resolving ailing financial 

entities.  

5.5  Finally, the ECB continues to stress the need for the draft financial stability fund law to provide for 

(i)  replenishing  the  Fund,  where  part  or  all  of  its  funds  are  used  to  support  an  ailing  bank’s 

liabilities, and (ii) the Fund’s winding-up. 

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This opinion will be published on the ECB’s website. 

Done at Frankfurt am Main, 15 November 2011. 

[signed] 

The President of the ECB 

Mario DRAGHI 

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