Saga of Central Bank Independence continues: Lessons from Slovenia

In cases of central bank independence, we often look at large economies and their central banks.

However, of late we are getting some intriguing cases from smaller economies. The latest I came across is that of Slovenia whose case is as enthralling as Cyprus which was discussed in earlier post.

Slovenia, which is part of Central Europe split from Yugoslavia in 1991 and became an independent State. The central bank was also formed the same year. After running its own currency Tolar, it joined the Euro at start of 2007, just at the eve of the crisis. Like most other European (and non-European economies), Slovenian banks also lent excessively to real estate and housing sector.  The crisis which started in US soon engulfed the European economies and exposed their banking follies including that of Slovenia.  The share of banking assets as a percentage of GDP was near 150% of GDP.

In a financial crisis, the first salvo usually comes from the central bank in form of lowering interest rates. This was missing in all Euro member economies as they had given up their monetary policy to European Central Bank. In Slovenia, the Government was reluctant to intervene and bail out the banking sector and the banks continued to bleed due to bad assets and low capital base. The losses in banking system were nearly 5 billion Euros in 2010-13 period.

Finally, in 2013 the government acted. First, the government recapitalized banks and as a result government ownership of banks increased from 23% in 2012 to nearly 60% in 2013. Second, non-performing loans were transferred to a bad bank. There were detailed asset quality reviews (AQR) done by independent consultants. There were stress tests based on both top-down and bottom-up approaches. The entire exercise was coordinated by the Solvenia Central Bank along with Finance Ministry, ECB and European Commission.

As State took over the banks, the shareholders and bond holders were wiped out and this is where problems began. The disgruntled investors formed Slovenian Association of Small Shareholders and filed lawsuits questioning valuation of their holdings. There were cries that the banking assets were undervalued and the investors were not paid fair prices.  Kristjan Verbic, who leads the Shareholders Association remarked that in Slovenia shareholders compensation issue was not even discussed unlike other European countries such as Greece, Portugal etc.

The Court ruled that measures to restore banking system in 2013 were constitutional and asked the government to adopt more effective judicial relief for former investors. This ruling led to the next question who will pay the investors?

Who else but the central bank! The Government proposed a Bill in 2016 which makes the central bank objective liable for the difference in the valuation liabilities irrespective of whether it was due to unfair or unlawful conduct by the Bank of Slovenia. This is breach of Euroarea monetary financing laws where bank resolution is a matter of government and prohibited for the central bank. The Government asked ECB for its view on this matter and was rejected each time by the European authority adding these actions also undermined central bank independence.

Boštjan Jazbec, who was appointed the Governor in 2013 and oversaw the restructuring exercise criticized the bill as well. He wrote an open letter to the Government in March-2018 pointing that that the Court had asked to make an effective legislation for compensation. The government has delayed the legislation and put the blame on the central bank. He added that the AQR and Stress tests only helped the banking sector. The real woes of banking sector was due to delayed intervention by the Government.

The Government obviously did not care and kept applying the pressure. Dr France Arhar who was also the first Governor of the Central Bank from 1991-2001. He later became a politician and remarked: “Each candidate for the position of governor will have to answer the question of how he or she sees the recovery story”.

The Central bank was raided and papers leading to 2013 restructuring were confiscated. This opened rebukes and call for actions by ECB and EC.

The end result of all this chaos went to another extreme as the Governor received death threats and threats on his family. Mr Jazbec said: “The threats are intolerable. Since the bank recovery was carried out in 2013 and 2014, I have faced a media lynch-mob, with calls for me to be lynched being published uncritically in readers’ letters. The author of one such letter, a member of one of the civil initiatives of holders of extinguished bank shares and bonds, threatened that those of us involved in the recovery, should the authorities fail to begin proceedings against us, would “be lynched by the people in the next uprising”. He sought police protection in March-2018 and eventually resigned in April-2018, a year before expiry of his tenure. Ironically, Jazbec joined the European Single Resolution Board, a body created to resolve banks at a pan-European level.

It is not as if the government relented on its proposal of holding central bank liable for the losses faced by former investors. The new Governor Bostjan Vasle is undergoing the same pressure (why did he take up the job?). He recently wrote an open letter to the Prime Minister echoing words of Jazbec:

“The prohibition of monetary financing and the independence of the Bank of Slovenia are rules that I must uphold as governor, and I must do everything within my power to ensure that they are enforced. I am nevertheless aware that the issue of the judicial protection of the holders of subordinated liabilities needs to be resolved as soon as possible. This is why at the very beginning of the procedure for drafting the bill the Bank of Slovenia drew attention to the key rules of central banking that need to be upheld.”

Vasle attached ECB comments on the Bill written in March-2019. The Government obviously does not care as it again sent a revised bill to ECB for comments in May-19, to which ECB replied and raised similar concerns as in earlier cases.

What do these events imply? The earlier fallouts between central bank and government was limited to interest rates. Now, it has moved to bigger issues such as bank NPAs, bank management and even shareholder/bondholder compensation as in case of Slovenia.

That this is happening in Slovenia (and Cyprus, and Italy, and Austria etc) whose central bank is protected under European treaty tells you how Governments eventually push and win such battles, outcomes be damned.

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