In addition, the EU/IMF programme foresees a rapid and substantial downsizing of the domestic banking sector, from about 550% to about 350% of GDP at the beginning of the programme. This is indispensable to reduce future contingent liabilities from the banks to the sovereign. The EU/IMF programme also foresees the full protection of deposits below 100,000 euros which will not suffer any loss from the resolution strategy. Despite the unprecedented steps taken so far, the banking sector has not yet been stabilised. The burden sharing arrangement negatively affected depositor confidence and required the introduction of temporary and proportionate capital controls and restrictions on deposit withdrawals. Short term risks are high, as the deep recession is expected to take a toll on banks’ balance sheets. The reliance of the largest bank on ELA continues to be exceptionally high. Hence, firm steps are needed to complete the financial sector reform so as to rebuild confidence in the viability of the banking system. 2  BIS central bankers’ speeches  Let me now turn to the lessons which we can draw from the experience in Cyprus. Lessons from the Cypriot experience  The Cypriot case has been a salutary reminder of the importance of establishing banking union as swiftly as possible. Only then we will be able to break the negative interaction between sovereigns and their banking systems. First, it has shown that the speedy entry into force and implementation of the single supervisory mechanism (SSM) is essential.
The two largest banks, which account for half of the domestic banking sector, had prospective capital needs of close to EUR 8 billion – or 44% of GDP. This is what the independent due diligence exercise revealed in February 2013. If the sovereign had shouldered these massive recapitalisation needs, debt would have risen to 145% of GDP. This would have critically endangered public debt sustainability. At the same time, traditional ways of burden sharing by the private sector bank creditors were limited, given little junior debt outstanding in banks. All this made the situation in Cyprus highly challenging and exceptional. One needs to bear in mind the starting conditions when assessing the design of the EU/IMF programme, to which I will now turn. Key elements of the EU/IMF programme  Three key objectives guided the negotiations of the MoU: first, to reduce the risks posed by the financial sector; second, to preserve debt sustainability; and third, to restore the conditions for sustainable and balanced growth. Combining these three objectives has proved to be a challenge, to say the least. Not only did the programme have to strike the right balance between short-term financial stability concerns and long-term debt sustainability considerations. It also had to be framed within a political context which requires unanimous decisions in the Eurogroup and ESM decision making bodies. Due to these exceptional economic and political circumstances, programme negotiations dragged on for too long, and the situation of the banking sector became critical. This forced the ECB to act.