Bad lending decisions ultimately break banks

Though the implosion of Cyprus’s bloated banking system has put other eurozone economies with oversized financial sectors such as Luxembourg and Malta in the spotlight, loan quality is the real litmus test of a country’s financial stability.

Attracted by low taxes, high interest rates and light regulation; foreign deposits largely from Russia and other former Soviet states pumped up the Cypriot banking sector to nearly eight times annual economic output, more than double the European average of around 3.5 times.

Stripping out Russian banks and other international lenders, the three Cypriot banks for which the state was liable had assets amounting to more than five times GDP, a huge proportion for an island of 800,000 people.