The lifting of all domestic capital controls and the first quarter results of banks are encouraging signs Cyprus' banking sector is on the right track. Recent credit rating upgrades and the successful sovereign bond issue mark the re-entry of Cyprus in international markets and have boosted confidence in the economy.
The Cypriot banking sector is going through an extensive overhaul following last year’s financial bailout, is the restructuring working and what is the current situation in the banking sector?
The financial bailout marked the beginning of a series of long-reaching reforms for the domestic banking sector. The past year was fraught with challenges; however, the Cyprus banking sector has shown remarkable determination to implement all necessary reforms, to comply with all Troika requirements as well as to overcome the adverse economic conditions.
Bank of Cyprus was fully recapitalised and exited the resolution process. The strategy for the cooperative credit sector has been agreed and on the basis of a restructuring plan aimed at restoring the sector to viability and profitability, all credit cooperative institutions have agreed to voluntary mergers. All the mergers have been completed by March 2014, resulting in 18 cooperative institutions (from 93 last year). The state acquired 99% of the cooperatives and their recapitalisation was completed. More recently the second biggest domestic bank, Hellenic Bank, was also successfully recapitalised from private sources, including with foreign participation, and without use of state support.
The fourth Troika review mission was completed and their preliminary conclusions point out that banks are making progress with restructuring according to their respective plans, resulting in significant relaxations of domestic capital restrictions. As at today, all domestic capital restrictions have been lifted in accordance to the roadmap agreed between Cyprus authorities and the Troika. This indicates that stabilisation is being reached and that public trust to banks is gradually being restored.
Are you seeing positive signs of recovery or renewed interest in the sector, despite the severe blow to confidence in Cyprus banks?
A tangible sign of improvement in the sector is the lifting of restrictions, which is progressing according to the set roadmap. Competitive conditions appear to function well in the domestic banking market since banks can be seen to scale up their promotion of products and services in line with the lifting of restrictions. Other encouraging signs are the recapitalisations of two banks by foreign investors, as well as the first quarter results of banks, which point towards a stabilisation of non-performing loans and a tentative return to positive returns. Following the serious setbacks in the recent banking crisis, these signs of stability are encouraging, however, it should be noted that these developments have not fully translated into more ample credit in support of a return to economic growth.
After the media frenzy surrounding Cyprus’ financial crisis, many misconceptions continue to prevail internationally. Is it safe to bank in Cyprus today and what advantages does the banking sector offer international business?
Cyprus has been handed a clean bill of health according to independent evaluations, which discredited accusations of a weak anti-money laundering (AML) system. The two parallel audits, conducted in April 2013 by Deloitte Financial Advisory (Italy) and Moneyval of the Council of Europe and were set as a precondition for the international bailout, evidence the island’s commitment to strict implementation of effective anti-money laundering measures. The outcome of the assessments indicates a solid level of compliance across the sector. The findings made no reference to systemic deficiencies, according to the Central Bank of Cyprus. On the contrary, the reports indicated that the standard building blocks are in place, the AML preventive measures and procedures in banks are sound, and in general, the banks have a high level of compliance with the statutory and regulatory requirements, which in some areas are more demanding than the EU and international requirements.
The Cypriot banking sector is now fully recapitalised and is in process of implementing changes mandated by the stricter regulatory framework, both at the domestic and EU level. Furthermore, the new Single Supervisory Mechanism is being implemented, while major steps are being taken towards a Banking Union, which will help restore confidence in the European banking system. In Cyprus, three banks as well as the cooperative credit sector will be under the direct supervision of the European Central Bank (ECB), while a number of banks that are subsidiaries of Greek financial institutions will be under the indirect supervision of the ECB. These structural and regulatory changes offer reassurance to depositors and investors. At the same time, the Cypriot economy and banking sector continue to maintain their traditional advantages. The geographic location of the island together with the multilingual and highly qualified work force offers an attractive proposition to international clients of banks. In addition, Cyprus banks maintain correspondent networks around the world and offer extensive working hours through their IBUs as well as a broad use of internet banking services.
What opportunities do you see in the banking and financial sector for foreign investors and international businesses?
The fact that Cyprus has so far had four positive reviews from the Troika is helping confidence to gradually return, both among Cypriots as well as among foreign investors. The recent credit rating upgrades as well as the successful sovereign bond issue that marks the re-entry of Cyprus in international markets are welcome signs that the economy is on the right track. Despite the current economic difficulties, Cyprus remains an attractive centre for international businesses, offering foreign investors a business-friendly environment, a low corporate tax regime, highly qualified labour force and strong institutions. A priority of the new government is to reform the public administration and reduce government bureaucracy in order to make Cyprus more competitive for both existing and prospective foreign investors. Regulations for residency and citizenship have been revised, making it easier for investors from outside the EU to gain residency and citizenship status. At the same time, the shipping sector is turning into a major contributor of the economy.
Some additional prospects that could develop into opportunities for the financial sector include the new European legal framework for UCITS funds, non-UCITS funds and the AIFMD whereby domestic financial institutions can offer solutions for investment funds that choose to operate from Cyprus. The exploitation of natural gas reserves and development of the relevant infrastructure are expected to provide opportunities for project financing and loan syndication.
What key challenges must the banking sector still overcome and how do you see the industry tackling them? Are you optimistic about the future of this sector?
At the moment, banks in Cyprus as well as in the rest of the Euro area are undergoing a comprehensive assessment conducted at the pan-European level as part of the launching of the ECB’s new system of supervision, the Single Supervisory Mechanism. Cypriot banks are already making efforts to prepare for this, as are other European banks, and are getting ready to increase their capital buffer according to the outcome of their internal stress testing.
A key policy challenge going forward, as identified by the Troika team, is dealing with the high levels of non-performing loans (NPLs). The banking sector is implementing loan workout processes through specialized units in order to treat NPLs and bank policies are being developed on the basis of the banks’ restructuring plans as well as on the new arrears management framework that the Central Bank has developed. A key element for addressing NPLs is the reform of the debt restructuring legal framework, which includes necessary changes to remove incentives for strategic default of borrowers.
Admittedly, the challenges lying ahead remain huge. However, there is a comprehensive recovery plan for the financial industry as well as for the Cypriot economy which is in the process of being implemented. All relevant stakeholders, including the bankers themselves, as well as the Cyprus government, the banking regulators and the foreign lenders are aware of the obstacles ahead and are prepared to make necessary adjustments to the plan as the need arises. The recent lifting of domestic capital controls as well as the first quarter results of banks are all encouraging signs that the domestic banking sector is on the right track.
What are your expectations for Cyprus’ economy in the next five years?
While the economy has demonstrably suffered during 2013, the GDP contraction of 5.4% was significantly lower than what had been initially anticipated. The macroeconomic adjustment program implementation remains on track, and the IMF note in their March 2014 review that Cypriot authorities should be commended for meeting their fiscal targets with significant margins, advancing fiscal structural reforms, and completing the recapitalisation of the financial system.
Economic conditions are expected to start improving in 2015, whereby the economy is expected to return to low levels of growth. The gradually improving confidence levels are helping to curb the decline in private consumption. The professional services sector has proven to be resilient and is expected to drive the future recovery, along with the tourism sector. However, significant downside risks remain, both internal and external, while the continuing high levels of private sector indebtedness are likely to keep medium-term growth at low levels. Looking forward, economic benefits from the hydrocarbon exploitation of the Levantine basin are expected to provide a significant boost to the country, and renewed political efforts under way to reunify Cyprus offer hopes for improved growth prospects.