Cyprus Profile

Banking

Redefining Cyprus’ Banking Sector

Returning to international markets with a stronger and fully recapitalised banking sector, Cyprus has shown remarkable determination and success in rebuilding its financial institutions.

Recent credit rating upgrades and positive first quarter bank results have marked an end to prolonged uncertainty in Cyprus’ banking sector. Today, the situation is stable and trust in the country’s banks has been further boosted thanks to a successful sovereign bond issue and the relaxation of all domestic capital controls. The restoration of credibility in Cyprus’ banks has been a top priority following the country’s €10-billion bailout deal from international lenders in April 2013, and the hard work is finally paying dividends.    

Cyprus’ economic recovery has been faster than many first projected and the country’s two largest banks, Laiki Bank and Bank of Cyprus, have been merged and recapitalised. The second largest bank, Hellenic Bank, has successfully recapitalised through private funds, and the cooperative sector has merged its institutions and is being restructured with a capital injection of €1.5 billion.

The local banking sector has faced major challenges over the last few years, especially following the write-down of Greek debt, which resulted in heavy economic losses and severely damaged confidence in the banks. This was a setback the country will need time to recover from and industry professionals have no illusions about how delicate the situation remains, not only in Cyprus but throughout the eurozone. However, the majority of banks on the island have been relatively unaffected by the economic storm as out of nearly 40 banks operating in Cyprus only two local banks were forced to undergo severe restructuring. The current overhaul is also opening up new opportunities in the banking sector, encouraging healthy competition and a wider range of services. With the current lack of liquidity, the Cypriot market is thirsty for funding providing exciting prospects for innovative financial instruments and new players to enter into the market.

The Development of the Cyprus Banking Sector

Enjoying decades of uninterrupted growth before the global financial crisis, Cyprus was considered an ‘economic miracle’ turning its economy around with strict austerity measures following the 1974 Turkish invasion and the subsequent division of the island. The collapse of the Soviet Union and wars in Lebanon and the former Yugoslavia provided the island’s economy with a boost of funds as businesses and individuals began to set up in Cyprus, attracted by the country’s stability, efficient infrastructure and straightforward procedures. In addition to Greek banks, also Russian, Eastern European and Lebanese banks began to set up shop in Cyprus to better service their clients, as funds and personnel flowed from their countries to the island. These events played a significant role in the development of the banking sector and the transformation of the country into both a business and financial centre. After Cyprus’ accession to the EU in 2004, the island established itself as a gateway to Europe and attracted increasing business from both Eastern European and Arab investors looking to expand into EU markets. Cyprus’ attractiveness for establishing holding and finance companies and the significant increase in the number of foreign trading companies and regional headquarters setting up in Cyprus, substantially increased the demand for banking services.

Banking in Cyprus is regulated by the Central Bank of Cyprus and is fully harmonised with EU legislation and directives, while commercial banking arrangements and practices follow the British model. Cyprus’ banking sector is comprised of two tiers: domestically-oriented banks and international banks. International banks have long been attracted to the island for its fiscal regime and to use Cyprus as a launch pad into high-growth markets. Over the years, Cypriot banks have also expanded into Russian and Eastern European markets and sought growth opportunities in China and India. The list of banks of foreign origin in Cyprus consists of around 30 institutions, which mainly carry out international banking business and have limited interaction with the domestic Cypriot economy – thus being largely unaffected by current developments.

Current Situation and Challenges

Cyprus has so far had four positive reviews from its lenders and has been handed a clean bill of health through rigorous independent audits, which completely discredited floating accusations of a weak anti-money laundering (AML) system. On the contrary, the assessments indicated Cyprus has a high level of compliance across the banking sector, with some statutory requirements being more demanding than in other EU member states.

Today, the Bank of Cyprus is the largest lender with around 50% of the market, the co-operative sector is the second largest with 93 co-ops now merged into 18, Hellenic Bank is the third largest lender and the rest of the market is made up of smaller banks and subsidiaries of foreign banks. Bank of Cyprus has officially exited administration status and posted profits of €31 million in Q1 2014, after seven quarters of losses and a severe restructuring plan imposed by the national bailout. Hellenic Bank avoided a state bailout by successfully completing its recapitalisation through private funds. New York-based hedge fund Third Point LLC, Belarus-owned online gaming developer Wargaming.net and local investment house Demetra pumped €100 million into the bank taking 75% of the share capital. The Cyprus Development Bank (CDB) also finalised a deal with a Russian group for the recapitalisation of the lender in June 2014. A new player is expected to enter the market by the end of 2014 to cater to small and medium sized enterprises (SMEs), which have been the hardest hit over the last two years. The Small Businesses and Self-Employed Coalition recently announced they will set up a bank to help their members gain access to low-interest loans.

As European banks are preparing for the upcoming European Central Bank (ECB) stress tests, Cyprus banks are projected to pass with flying colours thanks to the hard work and restructuring achieved over the last year. Changes introduced by the EU’s Single Supervisory Mechanism (SSM) are scheduled to start in November 2014 and will transfer the supervision of the eurozone’s largest banks to the European Central Bank (ECB) in Frankfurt. For Cyprus, this means that Bank of Cyprus, the Cooperative Central Bank, Hellenic Bank and RCB Bank will be transferred from the supervision of the Central Bank of Cyprus to the ECB. Despite the significant progress made since the country’s bailout, challenges remain. Adopting a new mentality in the banking industry is crucial, as is the introduction of fresh ideas and new people to provide sound advice and international expertise. Cyprus needs to reduce the size of the sector, tackle its non-performing loans and fully lift capital restrictions as soon as possible for a complete recovery.

A Stronger Future and New Opportunities

New opportunities are also springing up in the wake of rebuilding the Cypriot banking sector. With the current lack of liquidity, Cyprus is providing opportunities for new players to enter into the market and encouraging healthy competition and a wider scope of services. Investment opportunities that could be tapped into by international banks and financial groups are mergers and acquisitions, private equity and venture capital projects as well as financing of large infrastructure projects in the oil and gas industry, casino and resort development and other large scale projects. To reduce its bank dependence, Cyprus has already turned its interest into alternative sources of finance such as bond markets and investment funds, also peer-to-peer lending and crowd funding are emerging as new finance models.

Despite the short-term pains of temporary capital controls, the rapid downsizing of the banking sector and the economic programme agreement ensure the public debt of Cyprus will be sustainable. Cypriot banks have already demonstrated resilience in the face of adversity and most industry professionals believe the current overhaul of the sector and increased supervision will produce a more efficient banking sector to boost the economy. The transition period continues to be tough, but Cyprus has already shown remarkable progress in steering its banks and wider economy back to growth.

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Updated July 2014