Cyprus Profile

Banking

Back on Track

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

The goals achieved by both Cyprus’ economy and banking sector over the last two years have been hailed impressive internationally. The successful and sooner-than-expected completion of the financial assistance programme in 2016, continuous credit rating upgrades, positive bank results and successful bond issues raising well over €2 billion, have marked an end to prolonged uncertainty, and revived confidence in the country. The restoration of Cyprus’ credibility has been a top priority following the country’s €10-billion bailout deal and the unprecedented bail-in decision by the Eurogroup to impose losses on depositors in 2013. However, the hard work is finally paying dividends and with the banks successfully recapitalised with foreign investment, Cyprus’ economic recovery has been faster than many first projected.

Return to Growth

At the height of the eurozone sovereign debt crisis, Cyprus became the fifth EU member state to request a financial assistance package from the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) – collectively known as the Troika. The 2013 Cyprus bailout captured global attention, as it was the first and only bailout worldwide with a condition to impose a bail-in of bank deposits – a measure considered inconceivable until then. As part of the terms, Cyprus was bound by a Eurogroup decision to set the controversial eurozone precedent of imposing losses on shareholders and large depositors in two of its major banks, Bank of Cyprus (BoC) and Laiki Bank.

Risky expansion strategies, imprudent lending and weak bank governance all contributed to the downfall of the banks. However, the most significant internal cause was the failure on a national policy level to recognise potential shocks and the risk of running a large bank industry with loose supervision. The collapse of the Greek economy and Cyprus’ significant exposure to Greek government bonds was the last straw for the sector. Following the events of March 2013, there were widespread predictions of the destruction of Cyprus’ financial sector. However, out of more than 40 banks operating in the country only two local banks were directly affected. The EUimposed measures were severe, yet unlike other EU countries undergoing bailout programmes, Cyprus did not see a run on the banks or social unrest, but a defiant show of resilience and a rapid return to growth. There is no doubt the local banking sector has faced major challenges over the last few years, but with the still-prevailing lack of liquidity the Cypriot market is thirsty for funding, providing exciting prospects for innovative financial instruments and new players to enter the market.

Key Players

The country’s banking sector is comprised of two tiers: domestically-oriented banks and international banks. Foreign banks have long been attracted to the island for its fiscal regime, and to use Cyprus as a launch pad into high-growth markets.

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 economy.

Key players in the Cyprus banking landscape are Bank of Cyprus (BoC), the Cooperative Credit Sector, Hellenic Bank and RCB Bank, with the rest of the market made up of smaller banks and foreign subsidiaries. The country’s largest lender, BoC, has come a long way since the 2013 events, posting positive results and raising over €1 billion in fresh capital. Despite the enormous task at hand, the Cypriot lender has surpassed expectations. Dynamic Irish CEO John Hourican is largely credited for the fast turnaround of BoC and for attracting big-league shareholders, including billionaire venture capitalist Wilbur L. Ross, who pumped €400 million into the bank in 2014, followed by the European Bank for Reconstruction and Development (EBRD) investment of €120 million into BoC. The bank is now opening its horizons and examining the possibility of listing BoC stock in a more liquid, index-driven, European stock exchange.

Hellenic Bank has also seen positive growth and 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, and local investment house Demetra, invested €100 million into the bank taking 75% of the share capital, and with a further €20 million investment from EBRD, securing a 5.4% stake in the bank. The cooperative credit institutions have also progressed with the implementation of their restructuring plans, with a recapitalising cash injection of €1.5 billion.

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. However, changes introduced by the EU’s Single Supervisory Mechanism (SSM) saw the transfer of supervision of all the eurozone’s largest banks to the European Central Bank (ECB) in November 2014, harmonising the landscape for all big banks in Europe. For Cyprus, this meant the transferring of Bank of Cyprus, the Cooperative Central Bank, Hellenic Bank and RCB Bank, as well as the subsidiaries of Greek banks under the supervision of the ECB.

Current Situation and Challenges

A key hurdle for Cyprus to overcome is the high rate of non-performing loans; at the end of February 2016, non-performing loans (NPLs) amounted to €26.8 billion. However, the Central Bank is confident that future prospects are positive and that the challenging NPL situation will start to be resolved in the next three to five years. Despite the significant progress made, adopting a new mentality in the banking industry is crucial, as is the introduction of fresh ideas and new people to provide sound international expertise. Cyprus has received much praise from its international lenders for taking firm steps to rebuild its financial institutions and received 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. Funding conditions for Cypriot banks are expected to improve in the next 12 months, with continuous growth in domestic deposits reflecting the improved economic conditions. Creditor confidence has also strengthened in recent quarters and Moody's rating agency upgraded its outlook on the Cypriot banking system from stable to positive, and expects banks in Cyprus to be profitable in 2016 and see a modest 0.3% -0.5% return on assets.

A Stronger Future

With stronger growth on the horizon, new opportunities are springing up in the wake of rebuilding the Cypriot banking sector. 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 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. Cypriot banks have already demonstrated their resilience and most industry professionals believe the current overhaul of the sector and increased European supervision has produced a more agile and secure 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.

August 2016