Cyprus Profile

Banking

Regaining Confidence

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

The performance of Cyprus’ economy and the goals achieved by its banking sector over the last two years has been hailed impressive internationally. Credit rating upgrades and positive 2015 bank results have marked an end to prolonged uncertainty in Cyprus’ banking sector. Today, the situation is stable, with confidence in the country’s banks recovering, following the lifting of all domestic capital controls and a return to international markets with successful bond issues raising well over €2 billion. The banking sector has successfully recapitalised, attracted significant foreign investors, and achieved positive results in the stress tests of the European Central Bank (ECB) and the European Banking Authority thanks to the overall strengthening of liquidity and capital adequacy. The restoration of credibility in Cyprus’ banks 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 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 ECB and the International Monetary Fund – collectively known as the Troika. The Cyprus 2013 bailout captured the attention of the world, 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 also 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. This was immediately followed by a closure of the entire banking sector for nearly two weeks with the imposition of capital controls in a bid to prevent a bank run. Cypriots and the local banking sector were severely hit by the closing of Laiki Bank and the restructuring of BoC, which entailed a haircut of 47.5% imposed on depositors. Deposits exceeding €100,000 were turned into equity to recapitalise BoC, which was also lumped with most of Laiki’s assets and debts, including €9.2 billion in emergency liquidity assistance.

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 low supervision. The collapse of the Greek economy and Cyprus’ significant exposure to Greek government bonds was the last straw for the sector, destroying the banks’ balance sheets. Following the events of March 2013, there were widespread predictions of the destruction of Cyprus’ financial sector. However, out more than 40 banks operating in the country only two local banks were affected.

The EU-imposed 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 sooner-than-expected return to growth. There is no doubt the local banking sector has faced major challenges over the last few years, but the overhaul of the sector has opened up new opportunities, encouraging healthy competition and a wider range of services. 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 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, Russian, Eastern European and Lebanese banks also 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, substantially increased the demand for banking services. The country’s 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 expanded into Russian and Eastern European markets and sought growth opportunities in China and India. However since 2013, most have divested foreign operations to strengthen their balance sheets. 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.

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 that Bank of Cyprus, the Cooperative Central Bank, Hellenic Bank and RCB Bank are under the supervision of the ECB.

Key Players

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, posting a net profit of €73 million in the first nine months of 2015. Dynamic Irish CEO John Hourican is largely credited for the fast turnaround of BoC and for attracting heavy-weight 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. A further vote of confidence for BoC came in late 2015, as Hourican announced he would stay in his position as CEO for another two years. The bank is now opening its horizons and examining the possibility of listing BoC stock in a more liquid, index-driven, European stock exchange. However, an immediate and serious concern remains with the high level of outstanding stock of non-performing loans (NPLs).

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, Belarusowned online gaming developer Wargaming.net, and local investment house Demetra, pumped €100 million into the bank taking 75% of the share capital and with a further €20 million investment from EBRD, taking 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.

One of the largest financial institutions, RCB Bank, celebrated 20 years of operation in Cyrpus in 2015 – a year, which also saw the expansion of its network of branches on the island and a Moody’s upgrade on its deposit ratings to B3 from Caa1, making it the highest rated bank in the country.

Current Situation and Challenges

At the end of October 2015, the total amount of deposits in the Cypriot banking sector, including banks and coops, reached just over €47 billion, exhibiting a net increase of €287.9 million and an annual growth rate of 0.4%.

A key hurdle for Cyprus to overcome is the high rate of non-performing loans, which stood at 47.8% of total loans at the end of September 2015. Following the adoption of a law that allows banks to sell loans to third parties, together with the foreclosure law, some banks are looking at opportunities of selling larger exposures in order to diversify risk – a practice applied by other European lenders.

However, the success of these measures will be highly dependent on the price and appetite of international investors. Another challenge on the horizon is the increasing compliance burden with the introduction of the OECD Common Reporting Standards in January 2016. However, this is a challenge all European institutions are facing. 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 advice and international expertise. Cyprus has already received 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.

A Stronger Future and New Opportunities

New opportunities are 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. 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 European supervision has produced 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.

Updated: February 2016