Redefining the 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.
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 relaxation of all domestic capital controls and a return to international markets with two successful bond issues in 2014 and 2015. 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. The banking sector has successfully recapitalised, attracted significant foreign investors, and gained 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 local banking sector 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 – a setback the country will need time to recover from. However, there is no fear of further damage from the current state of the Greek economy. The overhaul of the sector has also 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, 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 received praise from its international lenders for taking firm steps to rebuild its financial institutions. The country also 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.
According to the Central Bank of Cyprus, at the end of August 2015, the country had seven banks, a Cooperative Central Bank with 18 affiliated cooperative credit institutions, four subsidiaries of foreign credit institutions from the EU and two non-EU subsidiaries, 10 branches of foreign EU credit institutions and 16 non-EU branches, as well as two representative offices. At the end of 2014, the total amount of deposits in the Cypriot banking sector, including banks and coops, reached just over €46 billion.
Bank of Cyprus is the largest lender with around 50% of the market, the co-operative sector is the second largest, Hellenic Bank the third, with the rest of the market made up of smaller banks and subsidiaries of foreign banks. Following restructuring, Bank of Cyprus (BoC) has gone from strength to strength, reporting two quarters of profits in 2015 – after-tax profits of €31 million for Q2, which added to the €29 million in Q1, give a first half figure of €60 million, which is a significant turnaround from the €337 million losses it reported in the final quarter of 2014. The bank also strengthened its capital position in Q2, with its Common Equity Tier 1 capital (CET1) ratio increased by 100 basis points to 14.9%, due to a reduction of risk weighted assets (RWA) and organic capital generation. During Q2 it also deleveraged its balance sheet by a further €1.3 billion, for a total 23% reduction of its overall balance sheet or by €7.6 billion since June 30, 2013.
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.
Changes introduced by the EU’s Single Supervisory Mechanism (SSM) also saw the transfer of supervision of the eurozone’s largest banks to the ECB in November 2014. For Cyprus, this meant that BoC, the Cooperative Central Bank, Hellenic Bank and RCB Bank were 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 also needs to tackle its non-performing loans, which currently constitute some 50% of total loans.
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.