Two factors govern the behaviour and prospects of the banks of Northern Cyprus. Embargoes by the international community have created a system that is under-resourced and stretched but hardy. Aspirations that Northern Cyprus will eventually be admitted to the international community ensure its politicians and financial managers have a vision that embraces membership of the EU and the application of international standards of banking.
The international community has ostracised Northern Cyprus since 1974, when it declared itself to be a separate state based on the quarter-million strong Muslim population living in the northern third of the island. The creation of the Turkish Republic of Northern Cyprus followed a 14-year struggle with its Greek Cypriot neighbours and subsequent invasion by Turkish troops. The embattled state was supported by Turkey, which continues to have a strong financial interest in its economy. Northern Cyprus uses the Turkish lira as its currency and the Central Bank of Northern Cyprus is run by Turks.
Embargo constraints
Embargoes against Northern Cyprus cross every area of the banking sector, from access to the Swift payment system to obtaining international legal and financial qualifications and travel. Such restrictions can leave managers feeling severely constrained, yet they continue to pursue international standards set by the European community in the belief that the EU will eventually lift the republic’s pariah status.
Minister of finance Ahmet Uzun says: “We are trying to bring all the sectors up to EU norms and this applies to the banking sector. The level of many of our banks’ share capital falls below that of European banks and we have passed a law and given banks a fixed period by which they must raise share capital to European standards. Some banks already meet the standards.”
Ahmet Tugay, the governor of the Central Bank of the Turkish Republic of Northern Cyprus, says: “Banks will be required to have share capital of not less than E5m. I expect the current [number of] 24 banks in northern Cyprus to fall to 15 in the next few years. But we are in no hurry to see this consolidation.”
Northern Cyprus currently hosts six foreign banks, 18 local private banks and one state bank.
In a bid to implement international standards, EU levels of maximum exposure limitations based on capital are starting to replace credit exposure based on deposit limitation. Basel I capital requirements have already been met in most cases and Basel II requirements are expected to be phased in over the next few years.
Total assets of banks in Northern Cyprus amount to about $4bn, but the country suffers from a massive drain in deposits to Turkey where many local citizens have investments and family links. About $1.7bn is invested in Turkish banks and investments.
Mr Uzun says: “We are trying to keep the deposits in the country. We want the deposits to be invested in our country instead of going abroad. We haven’t been able to overcome the problem and make it more attractive to keep them in the country.”
Local investors operate a form of carry trade between accounts based on the Turkish lira, which pay high interest rates, while borrowing in foreign currencies where interest rates are low. The risk of a sharp misalignment between the two currencies gives Cyprus bank managers cause for concern.
Bülent Berkay, the chairman of the North Cyprus Banks Association and general manager of Iktisatbank, says banks are impeded from investing in larger projects because of a mismatch between length of deposits and funding requirements. “There is a problem with long-term investment because the money is all on short-term deposit rates and the banks are constantly having to roll-over the loans.”
International isolation
The risk of financial instability is enhanced by the country’s international isolation. International banks, rating agencies and credit card companies are barred from dealing with Northern Cyprus by EU and other embargoes. Banks complain most vehemently about their exclusion from the Swift system of financial messaging.
Northern Cyprus is denied its own Swift country code and banks that want to use the Swift system are told to apply to a bank in the Republic of Cyprus, which Swift recognises. The offer is inevitably refused because Northern Cyprus has no significant trade or financial links with the Greek Cypriot sector. The island’s financial affairs boil down, for the most part, to politics. (Swift did not respond to a request for an interview for this article.)
Tolga Çagakan, assistant general manager at Kibris Vakiflar Bankasi, complains bitterly about Swift as well as the lack of ratings. “We are not a member of Swift because we are not a recognised country and this is creating a big problem. We still use telex and, in some cases, send faxes or e-mail. We don’t have lines of credit with any bank because we don’t have a rating.
“The rating agencies and Swift tell us to go through the Central Bank of Cyprus [in Nicosia]. We tried to apply for a rating and the agent was optimistic, but it never happened. With each step, there’s a new problem.”
Security issues
Besides creating inefficiencies, the inability to use Swift adds to banking risk in Northern Cyprus. Selami Kaçamak, general manager of Kuzey Kibris Bankalar, says: “The fact that we have to use e-mail and other forms of communications means that we have security problems. We have a cypher code with other banks, but we have to face these threats.” (In fact, the bank is part of the Turkish Is Bank and can use the Turkish Swift country code.)
Entry points into the banking system, other than Swift, are open to Northern Cypriot banks that have links to international institutions. The Cyprus Turkish Co-operative Central Bank (CTCCB), for example, is linked to HSBC and Commerzbank. It can access the online Hexagon service (run by HSBC) and make international transfers and honour letters of credit.
However, Gülhan Alp, assistant general manager at CTCCB, says that HSBC charges heavily for its services. “If we open a letter of credit with HSBC or Commerzbank, they will require full cash cover as collateral for it. They don’t give us any interest rate for the cash cover. So this is a cost. HSBC will pay the seller of the goods, but the bank wants cash from us as the guarantee. This increases the price to our customer, who has to pay the charge.”
Northern Cyprus banks are also restricted in offering credit facilities, as credit card companies enforce an embargo. CTCCB has teamed up with Turkey’s Denizbank to provide a Mastercard to local citizens. Denizbank charges CTCCB $100,000 annually for a licence to issue the cards and Mr Alp says that he plans to pass that on to his card customers shortly.
One medium for investment in the Cyprus market is provided by the Development Bank of the Turkish Republic of Northern Cyprus, which borrows much of its funds in Turkey. The bank lends up to 50% of the cost of a project, while the remainder comes from borrowers’ equity sources.
Local lender
Fatma Kinis, assistant general manager, says that the development bank can lend up to 60% of the cost of central authority projects, and up to 90% for transactions undertaken in sectors that have been given priority, such as education, tourism and industry. “Large credits that are usually project finance related go to the State Planning Office for approval, while others are approved in house.”
Private sector banks in Northern Cyprus have to place 2% of their deposits with the development bank, effectively subsidising their competitor’s cost of funds.
Isolation has meant that foreign banks play a minimal role in the development of the country. Northern Cyprus’s central bank says that foreign branches hold 31% of the banking sector’s assets and 33% of deposits, but they make only 5% of the loans.
“Foreign banks do not have any positive impact on the country’s economic growth. They collect deposits from the local market and transfer those savings overseas. Currently, the government is taking some measures to prevent the transfer of domestic savings to other countries,” says the central bank.
