Cyprus reborn: CBG looks to a bright banking future

Q. How would you describe the banking sector in Cyprus since the crisis?

A. The banking sector in Cyprus experienced a severe shock in March 2013 [when it had to be bailed out by the 'troika' – the European Commission, European Central Bank (ECB) and International Monetary Fund] but has managed to get through it almost unscathed.

Foreign investors have made a significant contribution to the recapitalisation of the Cypriot-significant banks, which have successfully passed the asset quality review [AQR] and the stress tests run by the ECB and the European Banking Authority [EBA] in the framework of the single-supervisory mechanism [SSM]. The prospects seem to be quite good, and the banking sector is expected to reclaim its leading position in the economy.

Q. What were the main changes made to the Cypriot co-operative credit sector?

A. The co-operative credit sector has been completely restructured as a result of the 2013 financial crisis. It has also been recapitalised through state aid. The 93 co-operative credit institutions that existed in March 2013 have been merged into 18, and they operate under the [newly empowered] Cooperative Central Bank. This has changed the sector in the sense that operations are controlled centrally and every effort is being made to guide the sector out of the crisis.

Q. Bank of Cyprus and Hellenic Bank were restructured and recapitalised in 2013. What is your assessment of the two banks now?

A. Both banks have been restructured and recapitalised through foreign investments, thus demonstrating the trust that international investors have in the Cypriot banking sector. The recapitalisation has helped the two banks pass the AQR, and the stress tests have highlighted their ability to sustain additional losses. Under the circumstances, the future of the two banks appears to be very positive.

Q. Non-performing loans [NPLs] are very high in Cyprus and a big problem. How are banks trying to deal with this? 

A. NPLs are indeed very high and this is probably the major challenge faced by the country's banks. The relevant directives of the Central Bank of Cyprus [CBC] aim at setting the right framework for dealing with this, and banks are expected to tackle the problem within the framework of these directives. Moreover, the ongoing intensification of the restructuring of loans by banks is expected to reduce the number of NPLs.

Q. Is it safe to bank in Cyprus today?

A. Certainly. The banking sector in Cyprus is now smaller and better capitalised, with its largest banks performing successfully under the recent ECB and EBA stress tests. There are encouraging signs that the Cypriot banking sector is on the right track and several measures have been undertaken to rebuild the domestic monetary and financial institutions.

Banks in Cyprus have successfully completed their operational restructuring and recapitalisation plans, with the co-operative sector also taking positive steps. Loan restructurings have progressed since the signing of the memorandum of understanding [MoU] with the troika, and are expected to be intensified following the positive feedback from the comprehensive assessment carried out in 2014, and the framework set by the SSM.

Q. How effective have the capital controls been at containing capital flight?

A. Indications are that capital controls have been quite successful in containing capital flight. As has been pointed out from the outset, the mechanism installed to ensure the correct application of capital controls was far less onerous than what the CBC had in place in the past, when exchange controls existed. Nevertheless, the co-operation of the banks was a key factor in ensuring the correct implementation of capital controls.

It should be noted that capital flows in and out of the country after March 2013 were not just confined by the capital controls [but also by investors' own decisions]. The recent initiation of the SSM, in which four large, significant Cypriot banks have also participated, is expected to help harmonise supervisory and regulatory standards across the region, as well as limit the sovereign-financial loop, given the possibility of direct European Stability Mechanism support to banks. This enhanced supervision is also expected to strengthen investor confidence in the domestic banking system.

The success of the aforementioned has contributed to the recent upgrades of the Cypriot sovereign rating as well as its general economic outlook by credit agencies. [Moody’s raised its rating on Cyprus from Caa3 to B3 in November 2014, a month after Standard & Poor’s upgraded it from B to B+. Fitch rates Cyprus B-.]

Furthermore, key policy initiatives have been put in place at the euro-area level, which Cyprus is expected to benefit from. The ECB’s policy rate cuts and the implementation of further non-standard measures to enhance the functioning of the monetary policy transmission mechanism [including the eight targeted long-term refinancing operations, two of which have already taken place, as well as the asset-backed securities and covered bond purchase programmes, and planned sovereign bond purchases] are expected to help financing in the Cypriot banking sector, resulting in increased credit provision to the domestic private sector.

Q. Most capital controls have now been lifted but some foreign capital restrictions are still in place. What preconditions have to be met for all of the controls to be lifted?

A. Capital controls were introduced in March 2013, as a precautionary measure against outflows of capital. All domestic capital restrictions were fully lifted in May 2014, with no irregular capital outflows being recorded so far. In fact, since May 2014 deposits by domestic non-financial corporations have exhibited positive growth, thus indicating signs of a rebound in confidence in the banking sector.

Foreign capital restrictions have been relaxed and are expected to be fully removed within the year, on a predetermined road map agreed with the troika.

Q. What are your expectations for the Cypriot economy in the medium term?

A. The Cypriot economy is successfully overcoming the impact of the March 2013 crisis, exhibiting better than expected resilience and flexibility. The labour market has reacted positively, with a significant reduction in wages both in the public and private sector. The financial sector has also shown resilience and is now rebounding, following a successful recapitalisation process.

Furthermore, the commitment of the government to successfully implementing the MoU with the troika is evidenced by the significant over-achievement of fiscal targets. As a result, the recession was not as deep as was originally expected, with a contraction of 5.4% in 2013 and 2.4% in the first three quarters of 2014. We expect a contraction close to 2.6% to be recorded for 2014, while positive growth of 0.8% and 2.1% is expected for 2015 and 2016, respectively. 

In the CBC’s baseline scenario for 2015 to 2016, growth is expected to stem primarily from domestic demand and to a lesser extent from net exports, building on the emerging signs of confidence, which are evident in a number of leading indicators.

Q. What impact do developments such as the recent involvement of the European Bank of Reconstruction and Development [EBRD] in Cyprus have on the country's economy?

A. The economy has generally benefited from the prospects of foreign direct investment, [and this is] also related to international organisations such as the EBRD. The establishment of the EBRD in Cyprus will focus on investments in the financial sector, energy, privatisations and the provision of finance to individual companies. The EBRD plans to invest up to €700m in the Cypriot economy until 2020, after taking a 5.12% equity stake in Bank of Cyprus through the recent recapitalisation. The plan is to invest at least €100m annually in Cyprus. Such activity not only contributes to the recovery in economic terms but also helps to build confidence in the banking system.