Things are looking up for banks in Cyprus, as the financial sector and economy recover. But a difficult journey still lies ahead with NPLs still high and calls for consolidation among the country's banks growing louder.

A bumpy ride on the Cypriot road to recovery

Cyprus’s banking sector is getting back to some semblance of normality following the 2013 banking crisis, but it still has some way to go before it is returned to full health. 

A joint statement issued by the 'Troika' of the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) in November 2015 on Cyprus’s economic reform programme, including its progress on restoring financial stability, neatly summed up the improving situation. Teams from the three institutions visited Nicosia to see how the programme – which is supported by financial assistance from the European Stability Mechanism and the IMF – was faring. 

“Economic activity has continued on a positive trend since early 2015, while the banking system continues to heal,” read the statement. “Although there is evidence that the slow pace of debt restructuring is picking up, non-performing loans [NPLs] remain high and the pace of lending is subdued. The fiscal targets for the third quarter of 2015 were met with substantial margins. In addition, the authorities are making progress on their structural reform agenda.”

Priority areas 

The Troika highlighted three priority areas. “Reducing the excessive level of NPLs remains the number one priority” in order to stabilise the banking system and increase lending, it said. The passing of a law to help banks sell their bad loans is good news, but a “consolidated official version” of the law and “implementing regulations” will be needed before it can take effect. Moreover, newly created insolvency and foreclose frameworks have yet to be properly implemented by the authorities. 

The second area of importance, according to the Troika, is the continued need for “sound public finances” and a reduction in the public debt ratio to an “acceptable level”, as well as “steering public spending toward growth-enhancing activities". The third priority is moving ahead with structural reforms, including privatisations and public administration reform. 

According to the Central Bank of Cyprus, NPLs account for 47.8% of total loans in Cyprus, a percentage that has barely changed since 2013. According to the European Banking Authority, Cyprus has the worst NPL ratio in the EU. The next worse is Slovenia, at 28%. Most member states’ ratios are in the range of 1% to 10%. 

To help banks reduce their bad loans, the Cypriot government has introduced new laws. The most recent was passed by the country's parliament on November 12 to allow banks to sell their loans, which is a precondition for the release of more aid by the Troika. 

The other significant piece of legislation in this respect was passed by parliament in April 2015, which introduced new insolvency and foreclosure frameworks to facilitate corporate restructurings and accelerate repossession processes. However, these frameworks have yet to be implemented. 

Slow economic recovery

The European Commission calculates that Cyprus’s gross domestic product (GDP) declined by 2.5% in 2014, but it forecasts it will grow by 1.2% in 2015, by 1.4% in 2016 and 2% in 2017. 

Inflation, which was -0.3% in 2014, is predicted to fall to -1.6% in 2015, before rising to 0.6% this year and 1.3% in 2017. Unemployment is expected to decline, from 16.1% in 2014 to a predicted 13.3% in 2017. Similarly, public debt as a percentage of GDP, which stood at 108.2% in 2014, is forecast to fall to 94.6% in 2017. 

There is also renewed optimism about the reunification of Cyprus, which has been divided since 1974 between the Greek Cypriots in the south and the Turkish Cypriots in the north. In a recent review, the IMF noted there had been a deepening of talks between the two sides. “While it is too early to assess how the process will unfold or its implications for policies, reunification could boost investment and trade in Cyprus, benefiting long-run economic growth,” it said. 

Top five banks in Cyprus

The bankers’ scalpel

John Hourican, CEO of the Bank of Cyprus, told a conference in December that a lot of “surgery” had been performed on the banking sector since the crisis, to great effect. “If you look at our institution, we have reduced the balance sheet by €9bn, mostly overseas, and exited a whole pile of other things we should never have done in the first place,” he told delegates at the 3rd Cyprus Banking Forum in Nicosia. 

Bank of Cyprus is by far the country’s biggest bank, with Tier 1 capital of $3.8bn, according to The Banker’s Top 1000 World Banks 2015. It was badly hit during Cyprus’s financial crisis and needed a depositor bail-in to keep it going. It began to recover with the arrival of new shareholders (including the European Bank for Reconstruction and Development) who injected €1bn in equity capital, a new chairman (Josef Ackermann, a former CEO of Deutsche Bank) and a new chief executive in the form of Mr Hourican, who was previously head of global banking and markets at Royal Bank of Scotland. 

“There is quite a lot of actual ‘therapy’ going on in some of the institutions here,” said Mr Hourican. “But we are nowhere near finished. The worry I have for Cyprus is that everyone thinks the crisis is abating. This crisis continues. 

“The level of debt, the lack of growth, high unemployment, the sheer size of the NPLs and the labour practices in the country – we are still at war with these circumstances and we absolutely have to stay at war with them, with the same level of intensity we have done over the past two years.” 

Revamping retail banking

The Cooperative Central Bank, the second biggest bank in Cyprus, with $1.5bn of Tier 1 capital, is considerably smaller than it used to be. Its network of 18 banks is way below the 93 it had before the crisis. Nicholas Hadjiyiannis, the bank’s CEO, told the banking forum that further changes are needed. 

“We need to create a revamped, simple, local retail banking model,” he said. “So we are going back to the basics, which means a customer-centric model, with a long-term presence. Corporate social responsibility is important, as it keeps customers close. We also need to attract young people, a new generation that is used doing its banking in a more modern way.” 

He said that retail banks in Cyprus need to be well capitalised, providing a decent return on equity for shareholders; have a multi-disciplined and sophisticated management; have strong and independent governance; shift their philosophy from product-driven to customer-driven; embrace new technologies; simplify structures; and continuously innovate. 

“We need to adopt best practices from other European financial institutions and adapt them to the small size of Cyprus,” he said. “Is all this achievable? Yes, but it will be a slow and bumpy path."

Fewer banks?

Bert Pijls, CEO of Hellenic Bank, told the conference that Cyprus has too many banks and there needs to be consolidation. “The key challenges facing Cyprus are that it is overbanked, real interest rates on new loans are low, there is a high level of NPLs and liquidity ratios for deposits are very high,” he said. “Cypriot banks have to deal with these challenges if they are to achieve sustainable growth.” 

Hellenic is the country’s third biggest bank, with $793m in Tier 1 capital. Mr Pijls became the bank’s CEO in January 2015, having previously been a managing director at British Gas and before that a senior executive at Citigroup. 

“We have a large number of credit institutions in Cyprus relative to the small population,” he said. “The population per local bank branch is just over 1000, the lowest in Europe. It is clear that this market is overbanked and inherently inefficient. Unfortunately, the inflexible labour relations situation in Cyprus does not allow us gradually to adjust this. Something has to give. Do we really need that many credit institutions in a market of only 800,000 people?” 


Central Bank helps get country back on its feet

Much of the credit for the return to strength of Cyprus’s economy and its banking sector can be attributed to the Central Bank of Cyprus, led by Chrystalla Georghadji, who became governor in April 2014 after 16 years as the country’s auditor general. 

The central bank has been working with the Troika since 2013 to turn the country around. Cyprus’s four systemically important banks (Bank of Cyprus, Cooperative Central Bank, Hellenic Bank and RCB) successfully passed the 2014 asset quality review and stress tests run by the ECB throughout the eurozone. 

The central bank’s priorities now include helping the Cypriot government complete the economic reform programme and reduce the level of non-performing loans. “The economic recovery that started in early 2015 has continued, despite a challenging external environment,” wrote Ms Georghadji and the Cyprus finance minister Harris Georgiades in a joint letter to the International Monetary Fund in late 2015. “The financial situation of the three largest banks has strengthened, with encouraging evidence that loan restructuring is proceeding at a faster pace.” 

Ms Georghadji’s tenure has not been without controversy. In 2014 she was accused of a conflict of interest because the law firm of her estranged husband was representing a former banker who is the subject of legal action by the central bank’s resolution authority. This was followed in March 2015 by allegations that she leaked to the press a list of MPs who owed tens of millions of euros in unpaid loans to the Bank of Cyprus, allegations that she strongly denied. Even so, the country’s president, Nicos Anastasiades, called for her removal on both counts. 

However, in a letter to a daily newspaper in September 2014 the attorney-general said that in a small country such as Cyprus, family connections were common, and he was satisfied there was no conflict of interest. In March 2015, the ECB intervened to warn that under EU law governments cannot dismiss a central bank governor unless a crime has been proved to have been committed. 

Furthermore, police investigating the leaked MPs’ names, which included the seizure of several central bank hard drives, announced in September 2015 that they had found nothing incriminating against the governor or her staff.

A market with too many banks also creates excessive competition and lax lending conditions, a major cause of the NPL problem. “Nearly 50% of loans are non-performing, and they account for 137% of GDP,” said Mr Pijls. “This is a huge problem for the country. It is everybody’s problem even though it crystalises itself on the balance sheet of the banks. 

“The ECB requires banks in the euro area to hold just 1% of their deposits on accounts with their national central bank. But the Central Bank of Cyprus has in place extraordinarily strict additional liquid asset ratios of 20% for euro deposits and 70% for all other currencies,” he said. These requirements restrict the use of deposits for lending and should be removed. 

Shock therapy

Haris Hambakis, senior general manager of Eurobank Cyprus, the country’s fourth biggest bank (with $713m Tier 1 capital) and a subsidiary of Greece’s Eurobank, said the viability of existing banking models is under threat. “Shock therapy” is needed to bring about change, he added. 

“If banks are to have a future, they have to adapt to the current environment, leave the past behind and convert into modern-day banks that offer integrated financial services and non-financial services solutions to meet a wide range of clients’ needs,” said Mr Hambakis. 

George Georgiou, managing director of Alpha Bank Cyprus – the fifth biggest in Cyprus (Tier 1 capital of $536m) and a subsidiary of Alpha Bank of Greece – told the banking forum that a milestone in the restoration of confidence in Cyprus’s banking system was achieved with the successful completion in late 2014 of the comprehensive assessment exercise carried out by the ECB. 

“The banks have been restructured and recapitalised and are focusing their operations with a prudent, risk-based approach to lending and investing," said Mr Georgiou. “But restructuring and clearing up the banks’ balance sheets is not easy while market conditions remain challenging.” Priorities are shedding non-core business lines, working through their large stock of NPLs and adapting to the new wave of regulations. 

Bucking the trend

For all the concern about NPLs, one bank stands out as a beacon of virtue. RCB Bank, owned by Russian banks VTB and Otkritie but operating only in Cyprus, has an NPL ratio of just 0.64%, compared with nearly 50% for the country’s banks as a whole. 

Moody’s upgraded RCB’s deposit rating from Caa1 to B3 in November, making it the highest rated bank in Cyprus. “This important upgrade reflects RCB Bank’s new capital structure, the diversification that characterises its earnings, the bank’s solid capitalisation and the fact that it is largely not affected by NPLs,” said the bank in a statement. 

Kirill Zimarin, the bank’s CEO and president of the Association of International Banks (Cyprus), added: “The upgrade will allow the bank to attract more resources, thus enabling additional lending to Cypriot businesses and making loans more affordable.” 

Nonetheless, Mr Zimarin is worried about the high levels of NPLs among other banks, as it tarnishes the country’s reputation among international investors and holds back RCB’s potential. 

“NPLs are preventing banks from extending their lending activities and holding back the economic growth of the country,” he told the conference. “It’s affecting the country’s attractiveness to foreign investors and the country’s credit rating. Cyprus’s credit rating is still below investment grade, meaning we are raising funds at a higher rate than in the rest of Europe.” 


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