Though Cyprus's banking sector is in a much healthier state than it was during the crisis years of 2012 and 2013, high NPL ratios and the country's negative interest rate environment are casting a shadow over its recovery, as Michael Imeson reports.

Bank of Cyprus

Cyprus will stand tall on the international stage in May when it hosts the 26th annual meeting of the European Bank for Reconstruction and Development (EBRD). It is the first time an international financial institution has held such a meeting in Cyprus, providing the third smallest EU member state with a platform to demonstrate how well it has recovered from its 2012-13 banking crisis and subsequent economic recession.

Then the country required substantial financial assistance from the ‘troika’ – the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF) – in the form of an economic adjustment programme. Signed in March 2013, the deal involved a special focus on the banking sector and a €10bn injection of funds.

Moving ahead

Chrystalla Georghadji, governor of the Central Bank of Cyprus, says 2013 was “inarguably the most difficult year in the history of the Cypriot banking sector”. 

She adds: “We feared that the consequences of the crisis would be long lasting and would result in irreparable damage to vulnerable sectors of the economy. Thus we are pleased to see that, having taken difficult decisions, we have made great strides forward in a relatively short period of time, with the economy now firmly on the road to recovery.”

The bailout programme was successfully concluded in March 2016. The country is now subject to post-programme surveillance (PPS) by the EC and the ECB until 75% of the financial aid has been repaid, which is forecast to take until 2029 unless early repayments are made. The IMF is carrying out a similar exercise in parallel, called post-programme monitoring.

International review

The EC and the ECB completed the first PPS mission in September 2016 and published their findings in December. The report noted that reforms undertaken by Cyprus “have started to bear fruit with robust economic growth and positive developments in the financial sector, which improved its liquidity and capitalisation”. The report predicted real gross domestic product (GDP) growth in 2016 to exceed 2.5% (it turned out to be 2.8%) and to “remain strong in 2017”.

However, the EC and ECB also pointed out that the reform momentum had significantly weakened, and banks’ non-performing loans (NPLs), though reduced, remained at a high level of 58% of loans to businesses and 56% of credits to individuals, the highest in the EU.

“We are well aware that NPLs remain at a high level, and reducing them is undoubtedly our main priority,” says Ms Georghadji. “It is clear that this is a problem that was many years in the making due to a number of reasons, and cannot be resolved overnight.”

In the more recent Country Report Cyprus 2017, published by the EC in February, the impact of the negative interest rate environment on Cypriot banks was highlighted. Although Cypriot banks as a whole had returned to profitability in 2016, for the first time since 2010, operating profits were still low due to low and negative interest rates and further balance sheet deleveraging.

Ms Georghadji notes that these concerns may appear to be high in Cyprus since some banks maintain “excessive levels of liquidity” with the Central Bank of Cyprus. “I believe, however, that these challenges may be addressed by better management of excess liquidity within the context of a prudent but effective strategy that avoids unnecessary risks,” she adds.

Bank financing of the Cypriot economy is about 470% of GDP, which is four times the EU average, so capacity for lending more is limited and non-bank financing via equity markets, debt issuance and venture capital is underdeveloped, according to the EC’s February report.

Bank of Cyprus bounces back

Bank of Cyprus is one lender that has reversed its fortunes. Having neared collapse during the banking crisis, the country’s largest lender posted a full-year 2016 profit after tax of €64m, its first in five years. In January 2017 it then repaid the remaining €200m of the €11.4bn emergency liquidity assistance (ELA) lent to it by the eurosystem – the amount was equivalent to 60% of the country’s GDP in 2013.

“We have repaid all the ELA in full and we are now in the process of normalising liquidity reserves,” says John Hourican, CEO at Bank of Cyprus. “It was an important task for us to repay the emergency funding – no one wants the word ‘emergency’ appearing on their balance sheet.”

Also in January, Bank of Cyprus issued €250m of Tier 2 notes. “It’s the first time in 10 years the bank has accessed the wholesale markets,” says Mr Hourican. “We were not under any instruction to raise it but I felt [it] was important to strengthen the bank’s capital base and put some subordinated capital in place above equity.” The bank now has a total capital ratio of 16%, which positions it as a “well-capitalised bank on the periphery of Europe”, according to Mr Hourican.

In the same month, Bank of Cyprus also moved its primary stock market listing from Athens to London, while retaining a listing on the Cypriot stock exchange. This was not done to raise any additional money, says Mr Hourican, but to list the company on a “much more liquid and index-driven exchange. Our intention is to transition the bank through the standard listing [on the London Stock Exchange] into a premium listing and ultimately, over time, aim for an index inclusion,” he says.

He admits the 2016 after-tax profit of €64m was “modest”. “We made €560m of profit before provisions and we put the majority of that against the NPL stock on the balance sheet,” he says.

The bank has almost fully recovered, though there is “still work to do”, he says. “The liability side of the balance sheet is looking more normal but the level of NPLs on the asset side is something we need to tackle,” he says. The proportion of NPLs to the overall loan book of Bank of Cyprus has come down from about 63% at the peak to 54%, with a medium-term target to get it below 20%.

A private co-operation

The Cooperative Central Bank (CCB), Cyprus’s second largest bank, is also making a comeback. It used to be a collection of about 100 co-operative savings banks centred around a holding company, the CCB, but in 2014 they all had to be bailed out by the taxpayer. The group is now 99% state-owned and the number of constituent banks has been reduced to 18.

While CCB’s ratio of NPLs to total loan book is still high, at slightly below 60%, its capital ratio rose to about 16% in 2016, up from 14% the year before. The bank has further brought forward its plans for listing on the Cyprus stock exchange.

“The bank received state aid and there is an obligation for it to be privatised,” says Nicholas Hadjiyiannis, CCB's chief executive. “According to the original restructuring plan this was due to take place in 2018 but the CCB has moved faster in transformation and a stock exchange listing is now planned for the second half of 2017. It will allow the bank to become more competitive.”

In December, an extraordinary general meeting approved a plan for the 18 separate banks to be merged with the holding company to create one bank, the Cyprus Cooperative Bank. “One bank, one entity, supervised by the ECB,” says Mr Hadjiyiannis. “Our strategy is to become a modern retail bank. The co-operative credit sector is like an old-style building society taking deposits and giving mortgages.

“Now we are expanding our services, moving into all categories of credit such as consumer car leasing, small and medium-sized enterprise lending, corporate lending, trade finance and bancassurance.” 

The bank accounts for one-quarter of the Cypriot banking sector’s assets, with mortgage loans featuring strongly. Its market share in other service areas is single digits or zero, so there is plenty of scope for growth.

Central bank saviour

Following the country’s crisis, the Central Bank of Cyprus worked closely with the troika on reforming the economy and saving the banking sector. “The economic adjustment programme included tough measures, many of which were front-loaded, while implementation took place in the context of a difficult external environment,” says Ms Georghadji. “These measures were aimed at restoring financial market confidence, and included, inter alia, the resolution of the two largest banks in Cyprus, the re-establishment of sound public finances and the enactment of various reforms across labour and product markets in an effort to enable the economy to return to sustainable growth.”

The central bank also made a number of regulatory changes that have led to closer and more effective supervision. “In the aftermath of the crisis, a number of directives were issued to assist the banks in addressing some of their weaknesses and thus reducing the risk of similar issues resurfacing in the future,” says Ms Georghadji. “For example, banks have been instructed to set up arrears management units, while a new loan origination directive was issued shifting the emphasis from asset-based lending to a stricter assessment of the ability to repay.”

The central bank has also taken steps to reduce the high level of NPLs, according to Ms Georghadji. These include formally regulating the creation of arrears management units at every bank; setting individual bank targets for the reduction of problematic loans and the number of restructurings; and pushing for appropriate legislation (insolvency and foreclosure, selling of loans, securitisation and so on) to be enacted.

Stelios Constantinou, a partner and financial services leader at PwC in Limassol, the country’s second largest city, says the banking recovery since 2013 has exceeded expectations. “The recapitalisation of the banking sector by foreign investors, the lifting of capital controls, the return to international capital markets, the positive results from ECB stress tests and the elimination of all emergency liquidity funding, and the listing of the Bank of Cyprus at the London Stock Exchange all underline the progress achieved over the past four years,” he says.

He believes that the next challenge is for the banking sector to get to grips with technological innovation, which is key to remaining relevant and competitive given the disruption by new players, as well as preventing cyber attacks and data theft.

Raising Cyprus’s profile

With the EBRD being an active shareholder in the Cypriot banking sector since the start of its involvement in the country in 2014, the decision to hold the bank’s annual meeting and business forum in Nicosia is timely.

“The EBRD is an active shareholder in two key financial institutions of Cyprus – Hellenic Bank and Bank of Cyprus,” says Mr Constantinou. “For each institution’s board of directors, the EBRD has nominated independent directors who have experience in NPL restructuring and are international experts in the field.”

“The annual meeting is quite an important occasion for the country and a significant signal of international support,” says Libor Krkoska, who heads the EBRD’s Cyprus office in Nicosia. “As for us, it will be a chance to demonstrate what we have achieved in Cyprus and in the wider Mediterranean region, where we have cumulatively invested almost €5bn.”

Two-thirds of the EBRD’s investment in Cyprus is equity, one-third is loans and trade finance guarantees, all in the private sector, according to Mr Krkoska. In addition to holding a stake of just over 5% in the two banks, it has also invested in five photovoltaic renewable energy projects. “They are relatively small but they will help the country increase its solar power generation by 20%,” he says.

Reunification hopes

The EBRD’s investment in Cyprus is set to end in 2020. However, if reunification talks between the Greek Cypriot south and the Turkish Cypriot north of the island result in agreement, it is possible that the investment period may be extended, says Mr Krkoska.

Realistically, reunification is unlikely to happen soon, despite the flurry of UN-sponsored talks earlier this year. (Only Turkey recognises Northern Cyprus as a separate political entity.) In February, Turkish-Cypriot leader Mustafa Akinci and Greek-Cypriot leader Nicos Anastasiades met in the UN Protected Area in Nicosia under the auspices of the UN special adviser, Espen Barth Eide.

A UN statement said the two leaders “underscored their strong resolve and determination to maintain the current momentum” of the reunification talks. Informal talks continued in April, but the two leaders were unable to agree on a date for the resumption of formal negotiations.

If and when reunification happens, it would end decades of mutual distrust and provide an economic boost to the island. It would also have geopolitical implications, and likely improve relations between Europe and Turkey. But it is still a big ‘if’. 


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