Credit Where It’s Due

  Chrystalla Georghadji, Governor of the Central Bank of Cyprus, tells Gold that the banking sector is beginning to see better times, partly due to its implementation of CBC directives. She also remains upbeat about the island’s professional services sector.

Gold: What are the main short-term and medium-term priorities of the Central Bank of Cyprus as regards the local banking sector?

Chrystalla Georghadji: As you know, the major challenge faced by the Cyprus banking sector today is the very high level of Non-Performing Loans (NPLs). Inevitably, the main focus of the Central Bank of Cyprus (CBC) is on the efforts of the banks to manage and reduce the level of their NPLs while, at the same time, maintaining an adequate capital position and safeguarding financial stability. This, in turn, will enable the banks to gradually increase the financing of the economy, with positive results for the banking sector and economic growth.

Gold: How can the NPLs problem be effectively addressed? Given that there is no ‘quick fix’ available, what kind of progress will the Central Bank be looking to see? What are the indicators that you will consider satisfactory? (e.g. percentage of NPLs to total loans and over what time period?).

C.G.: The CBC considers that the best route to reducing NPLs is that of the viable restructuring of loans, which would enable borrowers to meet their obligations and repay those loans. In this context, the CBC has already issued the Arrears Management Directive, which aims to guide banks on how to manage their NPLs. We have also issued a Directive on Impairments, the aim of which is to guide banks in prudently applying International Financial Reporting Standards (IFRS) when calculating the provisions for bad debts. Furthermore, supervisory reporting on NPLs and restructuring progress has been enhanced, while restructuring targets have been introduced in order to incentivize banks to engage in more restructurings and address the early arrears, thus preventing them from developing into NPLs. Given that banks are still in the process of reviewing a huge number of NPLs to assess whether a viable restructuring solution can be offered to the borrower, it is too early to forecast when the percentage of NPLs to total loans will fall to the European average.

Gold: Some observers believe that there are too many banks serving the small market of Cyprus. Do you agree that it is overcrowded? Do you foresee mergers/acquisitions and market consolidation in the sector over the coming years?

C.G.: The European Regulatory and Supervisory environment imposes high demands on the banks in terms of capital, liquidity and internal governance, while the current low interest rate environment and adverse macroeconomic conditions are having a negative impact on banks’ profitability. This inevitably creates pressure for leaner and more efficient banks and, thus, some market consolidation seems unavoidable in the coming years.

Gold: On the other hand, others argue that Cyprus needs a strong/flagship foreign international bank to come and set up base in Cyprus. Is this possible/achievable? If so, do you believe that such a development would enhance the reputation of Cyprus as an international business centre?

C.G.: In the aftermath of the global financial crisis, which erupted in 2008, many of the large international cross-border banks have been retreating to their home countries and exiting many of the foreign markets that they had ventured into prior to the crisis. A recent example is the decision of Barclays Bank to close its only branch in Cyprus and in a number of other jurisdictions. Thus, the likelihood of a strong/flagship foreign international bank establishing operations in the current economic climate is low. That should not, however, hinder the efforts of Cyprus to enhance its reputation as an international business centre. Following the events of 2013, there were serious concerns that there would be a large exodus of international companies from the island but this did not materialize. International companies can still set up business in Cyprus and take advantage of the tax incentives that are still in place and conduct their banking transactions with any bank, either domestic or international.

Gold: When will the next stress test take place? Do you predict a need by some banks for further injections of capital or is it your view that the local banks are adequately capitalized?

C.G.: The EU-wide stress test is currently in progress and is being coordinated by the European Banking Authority (EBA), which has decided to limit the sample of banks subject to this exercise to those with total assets of over €30 billion, which still covers a very high percentage of the total assets of the EU banking system. This means, however, that none of the Cypriot banks is in the EBA sample. However, all the significant institutions that are directly supervised by the European Central Bank (ECB) under the Single Supervisory Mechanism (SSM), which are not in the EBA sample, are undergoing similar stress tests, under the coordination of the ECB, using the same methodology and scenarios as for the banks in the EBA sample. For Cyprus, this covers the four significant institutions – namely Bank of Cyprus, the Co-Operative Sector, Hellenic Bank and RCB Bank. The EBA and the ECB have decided that the results of the current stress tests will be used as input regarding their decisions on the capital adequacy of each bank within the annual Supervisory Review and Evaluation Process that is also in progress for 2016. The Cypriot banks were recapitalized in 2014 and 2015, while in 2015 they also managed to increase their provisions significantly without a significant impact on their capital position. The average Common Equity Tier 1 ratio for the Cyprus banking system was 15.44% at the end of 2015. NPLs have peaked and some signs of a decreasing trend have been observed, while the economy is in a better shape than last year. However, it would not be proper for me to prejudge the outcome of the ECB assessment of the 2016 capital adequacy.

Gold: Do you believe that the local banks have now found the right balance between a prudent, risk-based approach to lending and investing and the need to offer loans to companies and individuals in the private sector? Can they do more?

C.G.: In December 2013, the CBC issued a Directive to banks on their loan origination processes, specifying repayment ability as the main and foremost criterion for the approval of an application for loan facilities. The Directive also listed the documentation that banks need to collect from an applicant in order to check that the income declared is, indeed, available to service the loan, as well as the requirements for the monitoring of the loan performance after its granting. This Directive has recently been amended, simplifying the loan approval process and, at the same time, making it more specific on the assessment of repayment ability. In particular, for loans to households, the loan instalment cannot exceed 80% of the net income available to service the loan and in the case of foreign currency loans, this limit is lowered to 65%. Moreover, one of the identified weaknesses of the past, which contributed to the high leverage of the private sector, was the lack of a national credit register to provide banks with information on the loans of a person (legal or natural) with other banks. This was resolved in October 2014 when, following a CBC Directive, a national credit register started operating. Since then, banks have been able to access information on the loans of each person (legal or natural) that applies for a loan, thus having a useful tool in the assessment of loan applications.

Gold: We often hear banks and other financial institutions complaining that energy, resources and money are being devoted to compliance and regulatory issues. This is not limited to Cyprus, of course. Do you think that there is too much regulation and too much emphasis on compliance or are you in favour of even more?

C.G.: As I mentioned before, the global financial crisis revealed that the global rules governing the operation of banks had to be overhauled. Global regulators are now approaching the end of this road. In my view, given the very nature of their business, strict rules are needed to regulate banks and avoid the buildup of excessive and underpriced risk in good times, which can prove catastrophic in bad times. I agree that banks have had to dedicate a lot of effort, resources and money to comply with the new rules. However, this relates to the one-off costs of changing their policies and procedures to comply with the new rules.

Gold: Accounting, legal and fiduciary firms, corporate service providers and fund managers have been offering services to international companies for many years and the sector makes a significant contribution to the country’s GDP. How important is this sector in your opinion and do you have suggestions on ways it which it can be improved? 

C.G.: Indeed, the professional services sector is very important to the Cyprus economy, contributing about 9% of GDP. The success of the sector is attributable to a series of policy choices and decisions, which have allowed for a stable tax incentive regime and, more generally, a relatively business-friendly economic and administrative environment. This environment offers certain advantages, including a robust and transparent legal system based on Anglo-Saxon law. The relatively low corporate tax rate as well as a number of other benefits related to an efficient tax system (corporate income tax exemption for capital gains and dividends, and no withholding tax on interest payments and dividends) should also be noted. One can also add the country’s telecommunications infrastructure and the availability of highly-skilled and educated personnel. Across euro area countries, Cyprus has been the one improving the most in terms of doing business. According to the World Bank Report on Doing Business 2016, which compares business regulation for domestic firms in 189 economies, between 2014 and 2015, Cyprus’s ranking moved up from 60th to 47th place. This improvement partly reflects a number of policy changes adopted in the context of the EU/IMF economic adjustment programme. However, more needs to be done in terms of achieving a friendlier business environment, including simplifying set-up and operation procedures as well as reducing red tape.

Looking ahead, a number of policy initiatives are under way, including the review of the existing tax/legal framework for businesses and of the public procurement processes, the establishment of a fast-track mechanism for strategic investments, the development of strategies for attracting foreign direct investment from non-EU countries – mainly in the banking and financial services, energy, tourism and real estate sectors – as well as schemes providing for the creation of business clusters and the setting up of a Science & Technology Park.