Central Bank of Cyprus (CBC) Governor Chrystalla Georghadji has expressed optimism that Cyprus will slowly emerge stronger from the recent regional economic downturn, adding that the CBC is committed to enhancing the leading role the island’s banking system plays in the economy at large.
Addressing foreign investors in the context of today’s plenary session of the Cyprus Investors Summit 2015, Georghadji told attendees that a solid banking sector is imperative in supporting Cyprus as a financial centre and proceeded to summarise the main developments in the sector to this end.
Recent macroeconomic developments
“Initially, it should be noted that developments in the real economy have been generally better than predicted by Cyprus’ international lenders,” the Governor divulged. “This indicates that the Cypriot economy and society in general, have exhibited considerable flexibility and endurance, keeping the country resilient even after the recent dramatic developments.”
In particular, while Troika in its fifth assessment of the Cyprus economic adjustment programme last July predicted a real GDP decline of approximately 4.2% for 2014, the most recent revised forecasts by the IMF and the European Commission project a real GDP decline of 3.2% and 2.8%, respectively. Moreover, according to the latest available data, the Central Bank of Cyprus expects a decline of around 2.5%.
For 2015, Georghadji detailed, the economy is expected to do better and rebound with a marginal positive growth.
“Secondly, the developments regarding public finances were significantly better than expected compared to past estimates by our international lenders.” In its fifth assessment Troika forecasts a budget deficit of 4.7% of GDP for 2014. However, most recent estimates suggest that the budget deficit will be substantially smaller.
This revision, she explained, enables a relatively more optimistic fiscal outlook for 2015, provided of course that the consistent and prudent implementation of the state budget continues.
Developments in the banking sector
During 2013, Cyprus’ banking sector experienced its most challenging period to date. Several Cypriot banks were faced with an urgent need to reconsider their strategies and steps had to be taken within the context of the Memorandum of Understanding with the Troika, to refocus and restructure the sector.
“Unfortunately, for many years, the banking sector in Cyprus adopted poor risk and credit management practices. The sector was dominated by asset based lending and a strong focus on the real estate market, leading to an overexpansion of the banks’ balance sheets,” the Governor stated.
Although the consequences of such practices, she continued, may initially be disguised and even appears successful during a growing and booming economy, eventually such recipes lead to serious imbalances.
Subsequently, the result is a high number of non-performing loans as part of the ripple effects of the global financial crisis. “With falling demand, the economy in recession and prices of real estate and other assets decreasing, banks have had to reconsider their strategies.”
In the past two years, a series of corrective measures and reforms have taken place, aimed at strengthening the foundations of the sector following the loss in confidence and the severe shocks experienced after March 2013. Cyprus embarked on an economic adjustment programme with the Troika. In the banking sector, an assessment was made of the immediate priorities with the aim of restoring the health of our banks and the wider financial system.
A milestone in the restoration of confidence, the CBC Governor said, has recently been achieved with the successful completion of the EU-wide comprehensive assessment exercise, conducted jointly by the European Banking Authority and the European Central Bank. This was aimed at rigorously examining the balance sheets and solvency of Europe’s 130 systemic banks prior to the SSM’s launch, which placed them under the ECB’s direct supervision.
The exercise applied the same methodology to all 130 banks tested, including the four significant banks incorporated in Cyprus. “It is important to note that the starting reference date to which the series of stress scenarios were applied was 31st December 2013. This was at the end of the most turbulent year in the history of Cyprus banking, effectively presenting our banks with the additional challenge of conducting the stress test at the very bottom of our economic cycle.”
Despite this additional challenge and the fact that the tests applied to the four Cypriot banks were the same as those applied to the major banks of Europe, our banks delivered successful and encouraging results.
“It is important for the wider economy and public finances that the €1 billion buffer provided within the €10 billion Troika programme will not be needed to cover any capital shortfalls in the banking system. The improving capital position of the banks, provides the opportunity to either reduce the lending required from the programme and the national debt by €1 billion, or consider whether this may be allocated to other areas.”
A further positive development, according to the official, is the high level of foreign investment injected across the banking sector by renowned international investors and institutions. In the past 18 months, experienced foreign investors have participated with significant funds and have taken substantial positions in several banks incorporated in Cyprus.
“These capital injections constitute some of the largest foreign investments seen in the history of our economy. This provides encouragement and a firm indication that the confidence of the international community is returning to the Cyprus banking sector,” she said.
The banks have been restructured and recapitalised and are refocusing their operations with a prudent risk-based approach to lending and investing, devoting their capital and liquidity to servicing local and international businesses wishing to invest in Cyprus.
Commenting upon the future of the island’s banking sector, Georgadhji admitted to the challenges ahead: “Restructuring and cleaning up a bank’s balance sheet is not easy, and market conditions remain challenging. However, this also provides opportunities. We remain fully committed to the implementation of the programme agreed with the international lenders and in re-establishing a thriving banking sector that can effectively meet the needs of businesses and households.”
This, she indicated, is only way that local credit institutions will eventually enable the island to once again have access to adequate borrowing from the markets and return to sustained growth and prosperity.
“Overall, the developments so far in the banking sector, the ongoing fiscal consolidation process and the better management of the economy as a whole are creating the conditions for the island’s exit from the crisis. With sound infrastructure, expertise in financial services, a strong legal and regulatory framework and a wide network of double tax treaties, Cyprus is setting the stage for a sustainable recovery.”
This includes regaining its role as an attractive financial centre but in a more prudent and robust way.
“I remain positive that the Cyprus economy will come out stronger from the current crisis. Cyprus is a European Union member state; it has a strategic location between three continents, well performing industries such as tourism and shipping and is expecting further investment in the energy sector. Moreover, it maintains a strong financial services infrastructure, experience and know-how,” Georghadji concluded.