Accumulating huge amounts of idle cash

By Les Manison

In response to the financial crisis of 2012/13 the government in agreement with the troika of international institutional institutions took measures to consolidate the banking sector. Cyprus exited the related adjustment programme in March 2016 with the authorities stating that financial stability had been restored and that the economy was recovering well. In this connection it was contended that the banks were well capitalised and had adequate liquidity giving them the potential to contribute to enhancing the performance of the economy.

However, the performance of Cyprus banks in contributing to the welfare of businesses and households and the real economy in general has been disappointing since 2015. Banks have failed increasingly to use a significant portion of their ample funds from deposits in extending interest-bearing loans to households and businesses and in consequence have had to unload huge amounts of their excess reserves into deposits at central banks “earning” negative interest. This resultant poor composition of assets has contributed importantly to banks recording low profits and losses over the last six years as their net interest income plunged.

Banking statistics

More specifically, published statistics of the Central Bank of Cyprus (CBC) show that interest-bearing loans and advances of banks have more than halved from 62.8 billion euros at end-2015 to 27.2 billion euros at end-2021 even though bank deposits increased by 12.1 per cent to 51.5 billion euros over this period. Bank loans to households fell steeply by 46.5 per cent between 2015 and 2021, while loans to non-financial corporations or businesses declined more by a spectacular 50.7 per cent.

The large amounts of deposits at the disposal of the banks were increasingly not employed in extending interest-bearing loans and ended up being redeposited at the ECB via the CBC “earning” negative interest. In fact, while loans and advances as a proportion of total bank assets fell precipitously from 82.2 per cent at end-2015 to 40.6 per cent at end-2021, cash and bank balances at Central banks rose very steeply from 15.3 per cent of total assets at end-2015 to 36.4 per cent at end-2021, with their liquid assets doubling or increasing by more than 13 billion euros over the last six years.

ECB supervisory banking statistics reveal that the composition of the balance sheets of the major banks in the euro area differs markedly from that of Cyprus banks. In fact, the proportion of total assets held as cash and cash balances at Central banks by banks in 18 euro area countries averaged just 15.6 per cent at end-2021, which was much less than half the percentage held by Cyprus banks. And the share of loans and advances of these euro area banks as a proportion of their total assets was 59.1 per cent at end-2021 as compared with 40.1 per cent for major Cyprus banks.

The profound shift in the composition of Cyprus bank balance sheets resulted in their net interest income falling from 2.0 billion euro in 2015 to 0.9 billion euro in 2021, that in turn contributed importantly to their diminishing and feeble profitability. Indeed, ECB supervisory banking statistics included in a table titled “key performance indicators” show that the returns on equity and assets in the fourth quarter of 2021 for Cyprus banks was 0.97 per cent and 0.07 per cent, respectively, well below that for banks in 17 other euro area countries except Greece. In fact, the average return on equity for banks in 18 euro area countries in the fourth quarter of 2021 was 6.72 per cent.

Move away from traditional banking

Partly in an effort to shift their very large amounts of NPLs off their balance sheets and gain access to the related collateral Cyprus banks have moved away from the “traditional” banking model that converted the savings of households into loans extended to businesses to finance their investments in the real economy. Banks have employed increasingly an “originate-to-distribute” model whereby they originate loans, but sell and pass them onto other parties, who bear the risk of bad lending. And with this shift banks decreasingly make profits from the spread between the interest rate borrowers pay them and the interest rate they pay depositors as under the traditional model, but increasingly make profits from fees charged at every stage in the distribution process.

In fact, with the preoccupation of banks in Cyprus to remove NPLs off their balance sheets including passing them on and their related collateral (mostly immovable property) to “credit acquiring companies” their NPLs have declined dramatically from 27.3 billion euros at end-2015 to 3.0 billion euros at end-2021.

The main Cyprus banks have sold packages of their NPLs to so-called credit acquiring companies that in turn try to sell the related property collateral and/or sell bundles of NPLs to asset management companies that usually package the NPLs into issues of securities. In this distribution process the last creditor or holder of securities bears the risk of the original borrower of the bank loan not repaying. And with non-payment the borrower loses his property or collateral, while the parties in between including Cyprus banks all benefit from the fees charged.

As a result of their sales of NPLs for cash and failure to significantly extend new credits with their additional funds, banks have accumulated more idle cash and consequently were unable to generate profits and contribute to the growth of the real economy.

Bankers argue that there is a scarcity of creditworthy customers to lend to and that loanable funds remain largely unused. However, bankers are not doing enough in restructuring the impaired loans of existing customers and in being more enterprising with competent risk analysis in seeking out new customers. Unfortunately, banks have not invested in training their staff appropriately so that they can properly assess loan applications. Bankers do not seem to have the competence to identify economically viable projects and assess the risk of repayment of potential borrowers? Given this background it could be argued that Cyprus bankers along with their counterparts in many countries prefer to make money by granting loans that become non-performing in line with the “originate to distribute model” rather than financing economically viable ones that support the real economy.

This said, there is an urgent need to create a project financing capability both within and outside banks. Accordingly, an independent Development-type bank or agency could be created and take the lead in appraising and financing large scale projects including a number of investments scheduled under the Recovery and Resilience (R&R) plan of Cyprus.

It is inexcusable that banks have such a huge amount of funds lying idle and being subject to negative interest rates. A significant amount of these funds could be used to capitalise a new Development Bank along with capital injections from the EIB and other institutions. And until this new development institution becomes hopefully operational, arrangements should be made between the government and banks for the joint financing of certain projects under the R&R plan. Undeniably, this presupposes that banks and government directorates, such as that for European Programmes, Coordination and Development in the finance ministry, have the institutional capacity to carry out tasks relating to project evaluation, preparation and financing. Accordingly, these institutions will need to urgently recruit and train staff to enhance the capacity of Cyprus to do project financing utilising productively the large amount of funds available including the immense cash resources of banks.

Leslie G Manison is an economist and financial analyst, specialising in macroeconomic policy analysis, bank viability assessments and international financial relations. He is a former senior economist at the International Monetary Fund, an ex-advisor in the Cyprus finance ministry and a former senior advisor at the Central Bank of Cyprus