Central Bank of Cyprus (CBC) governor Constantinos Herodotou on Tuesday addressed the annual general meeting of the Association of Cyprus Banks, touching on domestic economic developments, the resilience of the local banking sector, as well as future challenges.
“The Cypriot economy is expected to remain robust in 2023, despite ongoing global challenges such as the prolonged war in Ukraine,” Herodotou said.
“The continued development of the country will primarily stem from increased domestic demand and, to a lesser extent, net exports,” he added.
He noted that “this is mainly because of the expansion of business activities of foreign companies already established in Cyprus, as well as the ongoing rise in tourism revenues, which have recovered to pre-pandemic levels in the first three months of 2023”.
Tourism revenue during the first quarter of the year increased by 46.1 per cent compared to the same quarter of the previous year, reaching 106 per cent of the first quarter of 2019 revenue.
Additionally, significant ongoing private investments and projects within the framework of the Recovery and Resilience Plan are expected to significantly support economic activity.
These include projects to promote digital and green development, such as grant schemes for the promotion of Renewable Energy Sources (RES) and energy efficiency measures.
In terms of unemployment, according to the CBC’s June forecasts, unemployment is expected to decrease to 6.7 per cent of the labour force in 2023, compared to 6.8 per cent in 2022, and to further decrease to 6.1 per cent in 2024 and 5.6 per cent in 2025, approaching conditions of full employment.
Regarding inflation in Cyprus, the Harmonised Index of Consumer Prices reached 8.1 per cent in 2022 compared to the euro area average of 8.4 per cent.
Based on the latest available data, inflation, continuing its downward trend, decreased to 3.6 per cent in May 2023, compared to 8.8 per cent in May 2022.
According to the CBC’s June forecasts, significant inflation reduction is expected in 2023 to 3.3 per cent, with further moderation of inflationary pressures projected for 2024 and 2025 at 2.3 per cent and 2 per cent, respectively.
The correction of inflation is expected due to further stabilisation of energy prices, the consequent deceleration in food prices, and the impact of the unified monetary policy in the euro area.
“The resilience of the Cypriot banking sector has significantly strengthened in recent years,” Herodotou stated, with the liquidity and capital adequacy of the banking system standing at satisfactory levels.
Specifically, the liquidity coverage ratio stood at 310 per cent as of December 2022, nearly double the corresponding average of the European Union, while the common equity tier 1 capital ratio reached 17.7 per cent.
“Despite the notable progress achieved, challenges persist,” Herodotou said.
“Economic uncertainty, resulting from inflation and the conflict in Ukraine, as well as banking disturbances in the United States and Switzerland last March, has once again demonstrated that there is no room for complacency,” he added.
Therefore, he continued, it is important to create capital buffers that can absorb shocks from unforeseen developments at any given time.
“Within this framework, the Central Bank of Cyprus (CBC) has decided, for the first time in history, to impose a countercyclical capital buffer of 1 per cent,” he explained.
“Cyprus now becomes one of the five countries that have introduced a policy allowing for a positive reserve requirement,” he added.
Furthermore, the CBC governor noted that this reserve can be released during periods of economic crisis, ensuring that banks can continue to provide lending to the real economy.
Additionally, the release of reserves has been seen in other countries to enhance confidence in banks and the economy, thus providing indirect benefits.
“A particularly positive development is the fact that our banking sector has effectively weathered the shocks from international developments,” he said.
“Significant factors contributing to this outcome include the supervisory requirement imposed by the CBC since 2021, which mandates banks to continuously manage the concentration risk in asset elements, so, as a result, our banking system differs significantly from banks that faced problems in the United States due to significant concentration risk in specific bonds,” he added.
In terms of medium-term challenges, Herodotou explained that despite the favourable condition of the domestic banking sector today, there are issues that continue to require timely attention.
The first issue he mentioned was that of Non-Performing Loans (NPLs), saying that these remain high on the supervisory agenda.
“It is a fact that significant progress has been made in managing the issue, but it has not been uniformly addressed, with small and medium-sized banks lagging behind larger banks,” he stated.
The Cypriot banking sector has experienced a significant reduction in NPLs, from 44 per cent in 2017 to 9.5 per cent at the end of 2022, a percentage that is still higher than the EU average of 1.8 per cent.
Regarding small and medium-sized banks, the NPL ratio at the end of 2022 was 25.4 per cent. Therefore, progress has been concentrated in larger banks.
“The uncertain economic environment may further pressure households and businesses to meet their existing obligations,” he said.
“It is crucial for banks to implement fast restructuring processes with reduced charges and no additional costs, focusing particularly on vulnerable customer segments,” he added.
To achieve further reduction of NPLs in the Cypriot banking system, he continued, the Central Bank has entered into an agreement with a consortium of companies consisting of experienced international firms.
The goal is to find a systemic solution that, together with existing tools, will contribute to a significant reduction of NPLs, especially in small and medium-sized banks.
Regarding the developments and discussions taking place, once again, in relation to the framework for foreclosures, the governor stressed that the existence of a stable legal framework is an important prerequisite for maintaining financial stability.
“Returning to practices of the past is not an option,” he said.
“The tool of foreclosures is not an end in itself but a pressure lever to lead creditors and borrowers to viable restructuring solutions,” he added.
Moreover, Herodotou said that the CBC is “open to discussing proposals that address any identified weaknesses”.
“As evidence of this, I cite our support for legislative proposals during recent sessions of the House Finance Committee, where we supported measures that, in our opinion, moved in the right direction,” he explained.
Moving on to another equally important challenge, Herodotou stressed the importance and role of good governance in the prevention and management of crises.
The issue of proper governance is constantly at the centre of discussions, he explained, as “well-governed banks do not fail”.
“It is known that significant and timely crisis decisions are not made on their own,” he added, noting that the continuous strengthening and proper staffing of banks should be a priority for everyone involved.
