Cyprus has lowest deposit rate hike among selected countries, agency finds

The Cypriot banking system presents the lowest rate of transmission of increased interest rates to deposit rates, according to an analysis report released this week by rating agency DBRS Morningstar, a reflection of local banks’ significant excess liquidity.

According to the report, the rating agency noted that since the end of 2021, the 12-month Euribor rate, which is considered the key interest rate in the European market, has increased from -0.5 per cent to approximately 3.75 per cent, representing a cumulative increase of 425 basis points.

This has been beneficial for the profitability of European banks as the increased interest rates have been “passed on” to lending rates.

“However, by the end of April, the corresponding increase in deposit rates was limited in EU banks,” the agency stated.

Based on the agency’s calculations, by the end of April, the corresponding increase in deposit rates was only 13 per cent of the average increase rate of the 12-month Euribor since the end of 2021.

According to DBRS, Cyprus has the lowest rate of increase in deposit rates among the selected countries it used for its analysis, with only 2 per cent, while the highest rate is recorded in France with 23 per cent.

However, the agency pointed out that there are various factors explaining the different transmission rates of interest rate increases to depositors, with an important factor being the type of deposits and the financial structure of each banking system.

“As a result, banking systems with a large proportion of stable retail deposits and deposits held as liquidity and working capital tend to have less pressure to pass on the interest rate increase to deposit costs,” the agency said.

For example, according to the agency’s analysis, the Cypriot banking system has a percentage of over 70 per cent in household deposits and over 15 per cent in corporate deposits, while government deposits and deposits from other financial institutions have much lower percentages.

Moreover, it should be noted that the Cypriot banking system is characterised by high liquidity, ranking among the highest in the EU.

On Tuesday, Constantinos Herodotou, the governor of the Central Bank of Cyprus stated that the liquidity coverage ratio (LCR) reached 310 per cent at the end of 2022, a rate almost double the EU average.

Additionally, according to data from the European Banking Authority, the Cypriot banking system at the end of 2022 recorded the second-highest deposit-to-total-assets ratio at 41 per cent.

Consequently, DBRS cited an analysis by the Central Bank of Spain that explains the variation in deposit interest rates, such as the liquidity situation in each banking institution or the use of financing from central banks.

However, according to the agency, there are various indicators that indicate that deposit costs will increase for European banks at a faster pace than expected.

It highlighted the fact that a significant amount of liquidity provided by the ECB to banks through targeted longer-term refinancing operations (TLTRO III) is expected to be repaid at the end of June.

It is worth noting that Cypriot banks have already partially repaid TLTRO funds without putting pressure on their deposit base.

The agency also stressed that pressure for an increase in deposit rates in European banks will intensify due to deposit outflows, which are being moved out of banks and into financial products with higher returns.

This phenomenon, it explained, is more pronounced in jurisdictions where increases in deposit rates are more limited, such as Spain and Portugal.

However, in an analysis of deposit outflows from their peak until April 2023, Spain and Portugal experienced the largest reductions at 3.8 per cent, while the corresponding decrease in Cyprus was 1.13 per cent, which is the average for the Eurozone.

Finally, the agency linked the issue of deposit rates to bank profitability, stating that “increases in deposit rates will demonstrate whether the improved profitability of EU banks, as recorded in the recent quarters, is structural, and thus more permanent, or temporary”.