Despite making easy money, Cyprus banks not helping economy and society
By Les Manison
Cyprus banks have benefitted considerably from the higher interest rate policies of the ECB since mid-2022, which has enabled them to substantially boost their profits. Over the same period banks have markedly increased their loan rates and charges., but have suppressed rises in customer deposit rates.
Moreover, with Cyprus banks making easy and safe money from their very large deposits at central banks (ECB now paying 4 percent per annum on its deposit facility) banks are likely to be more reluctant in financing projects that support economic growth.
Developments
When Cyprus exited the adjustment programme with the “Troika” of international institutions in March 2016 it was stated that financial stability had been restored with banks well-capitalised and furnished with adequate funds to back a sustained recovery of the economy.
However, as argued in previous opinion pieces, since 2015 there has been a persistent failure of banks to deploy their ample funds in extending interest-bearing loans to finance productive investments in the real economy.
Consequently, banks deposited ample amounts of their idle cash balances or excess reserves at the ECB earning negative interest over the period from December 2014 to July 2022. And owing to the poor composition of their assets, that included a very large amount of NPLs as well as their excessive cash balances, banks recorded very low profits or losses in the period from 2015 to mid-2022.
By end-June 2022 the cash and cash balances held by systemically important Cyprus banks had accumulated to 17.9 billion euro and was above their outstanding total loans of 17.6 billion euro. As a result, the return on assets of these Cyprus banks was extremely low averaging 0.02 per cent for the six months ending June 2022. In sharp contrast other systemically important banks in the euro area employed a greater proportion of their total assets in interest-bearing loans and, thus, the resultant return on their assets averaged a much higher 0.46 per cent according to the supervisory statistics of the ECB.
But in the first nine months of 2023, despite failing to increase significantly their portfolio of loans at higher interest rates, Cyprus banks recorded very large increases in their profits. In fact, in the first three quarters of 2023 the profit of the Bank of Cyprus increased to 349 million euro compared with a loss of 19 million euro in the corresponding quarters of 2022, while the profit of Hellenic Bank rose to 241 million euro from 74 million euro between these same two periods.
The extraordinary increase in the profits of these two Cyprus banks and also that of Eurobank Cyprus is attributable mainly to their much higher net interest income recorded in the first three quarters of 2023, stemming mostly from the greater interest income received on their holdings of deposits at central banks. The latter in turn reflected the profound change in the interest rate policy of the ECB, with the rate on its deposit facility increasing in steps from zero on July 27, 2022 to 4 per cent on September 20,2023.
More specifically, interest income of the Bank of Cyprus increased by 62 per cent to over one billion euro in the first nine months of 2023 compared with 630 million euro in the same period of 2022, mainly owing to the increased receipts from its huge deposits at the ECB. Similarly, the profits of Hellenic Bank benefitted from a more than doubling of interest income from its considerable holdings of deposits at the central banks.
In addition, the suppression of deposit interest rates for bank customers has contributed to increased profitability of Cyprus banks. In fact, the net interest margin of the Bank of Cyprus increased steeply from 1.36 percentage points in the first nine months of 2022 to 3.32 percentage points in the corresponding period of 2023, while the net interest margin of Hellenic Bank rose from 1.47 percentage points to 2.59 percentage points between these two periods.
Practical Implications
What should be of major concern to policy-makers in the euro area is that, especially given current uncertainties and the high interest rates on deposits of banks at the ECB, bankers are likely to be more reluctant to use their funds in risky lending to businesses and households, but will play it safe by profitably deploying their excess reserves in deposits in relatively high interest-bearing deposits at the ECB.
Furthermore, there is the danger that banks under the fractional reserve system may increasingly engage in creating deposits by advancing loans (that is, “creating money out of thin air”), and lodging additions to their excess reserves as deposits in the ECB at relatively high interest rates. And if interest rates paid on customer deposits are kept significantly below those on deposits at the ECB there is the prospect also that banks will just collect deposits mainly to profit from redepositing them at the ECB.
To lower the incentive to place excess reserves in deposits at the ECB interest rates on these deposits should be reduced to levels less than those on fixed deposits offered by banks. And to increase the demand for bank credit via lower bank loan rates the ECB should decrease interest rates on its lending facilities.
In truth, with Cyprus banks not having a funding problem, the real issue for policy-makers is to ensure that their funds are used productively to contribute to the growth of the real economy without jeopardising financial stability. And to guard against their return to very low profitability when inevitably ECB deposit rates are reduced, it would be crucial that Cyprus banks make much greater use of their funds in extending interest-bearing loans to businesses and households so as to raise their profits and support the economy.
Unfortunately, in the long aftermath of the 2012/2013 financial crisis, Cyprus bankers have continued to be pre-occupied with the self-centred lucrative activity of calling-in and selling their NPLs, instead of focusing their efforts on identifying and using their funds to finance worthwhile projects. Probably this deficiency results from bankers generally not having the ability to competently appraise the income potential of investment projects and the borrower’s capacity to repay, seemingly just basing their lending on the security or collateral of the borrower.
Accordingly, there is a compelling need in Cyprus to create a decent project financing capability both within and outside banks. And as has been argued repeatedly by Savvakis Savvides and this author an independent development-type bank should be set-up. Ideally, such an institution could take the lead in appraising and financing large-scale projects including the many investments proposed under the Recovery and Resilience plan.
And although, banks may be improving the quality of their asset portfolios with the selling of NPLs and related property collateral to third parties, they are not relieving private sector entities of their heavy debt obligations. While bank NPLs relating to NFCs and households are estimated to have been reduced by over 24 billion euro between December 2015 and June 2023, debt outstanding of NFCs and households has been decreased by just 1.7 billion euro to 60 billion euro or to 209 per cent of estimated 2023 GDP.
Furthermore, the sale by banks of NPL related property collateral to private investment and equity funds at large discounts is merely resulting in the transfer of wealth to richer entities rather than real wealth creation. Instead, it should be the production of real wealth for the economy together with the provision of good customer service that banks should aim at in conducting their financial activities and operations.
Leslie G Manison is an economist and financial analyst. 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
