The last time politicians and bankers ignored sound banking practice we got the 2013 haircut

By Erol Riza

Last week the two major opposition parties locked swords with Akel calling for a windfall tax on the “unexpected” earnings of the banks while Disy accused Akel of populism, wishful thinking and likely to cause harm to Cyprus’ economy and reputation if its policies were implemented.

The unexpected millions announced by the banks is not a Cyprus phenomenon. The billions of deposits held by eurozone banks with the European Central Bank (ECB) had until 2022 to suffer a cost in terms of negative interest rates, and this was changed dramatically (ten times) when the ECB raised interest rates by 4 per cent, an unprecedented increase, to fight inflation. Since 2022 the huge deposits held by banks at the ECB have been earning millions in interest. Akel may argue that the earnings were unexpected, or rather unearned, since the earnings of the banks was not because of increased lending but that would be a wrong argument.

Both parties should refrain from publicly arguing about the banking system since the events of 2013 should have taught them a lesson. The banking system suffered a huge loss of trust, and it took the sacrifice of depositors and a big injection of state aid to stabilise the banking system. It should not be the object of politics and it is for the government, in consultation with the ECB, to discuss what if any action the banks should be asked to take. The parties may have their own ideological views and difference of opinions on banking but that should not be brought out in the manner it has been in the local media.

The evidence that banks have not earned all their profits from increased financial support to the economy may be inferred, but not definitely, in the statistical bulletin of the Central Bank of Cyprus. While some lending has taken place the total lending to the economy shows no change as some of the increased lending was offset by repayments of loans from the private sector. 

According to the Statistical Bulletin published by the Central Bank of Cyprus total Monetary and Financial Institutions (MFI) loans to non-MFIs’ domestic residents were €23.3 billion at the end of 2022 while at the end of 2023 the amount outstanding was €22.2bn. The key sectors which received the total loans were non-financial corporates (NFC) and households (outstanding at end 2023 €11.7bln against 12.6bn for NFC and for households the amounts were €24.4bn at end 2023 against €25.5bn. For domestic borrowers the amounts were NFC €8.9bn against €9.9bn and for households €20.2bn against €21.6bn for the same period, a small decline in outstanding loans to corporates and households.

This does not necessarily mean that the banks did not support the economy, or their earnings were unexpected, since banks offer other services and products to their customers which oil the economy. The main source of earnings of banks was the widened interest rate differential in lending and this was not unexpected.

Even if the banks earned millions from their deposits with the ECB it did help banks build their capital positions and led to better risk assets on their balance sheets. When seen in the context of the financial soundness of the banking system the improved capital and risk assets are a welcome set of developments, and this is reflected in the improved ratings of banks and of Cyprus. 

The vital numbers on banks’ deposits with the ECB are obtained from the ECB data published on its website; these show that from the end of 2020 the deposits of Cyprus banks stood at €12.9bn, at end 2021 €22.9bn, at end 2022 €23.8bn, at end 2023 €23.6bn and at end March 2024 €21.0bn. Thus, one can see that there was a very significant increase of deposits at the ECB from 2021, but this alone does not explain the earnings announced. Debt securities held by banks were moderately higher from €13.9 to €19.1bn and in a rising interest rate environment can cause losses on a market to market basis. This partly offset some of the gains and the ECB also refers to this in its opinions given to selected EU member states. 

Cyprus’ authorities and politicians should look at the opinion of the ECB to the Bank of Spain when the Spanish government sought to introduce a windfall tax and similarly to the Italian finance ministry, The Netherlands, Slovenia and Lithuania. 

The relevant reasoning given by the Spanish parliament was that it sought to levy a tax for social reasons while most other countries sought extra revenues for their budget. The proposed Spanish imposition was to be temporary and that the levy should contribute to the meeting of social pact (pacto de rentes) to ensure an equitable distribution of the burden of inflation across Spanish society.  The proposed levy was for Spanish banks whose earnings exceeded €800m and was set at 4.8 per cent. The levy should not have any direct or indirect financial impact on clients. 

In all cases the ECB opined that the imposition of a windfall tax on banks’ earnings owing to higher interest rates was not recommended as it could affect the adequacy of capital and the financial soundness of banks as well as impact the bank-based transmission of monetary policy to the wider economy.  The ECB said that an equitable income and profit distribution needed to be addressed by appropriate fiscal measures.

In reply to the Dutch authorities the ECB opined as follows “In effect, such taxes could have negative economic effects by limiting credit institutions’ ability to provide credit, contributing to less favourable terms for customers when providing loans and other services. It is essential that credit institutions have a sound capital base for them to fulfil their role as credit intermediaries within the economy. Higher costs and reduced credit supply, or higher costs of other banking services, can adversely affect real economic growth.”

In Cyprus it appears the parties have not looked at what other EU member states did and what the correct process was advisable. The parties should not seek to score political points just ahead of an election and the responsible process is for the parliament to ask the finance ministry to seek the opinion of the ECB as to the efficacy and the validity of a windfall tax on banks’ unexpected earnings. If there is one thing both Akel and Disy should learn it is to work within the ECB norms that any actions that affect banks is not in the gift of the government only, but they should seek the ECB’s views. The last time politicians and bankers ignored the norms of sound banking practice/process, assisted by lack of good corporate governance at the board level, it led to the resolution of two banks and the bail in of the Bank of Cyprus. Has nothing rubbed on politicians in Cyprus not to meddle in matters that are not their mandate?

Instead, parties could lobby the finance ministry and the Central Bank of Cyprus to ask bank boards to make a voluntary contribution of a percentage of their profits towards the fund set up by the government to compensate depositors who with the state bailed out the largest bank in Cyprus and stabilised the whole banking system. Had there been a resolution of the Bank of Cyprus there would have hardly been a banking system to talk about.  Instead of the share buybacks announced by the Bank of Cyprus it could contribute to the fund!

Erol Riza is former managing director of DEPFA Investment Bank and former vice- chairman of the Interim Board of Bank of Cyprus 2013