Central Bank of Cyprus (CBC) governor Christodoulos Patsalides on Wednesday opposed the imposition of a windfall tax, emphasising that such a tax would harm the economy by disrupting the necessary fiscal predictability needed to attract foreign investors to a small, open economy like Cyprus.

The CBC governor expressed this viewpoint during his first press conference since taking office.

Moreover, Patsalides highlighted the need for changes in the governance of the CBC, stating that this institution must undergo a transformation.

He indicated that broad powers would be granted to the executive members of the bank’s board of directors.

Addressing the state of the Cypriot economy, Patsalides made note of its robust growth, urging stakeholders to utilise this period for reforms to enhance economic resilience.

Regarding interest rates in Cyprus, Patsalides remarked that following the European Central Bank’s (ECB) initial reduction of key rates, the gap between lending and deposit rates is moving in the right direction, albeit at a slow pace.

In this context, he warned commercial banks of the risk of appearing insensitive to these changes.

Additionally, he expressed approval of the acquisition of Hellenic Bank by Greece’s Eurobank, noting that it would boost competition.

Commenting on the ECB’s interest rates, Patsalides was non-committal about future actions, stating that the ECB would consider upcoming inflation data before making decisions.

The need to boost resilience

In his statements, Patsalides emphasised that the Cypriot economy is experiencing “very good growth rates,” highlighting significant fiscal surpluses and a declining public debt.

These factors are crucial for Cyprus, he explained, especially as many countries strive to meet the Maastricht criteria, which dictate that the government budget deficit must not exceed 3 per cent of GDP, while public debt must be limited to no more than 60 per cent of GDP.

He mentioned that while banks are performing well with high capital ratios, strong return on equity, high liquidity, and improved asset quality, non-performing loans still exceed the European average.

“We are not out of the woods. Cyprus cannot afford to be below average,” he stated.

Patsalides also stressed the need for urgent action, warning that the current positive outlook could change.

“There is an economic cycle, and as a small open economy, we are vulnerable to external shocks,” the governor said.

“We must act decisively to become more resilient,” he added, before calling on both public institutions and the private sector to use this period to prepare for potential disruptions, acknowledging both known and unprecedented risks.

Excessive liquidity described as a distortion

Regarding interest rates, Patsalides explained that due to the small size of the Cypriot economy, interest rate adjustments do not align with the rest of Europe.

He noted distortions such as the excessive surplus liquidity in Cyprus, which takes time to balance out. He pointed out that lending rates have risen faster because banks offer variable-rate loans, whereas other countries have more fixed-rate loans, particularly for mortgages, which are less common in Cyprus.

Patsalides linked this issue to financial literacy, noting that Cypriots are reluctant to pay higher rates for fixed-rate loans or insurance premiums to hedge against rising rates.

He recounted his unsuccessful efforts to promote fixed-rate loans as a banker in the 1990s, stating that “this a distortion that does not exist elsewhere, and it will take time to balance”.

Ethical standards for banks

Regarding the narrowing gap between lending and deposit interest rates, Patsalides said this is progressing slowly.

He noted that the CBC has directed banks to adhere to internal governance guidelines, which include ethical standards derived from the European Banking Authority (EBA).

Patsalides stressed that a more balanced relationship between banks and their clients is necessary.

He called on banks to consider the reputational risk of appearing insensitive to social concerns.

“Reputational risk includes public dissatisfaction, which cannot be ignored,” Patsalides said, noting that “banks have an obligation to consider all risks, including social discontent, which can lead to dangerous outcomes”.

“We advise banks to adopt strategies that better account for social sensitivities,” he added.

Patsalides also highlighted the need for better asset management and linked this to financial literacy.

“Gradually, we need to explore other options, such as deposits in other Eurozone banks, bonds, and other investment products,” he stated.

Cyprus must avoid imposing a windfall tax on banks

When asked about proposals to impose a tax or levy on so-called bank windfall profits, Patsalides revealed that he had met with Akel, the party which had presented such a proposal.

He acknowledged the seriousness of the proposal but maintained that “a windfall tax does not help the economy; instead, it harms it”.

“The undesirable spread between deposit and lending rates should be managed through measures that alleviate the problem, not through taxation,” he said.

He added that “taxation will not help,” emphasising that the concept of windfall profits does not exist in economic theory.

He noted that such ad hoc taxes cause side effects in the economy without providing solutions and stressed that any tax reform must be predictable.

Patsalides pointed out that the Cypriot economy relies on investments, particularly from abroad, which help reduce the current account deficit.

Furthermore, he warned that the cost of such taxes would ultimately fall on consumers and borrowers, as banks would pass the cost on to them, a phenomenon observed in other countries with similar levies.

“Imposing an extraordinary tax is not a good idea, no matter how well-intentioned, because it ultimately causes more harm than good,” he said.

CBC in favour of Hellenic Bank acquisition by Eurobank

Regarding the acquisition of Hellenic Bank by Greece’s Eurobank, which has received supervisory approvals from the Single Supervisory Mechanism (SSM), the ECB, and the CBC, Patsalides said, “We at the CBC view Eurobank’s application positively, as we believe it will enhance competition.”

Describing Eurobank as a significant institution supervised by the SSM, he said that “we do not see any problem or anything that would cause us to think negatively”.

He confirmed that the CBC had raised some issues to protect the Cypriot economy but had ultimately approved Eurobank’s application.

Banking license applications from “serious banks” welcome

On the subject of granting banking licences to fintech companies, Patsalides confirmed that there are applications and it is common for various entities to seek banking licences.

“New banks in Cyprus, provided they are serious and meet supervisory criteria with a viable plan, are welcome,” he said, emphasising that the CBC only considers banks with serious business plans, noting that Cyprus is too small to attract a large number of banks.

Non-performing loans

Regarding the reduction plan for non-performing loans (NPLs) held by credit acquisition and management companies, with a nominal balance of €21 billion, Patsalides acknowledged these loans as a burden but stated that economic growth mitigates their impact.

He noted that the main concern is that these companies hold properties for sale, which could potentially affect property prices more broadly. However, he noted that “at the moment, we do not see such a risk”.

CBC transformation

Patsalides also stressed that the CBC needs to be transformed to become more effective.

Saying that “everything [currently] depends on the governor,” Patsalides noted that at some point there needs to be “a broader mechanism for decision-making”.

He mentioned that, as an initial step without legislative changes, he created a coordination team to address all issues.

He explained that as studies for changes in the CBC’s governance progress, all issues will eventually be brought to the senior management level for discussion.

He highlighted that although there are earlier studies on changing the CBC’s governance that had received the ECB’s consent, he noted there were some constitutional issues.

He stated that he is in discussions with the SSM and other central bank governors to find the best practices, while at the same time issuing a reminder that there are peculiarities involved, such as the use of English law and the provision for a Turkish Cypriot deputy governor.

He mentioned that this issue is a priority for him, but changes must be made in a legally sound manner.

Finally, he said that “broad powers” would be granted to the Executive Members of the CBC’s board of directors and added that the sectors each member will take over have already been decided and will be announced to the staff in consultation with the CBC’s legal department.