A windfall tax on the banks’ big profits would harm the economy, Central Bank governor Christodoulos Patsalides said last week, in his first news conference since taking the job. He explained that such a move would undermine the fiscal stability that is essential for attracting foreign investors to Cyprus.

He had made a good point, which did not occur to politicians, with their tendency for short-term thinking. They believed that demanding a windfall tax on bank profits would win public support as the banks are not popular organisations. But what foreign business would invest in Cyprus when it could be slapped with a windfall tax on the whim of a political party wanting to boost its support?

Patsalides, who was optimistic about the performance of the economy, still warned that a more balanced relationship between banks and their customers was necessary. He raised the issue of “reputational risk” linked to appearing insensitive to social concerns that led to public dissatisfaction, something which could not be ignored. “We advise banks to adopt strategies that better account for social sensitivities,” he said.

It is not often a central bank governor asks commercial banks to show awareness to social sensitivities, but it was a diplomatic way of telling the banks to reduce the heavy-handedness, often verging on arrogance, with which they treat many customers. But the “reputational risk” he spoke about might not be of great concern to the banks for which good customer relations are not the priority they used to be in the past.

As the governor said last week, there were distortions such as the excessive surplus liquidity which takes time to balance out. This problem was partly cause by the absence of fixed interest loans in Cyprus, which caused lending rates to rise faster – they did not align with the rest of Europe – and create “an undesirable spread between deposit and lending rates”. It does not help that the banks can deposit their excess funds at the ECB and earn a handsome return with zero risk involved. They can charge higher interest rates on loans to businesses and households, but there is risk.

A survey carried out by the central bank found that demand for loans in the first quarter had declined because of the high interest rates while the number of loan applications being rejected by the banks had risen, because of the introduction of tougher criteria. These are not positive developments for the economy and its growth prospects. When businesses decide against investment in expansion because the cost of money is too high, this is bound to have an adverse effect on economic growth.

Falling demand for loans could also be seen as a fall in confidence in the economy’s prospects, which is not a good sign. In theory, the market will eventually find its equilibrium, but nobody can predict how long this will take nor how an extended period of the distortions the governor spoke about would impact the economy.