Central Bank of Cyprus (CBC) governor Christodoulos Patsalides on Monday highlighted the importance of taking a forward-looking approach to assessing individual risks, combined with a thorough analysis of the prevailing environment in which organisations are called to act.

This approach, he explained, is relevant both when devising agricultural policy and making decisions about granting a new loan or calculating provisions for non-performing loans.

Patsalides’ comments were part of a speech presented at the Credit Risk Management Conference, organised by ICAP CRIF and the Artemis Credit Bureau.

This year’s conference revolved around the impact of ESG on credit risk, as well as the challenges companies and other organisations have to navigate in this context.

In his speech, which focused on the current challenges in the banking sector and the implementation of credit risk analysis in times of economic uncertainty, Patsalides outlined several key factors that need to be taken into account.

These include the profitability of a company operating in a sector with a heavy environmental footprint, unexpected disruptions to the supply chain caused by geopolitical instability, as well as the impact of cyberattacks.

“Fortunately, in recent years, these concerns—encompassing, among others, the broader lens of Environmental, Social, and Governance (ESG) risks—have been elevated to key aspects of risk management across the business spectrum,” he said.

“This elevated role of newly emerged risks, cultivated in the context of the prolonged uncertainty we face globally and on multiple levels, undoubtedly presents challenges for the banking system but simultaneously creates opportunities,” he added.

These opportunities, he continued, “could, on one hand, greatly enhance the catalytic role of the banking sector in the challenging journey towards a green transition, and on the other hand, forge a more resilient, more reliable system in managing broader, non-traditional risks—particularly in an era rife with instability and asymmetric threats to financial stability”.

He then delved into the dual role of risks, challenges, and opportunities, and how they are positively transforming the banking system and, by extension, the entire economic activity.

Patsalides emphasised that integrating new risk factors into credit risk management is now a transformative force in financial analysis, fundamentally altering how banks evaluate borrowers’ risk profiles.

“These factors are now central at every stage of the credit lifecycle,” he said, noting that “from initial evaluation and loan origination to ongoing monitoring, including forecast modelling”.

This approach, he stated, mirrors their increasing weight within the broader European regulatory landscape.

Patsalides explained that, historically, banks focused primarily on traditional indicators like cash flow, liquidity, and leverage ratios to assess creditworthiness.

However, today’s economic uncertainties have expanded the scope of risk assessment, necessitating “a more holistic approach that goes beyond conventional frameworks,” he remarked.

Now, banks must consider an array of emerging factors—environmental, social, and governance-related risks—alongside geopolitical instability and the sharp rise in cyber-attacks, which, he said, “all require careful and thorough evaluation”.

Moreover, he said that at the loan origination stage, financial institutions are increasingly expected to conduct a comprehensive assessment of how these emerging factors impact a borrower’s creditworthiness.

“This broader evaluation reflects a growing recognition of these risks’ long-term implications for businesses,” Patsalides pointed out.

He noted that these additional insights help gauge a business’ future viability and its ability to meet financial obligations.

This evolving risk landscape, Patsalides said, calls for a more sophisticated, forward-looking approach—one that now encompasses “not just financial dimensions but also broader, long-term risks and factors previously seen as secondary or even overlooked”.

Patsalides highlighted how environmental risks, like extreme weather and climate change, can significantly impact a borrower’s resilience and creditworthiness.

“Prolonged heat or drought can severely affect weather-dependent industries, potentially rendering some business models unsustainable,” he said.

He also pointed out that social and governance factors are increasingly crucial in credit assessments.

“Labour practices, employee wellbeing, and corporate ethics directly influence a company’s reputation and financial stability,” Patsalides stated, adding that poor governance could lead to legal and reputational risks with severe financial consequences.

Moreover, Patsalides further warned about the effects of geopolitical risks and growing protectionism on credit risk.

“Global tensions disrupt supply chains, impacting market stability and raising the risk of default,” he remarked.

He added that these disruptions can also drive inflation and slow economic growth, challenging both businesses and households and potentially undermining banks’ asset quality and capital position.

Patsalides also said that modern threats go beyond traditional military conflicts and sanctions, extending deeply into digital and infrastructure realms.

“Our banking system now faces unprecedented risks,” he said, noting that the shift towards digitalisation and online payments has opened doors to cyber threats that can undermine banks’ very sustainability.

“Cyber-attacks or IT failures pose serious risks, potentially destabilising even healthy business units,” he warned.

He cited the 2014 cyber-attack on Code Spaces, a cloud provider that was ultimately forced to shut down.

“This incident underscores why IT risks must be part of credit risk analysis, as such vulnerabilities can be fatal,” Patsalides stated.

Commenting on recent cyber threats targeting Cyprus, he said that “while these attacks may not directly impact banking systems, they pose a broader risk that could affect credit profiles across the economy”.

The CBC governor also stressed that the banking sector is increasingly prioritising the integration of emerging risks—environmental, social, technological, and geopolitical—into credit risk management frameworks.

“These factors have become central to assessing credit risk at all stages, from loan origination to ongoing monitoring,” he stated.

He explained that this shift reflects a more comprehensive approach, looking beyond conventional financial indicators like cash flow or leverage, to consider how broader risks might affect a borrower’s long-term creditworthiness and resilience.

One of the main challenges, Patsalides said, is the scarcity of high-quality, reliable data, particularly from small and medium-sized enterprises that form a substantial portion of Cypriot bank loan portfolios.

“Inconsistent or incomplete data limits banks’ ability to fully assess the impact of these emerging risks,” he said.

Furthermore, even for large borrowers with better disclosures, integrating these data points into traditional credit risk models proves challenging.

The dynamic nature of climate change and geopolitical tensions calls for predictive, forward-looking models, which traditional frameworks lack.

“The short-term strategic planning of banks often clashes with the long-term horizon of these risks,” he added, noting that many risks will take decades to fully manifest, far beyond the typical credit risk assessment period.

Despite these difficulties, Patsalides highlighted the importance of strong governance frameworks in managing these risks effectively.

He advocated for open collaboration within banking institutions to ensure that risk management decisions reflect collective wisdom and account for the complex factors shaping the sector.

“Clear division of responsibilities within governance structures also helps banks detect, identify, and address risks more efficiently,” he stated.

However, he also underlined that addressing these emerging risks also presents opportunities for banks to lead in sustainable finance.

“With a proactive, forward-looking approach, banks can strengthen their risk management frameworks and serve as models for sustainable finance, supporting the shift to a greener and more resilient economy,” Patsalides said.

He pointed out that banks that successfully incorporate these risks will be better positioned to identify quality credit opportunities and support clients in meeting global sustainability goals.

This approach, he continued, would ultimately benefit banks’ access to capital markets and reduce financing costs, enhancing their competitive edge.

“The emerging risks cultivated in recent years amidst the current economic uncertainty will increasingly affect the financial stability of banks and the wider economy,” Patsalides said.

“The future demands collaboration, innovation, and an unwavering commitment to embed these factors at the heart of credit risk management,” he added.

“This is essential for the progress of the economy, to strengthen its resilience, maintain financial stability, and, overall, to create conditions for a prosperous future for the present and future generations,” the CBC governor concluded.