Cyprus banks are failing in giving decent interest rates on customer deposits and in providing sufficient credit at reasonable interest rates to businesses and households to support balanced economic growth and an equitable society.
Instead, Cyprus banks have devoted much of their activity over recent years to the self-serving behaviour of collecting deposits from households and businesses at very negative real interest rates and redepositing a large portion of their abundant funds at interest rates of up to 4 per cent at the ECB.
In supporting economic growth and society, Cyprus banks are performing much worse than their counterparts in the euro area. Indeed, over the last two years to March 2024 Cyprus banks used on average a mere 40 per cent of their assets in loans and advances, whereas the systemically important banks of the euro area allocated an average of over 60 per cent of their assets to such lending.
Conversely, Cyprus banks piled up cash amounting to around 37 per cent of their assets over these two years, while the systemically important banks of the euro area held a much lower average of 13.5 per cent of their assets as cash.
The overriding propensity of Cyprus banks to keep their ample excess reserves as cash at central banks rather than using their funds to extend new loans can be explained by a number of factors.
Firstly, after the financial crisis of 2012/13 that was caused in large part by banks carrying a very large amount of NPLs, bankers became ultra conservative in their lending practices complaining that many loan applicants were uncreditworthy.
Secondly, following the financial crisis bankers increasingly realized that they could make more money by calling-in impaired loans, getting NPLs off their balance sheets and passing them onto credit acquiring agencies, and selling the related property collateral to third parties, rather than extending more risky new loans.
And, thirdly, more recently, with the increases in interest rates on overnight deposits of banks held at the ECB, Cyprus banks preferred to maintain very large proportions of their assets in cash earning up to 4 per cent interest risk-free, as opposed to extending more risky new credits at higher interest rates.
Consequences
The bottom line is that Cyprus banks are deploying are large proportion of their resources unproductively in depositing “idle” cash at the ECB in order to make profits for their shareholders, many of which are foreign equity and investment funds. Instead, Cyprus banks should be supporting the economy with much greater amounts of financing of investments in productive projects, that would constitute the mainspring of economic development.
Furthermore, Cyprus banks are contributing to widening inequalities in the sense that the majority of the credits they extend, such as mortgage loans, require backing by property collateral, resulting in wealth inequalities being perpetuated with poorer citizens being discriminated against and becoming less able to get on the “property ladder”.
In addition, the anti-social behaviour and greed of Cyprus banks is demonstrated by their interest rate policies, which despite their abundant funds and their lower funding costs, charge borrowers much higher loan rates than most banks in the euro area.
In May 2024 the average bank loan rate for a house purchase was 4.53 per cent in Cyprus, whereas the average for other banks in the euro area was 3.80 per cent. And for bank loans to non-financial corporations the average interest rate charged by Cyprus banks was 5.73 per cent in May 2024 compared with 5.10 per cent charged by other euro area banks.
But, it is on bank term deposits where interest rates in Cyprus have shown the greatest difference with their euro area counterparts. In fact, in May 2024 Cyprus banks were offering an average interest rate of just 2.02 per cent on deposits with an agreed maturity up to one year, while euro banks on average were offering a much higher 3.11 per cent.
Furthermore, the corresponding interest rate on deposits from non-financial corporations in Cyprus was 2.29 per cent compared with that offered by other euro area banks of a much higher 3.64 per cent.
Thus, as a consequence of suppressed deposit rates and relatively high loan rates Cyprus banks have a much higher interest rate margin than the majority banks in the euro area. In 2023 and the first 5 months of 2024 it is estimated that the average net interest margin of Cyprus banks was above 3.0 percentage points, whereas the average of other euro banks was below 1.5 percentage points.
Indeed, in 2023 the elevated net interest margins of Cyprus banks together with the very large amount of interest income received from the ECB estimated at over €650 million, contributed most importantly to increasing their profits to €1,273 million compared with €171 million in 2022.
Policy challenges
Major challenges for the Cyprus authorities are to induce the Cyprus banks to allocate a greater portion of their assets to extending longer-term loans to finance real economic activity rather than holding huge amounts of cash to gain short-term profits, while at the same time easing the burden on borrowers with lower loan rates and raising deposit rates to provide real returns to bank customers.
These tasks will be difficult to accomplish and Central Bank Governor Christos Patsalides, as a member of the ECB Council, needs to argue that a further significant reduction in the ECB’s overnight deposit rate from the current 3.75 per cent is required to encourage banks to deploy their surplus liquidity in providing more loans to finance real production at lower interest rates
However, given that Cyprus banks have made abnormally high profits mainly from engaging in activities such as deriving much interest income from the ECB while providing hardly any benefits to the economy and citizens of Cyprus, there would appear to be a compelling need to tax such abnormal profits.
Notably, the Spanish government imposed a temporary levy of 4.8 per cent on the net interest income and commissions of banks for 2023 and 2024. Thus, it is welcome that the political party Akel recently submitted a similar proposal to the House of Representatives for the taxation of such bank revenue of Cyprus banks for 2023 and 2024, calling for the proceeds of the tax to be used in providing interest rate subsidies on loans to lower and middle-income borrowers.
Bank deposits are the main means for saving by Cyprus households. And moral suasion should be employed by the authorities to pressure banks to raise deposit rates above the ongoing rate of inflation so that holders of fixed-term deposits do not suffer further erosion in the real value of their savings.
In truth, Cyprus banks need to display more social sensitivity and the government could help as well by lowering the defence tax rate on interest income from the current 17 to say 7 per cent.
And banks need to shift away from approving loan applications for financing projects on the basis of whether the borrower has the collateral to secure the loan to one where loan approvals are premised on the ability of the borrower to repay the loan from their income.
But, with Cyprus bankers very reluctant and seemingly incapable of significantly changing their lending practices, especially with respect to project financing, as well as the corrupt and wasteful use of resources in the negotiation and execution of PPP projects, the need for an alternative financing institution is paramount.
Hence, as long recommended by fellow economist Savvakis Savvides and this author, serious consideration should be given to setting up an independent Development Bank tasked with evaluating and financing large-scale investment projects.
Otherwise, the continued building and purchase of properties based on collateral financing in an already over-supplied property market of commercial establishments and apartments, would in the event of a marked decline in property collateral prices, bring about another crisis in construction and related sectors.
Furthermore, without a fundamental shift away from an economy based importantly on the financing of property development and consumerism, including the unrelenting surge in the purchase of motor cars, towards financing projects to expand sectors such as vocational education, research and old-age, child and health care, the Cyprus economy will be condemned to experience little productivity growth and low private sector wages.
These developments in turn would mean hardly any advances in the standard of living of most citizens and the need, also, for more lowly-skilled migrant labour, as Cypriots continue rejecting employment in poorly paid jobs.
Les Manison 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
