Patsalides’ message to the banks over the risk to their image and reputation

The Governor of the Central Bank of Cyprus (CBC), Christodoulos Patsalides has sent a message to the banks suggesting that, when formulating their pricing policy, they should take into account the social aspect, and also the strengthening of the economy’s competitiveness.

Speaking to the Cyprus News Agency, he warned the banking sector about the risk of erosion to their image and reputation.

A few days before the session of the Board of Directors of the European Central Bank (ECB) on monetary policy issues due to take place on 18 October, Patsalides referred to the sluggish economic growth of the Eurozone and also to indicators of economic trends, such as the PMI (Purchasing Managers Index), which fell below the 50-point mark, to emphasise that "there seems to be room for interest rate cuts."

He also emphasises, however, that all the data should be discussed, simultaneously including putting any effects from the developments in the Middle East in the equation.

In his interview with CNA, Patsalides notes that the Cypriot economy has shown significant resilience in the midst of continuous external shocks, with growth rates that far exceed the EU average, stressing that the strengthening of the economic development path should be based on expanding the productive fabric, fiscal discipline, structural reforms, as well as strengthening governance based on the best international practices, both in the public and private sectors.

Regarding the image of the banking sector in Cyprus, Patsalides recognises the high levels of capital and liquidity that characterise the Cypriot banking system, to emphasise that there should be no complacency, highlighting the emerging risks, such as geopolitical, climate and cybersecurity, risks that are not easy to predict and assess.

"Today's sound financial indicators are not capable by themselves of ensuring long-term stability and sustainability," he underlines.

He announced changes in the direction of the regulatory burden at the end of the year, along with the orderly operation of banks in serving their customers, without differentiating the goal of zero tolerance in the fight against money laundering.

Finally, regarding the transformation of the CBC, Patsalides says that the role of the Cypriot supervisory authority requires the adoption of a reliable central banking model, bearing in mind the evolution of the ECB itself and the characteristics of Cyprus. "Collectivity and efficiency are needed in the way decisions are made and executed," he points out.

The full text of the interview, translated from the original Greek, can be seen below:

The Cypriot economy has shown signs of resilience both during the pandemic and during the escalation of geopolitical challenges that followed. Where should we focus policy decisions so as to make the growth outlook of the economy more sustainable?

The Cypriot economy has indeed demonstrated considerable resilience and flexibility despite the successive geopolitical and other upheavals of recent years, showing growth rates higher than the euro area average – in the second quarter of 2024, the GDP recorded a growth rate of 3.6%; far exceeding the corresponding growth rate in the Eurozone which was 0.2%.

The diversification achieved in economic activity contributed to this, for example the promotion of the tourism product in new markets, the information-communication-technology (ICT) sector, shipping services, and professional services, which despite the negative effects of the ongoing sanctions against Russia, seem to be recovering in recent quarters.

The strengthening of the development course of the economy must be based on the further expansion of the production network, the maintenance of public finance discipline and the dynamics of structural reforms, as well as the strengthening of governance based on the best international practices - I am referring to those sectors, both public and private, that operate with regimes and perceptions that now belong to previous eras.

Cyprus, as a small and open economy, is called upon to compete adequately in a rapidly changing international environment. The emerging risks and challenges in the new geopolitical, climatic and technological setting force the modernisation of the economy and society.

What do you think of Mario Draghi's report on the competitiveness of the EU? He spoke of an existential challenge and estimated that around 5% of Europe would need to be invested in to achieve digitalisation, decarbonisation and to strengthen the Union's defense capability.

The Mario Draghi report is an important project for the future of the European Union. It highlights the challenges and opportunities regarding competitiveness. It explains the strategic importance of a Europe capable of addressing the issues of digitalisation, meeting the decarbonisation target, and the need to strengthen the competitiveness of the economy in relation to other major economies.

Ensuring sustainable development and strategic autonomy does require substantial investment.

European institutions should study and discuss this report with the aim of formulating the appropriate direction and policy.

The debate on the need to strengthen the competitiveness of the European economy as a whole demonstrates the importance for the continuous modernisation of small Cyprus.

Interest rate reduction

The Governing Council of the ECB recently proceeded with the second reduction of the deposit rate (now the main rate of monetary policy) by 25 basis points, setting it at 3.5%. The eurozone economy is showing subdued growth rates with GDP growth in the second quarter falling to 0.2% from 0.3% in the first quarter, below the ECB's forecasts. With this in mind, could monetary policy be overly restrictive? The market is taking for granted another tapering in the monetary policy session in December. Do you share that assessment or will a move be required in October?

As the Governing Council of the ECB, we continue to consistently follow an evidence-based approach and take decisions on a meeting-by-meeting basis to determine the appropriate monetary stance to achieve the 2% inflation target.

Indeed, there is sluggishness in terms of economic activity and inflation. The Composite Purchasing Managers Index (PMI) for the euro area fell from 51 in August to 49.6 in September, indicating a slowdown in economic activity (below the 50 mark). Inflation is expected to decrease in September to 1.8% from 2.2% in August.

Based on the above, there seems to be room for a reduction in interest rates. But all new data should be discussed, as usual. Among other things, any implications of developments in the Middle East should be assessed.

Estimates for the banking sector

Cypriot banks now show a high capital adequacy (the highest in the EU based on the latest EBA data). At the same time, they show significant excess liquidity and profitability. How do you evaluate the performance of the banking sector, and in general the financial sector in our country?

After a difficult decade, the banking sector today presents very high ratios of capital adequacy, liquidity, and profitability, among the highest in the euro zone.

In the first half of 2024, the banking sector's common equity capital ratio stood at 22.5% compared to the European average of 16.1%, while the liquidity coverage ratio reached 328% compared to the European average of 163.2%. During the same period the return on equity reached 21.3%, much higher than the European average of 10.9%.

NPLs have made substantial progress and are at a single-digit rate (6.9%). However, they are still above the average of the Eurozone banks, while progress was not uniform across all credit institutions.

It is noted that, despite the increase in interest rates to deal with inflation, NPLs do not show a deterioration, while in some other euro zone countries the quality of the loan portfolio is declining.

Despite the healthy performance of the banking sector as a whole, there should be no complacency. As the Chair of the ECB's Supervisory Board, Claudia Buch, recently stated, emerging risks such as geopolitical, climate, and cyber risk are not easy to predict, assess, and therefore manage.

In view of this, how we ensure the highest levels of governance becomes even more important. A cornerstone of the ECB's Single Supervisory Mechanism, which celebrates its tenth anniversary this year, is the promotion of good and effective governance. Cyprus, as an active member of the Single Supervisory Mechanism, benefits the most from the experience and quality of the exercise of supervision.

CBC addresses all credit institutions by sending the message that it attaches particular importance to governance issues. Today's sound financial indicators alone are not capable of ensuring long-term stability and sustainability.

The CBC is the competent state body for ensuring financial stability. It acts as a Macroprudential Authority and participates in the European Systemic Risk Board (ESRB) which is charged with the supervision of systemic risks in the EU financial system.

In this context, the CBC assesses the stability of the entire financial system, including the banking sector, insurance companies, investment funds, electronic money institutions, etc. Financial risks are analysed in detail in the CBC's Annual Financial Stability Report and concern among other things, the over-indebted private sector and the exposure of financial institutions to the real estate sector.

These risks intensify when international macroeconomic conditions deteriorate. The CBC has tools at its disposal to mitigate and deal with such risks.

Finally, I would also like to refer to the field of electronic money institutions, which is developing at high rates as a result of the rapid development of digital technology. The CBC aims at proper proactive and dynamic supervision in this area as well.

Deposit and lending rates

However, coming back to the banking sector, I would like to point out that it has perhaps the largest "gap" between deposit and lending rates in the Eurozone, which creates discomfort for both depositors and borrowers. Perhaps the banks should absorb some of the rising interest rates, as part of their corporate social responsibility?

As I have mentioned in the past, Cyprus is a small economy and it is normal that prices, in this case interest rates, do not adjust at the same speed as in other larger economies.

Lending rates in Cyprus react with a time lag of one and two quarters to changes in the ECB's key interest rates.

Additionally, due to the small size of the market, it is common for some trades to deviate from the broader trend.

However, the course of lending rates remains downward with the average cost of new borrowing showing a decrease of more than 0.60% from the maximum interest rate towards the end of 2023.

Deposit rates have lagged more due to comparatively higher excess liquidity than the rest of the eurozone. Therefore interest rate margin is decreasing, but slowly.

Despite this, Cypriot credit institutions should demonstrate a more comprehensive approach in terms of their pricing, taking into account the social aspect as well as strengthening the competitiveness of the economy.

In the medium term, the interest of the shareholders of the banks should be aligned with the goals of society and with ensuring the competitiveness of the economy - the Cypriot business. Otherwise the image of the banking sector will be eroded and reputational risk may lead to undesirable results.

Recently, the CBC made public for the first time the levels of deposit and lending rates per credit institution. What was the purpose of this move?

This move was intended to further strengthen transparency. In this context, the CBC proceeded to publish on a monthly basis, analytical data of weighted average interest rates for various lending and deposit products, per bank.

This publication facilitates public information, providing households and businesses with immediate access to more complete information. But I emphasise that households and businesses should continue to be informed by the credit institutions themselves about the interest rates on offer.

The CBC will further expand this information and intends to promote changes in the regulatory framework regarding reputational risk.

You have had some meetings with both the Association of Cyprus Banks and business organisations on the subject of requirements from banks for regulatory compliance. What was the outcome and what are the suggestions for the banks towards reducing this regulatory burden?

We had meetings with the Association of Cyprus Banks, as well as with organszed bodies such as OEB, KEBE and others. Among other things, we discussed issues of regulatory compliance, and in particular the operation of banks with regard to anti-money laundering regulations.

The goal is the more orderly operation of the banks to serve their customers, without differentiating the goal of zero tolerance.

The Association of Cyprus Banks, in cooperation with the other bodies, has responded satisfactorily to our request. CBC's goal is to complete our effort by the end of the year.

In the first press conference you gave after assuming your duties, you spoke about the need to transform the CBC with the aim of a broader decision-making mechanism. How are you going about this? Have you looked at other Central Bank models of Eurosystem members? What do you think would be the optimal model for the CBC?

In my interview I repeatedly referred to the need for good administration and good governance, both in the public and private sectors, with specific references to the banking sector.

The CBC plays a pivotal role in the Cypriot economy and is an integral part of the European System of Central Banks. Consequently, it is necessary for the CBC to respond to the demands of the times in an efficient manner and on the basis of best practices. This requires the adoption of a reliable central banking model, bearing in mind the evolution of the ECB itself and the characteristics of Cyprus.

The CBC actively participates in a large number of committees and working groups of the ECB, the Single Supervisory Mechanism, and the European Systemic Risk Board.

The effective participation and contribution of Cyprus to the European vision requires, in my opinion, the modernisation of the CBC governance model. Collectiveness and efficiency are needed in the way decisions are made and executed.

In addition, the reorganisation at the level of management bodies is required with the aim of orderly operation, enhancing efficiency, and strengthening the culture of risk management and internal control.

(Sources: CNA, InBusinessNews)