EY Cyprus has presented its report on the Future of Banking in Cyprus, prepared with the support of the Association of Cyprus Banks (ACB). The report has been developed in consultation with local banking experts and senior industry representatives, as well as primary research by ACB on Cypriot banks’ financials.
The report highlights the significant role that the banking sector plays in the economy as a catalyst for growth.
Banks today do not act merely a credit lender and safekeepers of peoples’ wealth, but also support people in a large number of financial transactions, from paying for their coffee, to receiving their salary, settling suppliers, being paid by clients and managing their wealth. Banks support economic growth and prosperity in society through solutions to a wide range of needs.
The Cypriot banking sector is at an inflection point; technological advances, changing customer preferences, increasing competition from the rise of Fintechs, high cost-to-income ratio, growing importance of funding the green transition and record high inflation are some of the challenges that are already changing the landscape and shaping their future. Challenges usually hide opportunities, hence effective response and quick adaptation may unlock significant value for banks.
The report showcases the importance and contribution of Cypriot banks to the wider economy and society, identifies current and upcoming challenges and opportunities, and concludes that the banking needs to transform in order to become Purpose-led, Viable, Safe and Stable and Progressive.
The role and significance of the banking sector
Banking sector activities contributed €1.29bn to Gross Value Added (GVA) in 2020 (6.6% of total), compared to 2.8% in the Eurozone. Despite the heavy losses incurred since the financial crisis of 2013 as a result of loan loss provisions, the largest banks in the sector contributed €216m in 2021 to the national tax revenue, which amounts to 4.27% of the total tax contribution in Cyprus.
Cypriot banks are among the largest employers on the island, employing approximately 7,400 people, or 974 bank employees per 100,000 customers, the third highest ratio in the Eurozone. Bank employees are also better compensated compared to the average salary in Cyprus. Since 2015, the average earnings in the banking sector have been around 1.8 times higher than the average salary across industries.
The loan balance of the Cypriot banking sector has sharply reduced from €63b in 2015 to €28b in September 2022, mainly due to the decrease of NPLs s, resulting in the credit to gross domestic product (GDP) ratio approaching the Eurozone average (80% as of December 2021). However, despite offloading large amounts of NPLs to asset managers, these toxic exposures still remain as part of the economy. . During the same period, deposits have been steadily increasing, approaching double the loans balance, resulting in excess liquidity. As of September 2022, the country’s financial institutions held €51,77b, or 186% of the country’s GDP, in deposits.
The banking sector emerged from the coronavirus pandemic relatively intact, supporting borrowers and the economy alongside impactful Government initiatives. The Russian invasion in Ukraine though, has shaken up economies and political relationships globally, causing disruptions in the production and supply chain of international trade with ripple effects on European economies. Euro-wide sanctions against Russia have a negative effect on energy bills in Cyprus, as the island is heavily dependent on imported energy, highlighting the need for an accelerated green transition. Record breaking levels of inflation have moved markets and are anticipated to stress borrowers’ repayment ability.
Cyprus has been hit from the EU-wide sanctions to Russia with lower inbound tourism, and lower Russian inbound investments. However, Cypriot banks have low credit and debit exposure to sanctioned Russian individuals. Any outflow in liquidity in this period of economic turmoil is expected to be absorbed as Cypriot banks have the highest liquidity coverage ratio in Europe at 314%.
Four pillars for the future
Although transformation initiatives were already underway in the banking sector, the pandemic, combined with the Russia-Ukraine war, have resulted in a new set of market developments and an accelerated transformation pace. Against this background, the report argues that, in order to deal with present and upcoming challenges and opportunities, Cypriot banks must embrace change and progression framed against a set of four key pillars. More specifically, the banking sector needs to become:
Purpose-led, placing the customer at its center, while balancing the expectations of different stakeholders and targeting for long-term value creation to society by respecting the environment and societal needs, promoting equality, and instilling trust.
A purpose-led banking sector is one that places its organizational purpose, a meaningful and enduring reason to exist, at the core of everything it does and how it operates. This involves placing the green transition and ESG at the core of its strategy, improving and repairing trust with the public, acting with integrity and in a humane manner towards its clients and instilling a corporate culture that enables the development of competencies.
Viable, ensuring sustainable profitability by remaining future-oriented through investments in technology, while, simultaneously, delivering value to customers and shareholders to stay competitive.
Banks need to ensure sustainable profitability and generate the desired return of equity (ROE), pursue income diversification by seeking more fee-based services to reduce their dependence on net interest income (NII), and transform their cost base through network reorganization, staff rationalization and digitalization.
Safe & Stable, acting in the best interest of the customer, being transparent and ensuring financial robustness by surpassing regulatory compliance and consumer protection standards and reassuring shareholders with regard to the soundness of their investment.
Cypriot banks’ capital adequacy ratios are higher than the European average, but they need to further reduce their non-performing loan (NPL) ratios down to the European average, even against a background of an unfavorable macroeconomic environment. At the same time, they must increase their efforts to make sure that future developments will find them in compliance with EU regulations on ESG, while also strengthening cybersecurity.
Progressive, by being forward looking, adopting innovative technologies, embracing future trends and remaining competitive against disruptive market entrants and resilient to future challenges.
This involves vigorously pursuing digital transformation to reduce costs and enhance customer experience, preparing for the threat posed by Fintech, and seeking the necessary talent while also investing in re-skilling and up-skilling of existing staff.
For each of these four pillars, the report highlights the relevant challenges and opportunities and outlines the required steps to deal with them:
Purpose-led, by aiming to instill public trust via a more client-centric operating model, by being flexible and responsive to customer needs, and by cultivating a healthy culture in which employees and employers align to deliver the highest possible value to the society and wider economy.
Viable, by pursuing diversification of income and targeted cost optimization, elevate their digital capabilities and advance their technology, or even partner up with fintechs to remain relevant in a tech-savvy world.
Safe and Stable, by acting proactively in identifying and preventing new NPLs from arising, being proactive in setting-up the relevant ESG structures and staff across their organization, develop the skills and invest in the right infrastructure that will keep customer data privacy and safety intact.
Progressive, by offering more ancillary services or integrating the existing capabilities of Fintechs through partnerships, producing synergistic effects; train, re-skilling and redeploying staff along with hiring new talent to line up with the requirements of future banking.
Commenting on the report, Savvas Pentaris, head of Financial Services of EY Cyprus, said: “The Cypriot banking sector is faced with unprecedented challenges in the midst of ground-breaking transformations. To continue playing its key role in supporting the national economy and successfully unlock the new era, it will need to identify current and future trends, challenges and opportunities and balance often conflicting stakeholder needs and expectations. Our report presents a framework for a collaborative and forward-looking discussion, aiming to convey messages to bank executives and stakeholders to embrace the everchanging future, marked by transformation and progress through the four key pillars of purpose, viability, safety & stability and progressiveness.”
On behalf of the Association of Cyprus Banks, Michael Kammas, Director General said: “We are delighted about the report presented today, because it is a very special study in relation to the banking sector of our country. It is the outcome of many months of intensive and thorough work and clearly highlights the importance of the banking sector, the challenges both for banks and the economy, the changes and trends that are being formed but also the great potential arising through the Green and Digital Transition.”
To access the full report, follow this link.