15.09.2022
The Governor of the Central Bank of Cyprus (CBC), Konstantinos Herodotou, addressed the Association of Cypriot Banks during the latter’s annual general meeting on Wednesday, touching on the uncertainty surrounding the current economic climate, as well as how Cypriot banks are coping with the current set of challenges.
During his speech, Herodotou said that in light of soaring inflation, especially in terms of energy prices, the ECB decided last Thursday to raise the ECB’s three key interest rates by 75 basis points, following a previous increase of 50 basis points in July.
The move accelerated the transition from long-term negative interest rate conditions to levels that would contain inflationary expectations, with the goal of inflation returning to a medium-term target of 2 percent.
Herodotus explained that the increase adopted last week is not a foregone conclusion in terms of the final level of interest rates.
“We must regularly review the course of our monetary policy in the light of incoming information and changing inflation prospects,” he said.
“In our monetary policy efforts to bring inflation down to the 2% target, it is important that fiscal policy be designed in a way that does not run counter to this goal,” he added, noting that “supporting fiscal policy therefore must be measured”, and targets vulnerable social groups, strengthening social cohesion in these difficult times, as well as supporting the green transition.” Regarding the Cypriot economy, Herodotus said that there has been significant growth so far, despite the outbreak of war.
The gross domestic product (GDP) of Cyprus recorded an annual increase of 5.8% in the second quarter of 2022, and overall GDP growth in the first half of 2022 was 6%.
“This significant growth is mainly based on a faster-than-expected recovery in tourism-related activities and, to a lesser extent, an increase in activity in the information and communications and professional services sectors,” the Governor said. “It is noted that the consequences of the war in Ukraine were not significantly reflected in the first half of the year, but they are likely to be more pronounced in the second half of this year and in 2023.”
In light of the delay in reflecting the true consequences of the war in Ukraine, Herodotus said Cypriot banks should continue to pursue prudent policies.
“They will have to constantly adjust their financial plans in order to solve emerging problems. While the direct effects of the geopolitical crisis are still considered manageable, the indirect effects are still in the process of crystallizing and are likely to affect the profitability and asset quality of banks,” Herodotou said.
The central bank governor said that while the policy of normalizing interest rates may improve interest income, it may not be enough to address the internal weaknesses that some banks face.
Herodotus was referring to the level of non-performing loans, increasing costs relative to income, limited sources of income, competitive pressure from companies operating outside the traditional banking space, the changing needs of today’s clientele, and the need to carefully manage investments in government bonds.
“Therefore, the banking sector must adapt its business strategies to the new realities arising from the pandemic and war crises, and this will not be an easy task,” he said.
Among the issues mentioned to Herodotus was the adjustment of the business model of the Cypriot banks and the provision of technologically modernized services, with digitalization being the main focus of these efforts.
“While low profitability is a broader structural European problem, the cost-to-income ratio of the Cypriot banking sector, which stood at 76% in June 2022, is significantly higher than the corresponding European Union average of 63%,” said to Herodotus.
“Investment in technology can be a catalyst for efforts to increase efficiency and close the gap with the rest of the eurozone,” he added.
Herodotus also said that the risks of climate change should also be a factor Cypriot banks should consider, which includes efforts to reduce Europe’s dependence on Russian energy, as this could significantly increase the cost of going green.
In addition, the Governor also referred to banks’ internal governance structures, noting that they are expected to have the necessary checks and balances in place to take measurable and acceptable risks and manage any conflicts of interest promptly and effectively.
Herodotus also spoke about the relationship of banks with their customers, emphasizing that it is in the interests of both consumers and banks to develop relationships of mutual respect and trust.
