Lower liquidity ratios on foreign currency deposits is expected to allow Cyprus banks to increase their lending without the need to raise additional capital, thus helping their bottom line profitability according to a research note by Egnatia Financial Services.
The local banking system consists of 13 commercial banks controlling 64.6% of the total market in deposits which account for CYP 27.4b as at August 2006 and 51.8% of market loans and advances which account for CYP 21.1b. The domestic banking sector is dominated by the Bank of Cyprus (BOC), the Cyprus Popular Bank (CPB) and Hellenic Bank (HB), all of which are listed on the Cyprus Stock Exchange.
Commercial banks control the largest share of deposits and advances in the domestic economy while we note the sizable share of co-operative credit institutions. The co-operative sector comprises of over 330 cooperative and credit institutions. In specific, 282 co-opearive societies and 66 co-operative savings banks control 18.2% of the total market in deposits and 17.6% of market loans and advances.
Indeed, there is a high degree of fragmentation in the coops market with the biggest 5 institutions capturing just about 10-12% of total segment assets. The plethora of credit institutions are one-branch units, lacking infrastructure, product knowledge and sophistication. Currently the supervision of the coops is carried out by the Cooperative Societies Supervisory and Development Authority (CSSDA). Despite the fact that the CSSDA liaises with the Central Bank of Cyprus for the supervision of the coops, the supervisory regime remains weaker than that for the other commercial banks.
As a result, coops have been able to charge higher deposit and lower lending rates than other commercial banks.
The Central Bank of Cyprus anticipates that the ongoing consolidation process in the cooperative sector will cause a large number of coop’s to come under the management of the Cooperative Central Bank by the end of 2007 and thus under the supervision of the Central Bank.
Finally, local authorities stressed that the overall liquidity of the cooperative credit institutions is sound and that no capital injection will be needed to align indicators with EU standards. A five year transitional period, following Cyprus’ EU entry was given to the coops to achieve this realignment to EU regulations.
International Banking units cover 17.1% of the total market in deposits and 30.7% of market loans and advances. Cyprus has a prominent international banking environment which provides financial services to international companies based on the island.
A mature banking system …
The banking/financial services sector in Cyprus is relatively mature and saturated as indicated by the substantially high ratio of total deposits to GDP (current market prices), which stands at c. 328%. Local deposits to GDP however, stand significantly lower at c. 212% still considered exceptionally high relative to the Greek market and other European countries.
Loans to local residence to GDP stand at c. 129% (excluding credit cooperatives) whilst if we include both IBU’s and credit co-operative institutions the ratio climbs to 252%. These figures are well above European averages and much higher than Greece and other South European countries.
….But growth will emanate from:
Lower liquidity requirements: Ahead of Cyprus’ entry into the EMU on January 2008, the potential of lowering liquidity requirements on foreign currency deposits would allow better use of the local excess liquidity and should consequently strengthen overall organic profitability (through resilient NIMs).
It is of paramount importance to note that growth for local banks would arise from the fact that on foreign currency deposits, a minimum 75% liquidity requirement is imposed by the Central Bank, such that 75% of these deposits should be kept in liquid form yielding only a very small fraction above LIBID.
With EMU entry currency risks should be eliminated and thus the Central Bank of Cyprus could lower its current practice and thus significantly reduce its reserve requirement ratio, without the fear of causing any unwelcome disturbances in the local banking system (and currency). In this respect, this will allow local banks to increase their loans/deposit ratio through additional lending facilities, with positive effects on NIMs.
In specific, foreign currency deposits in Cyprus come at around CYP 7.66b and account for 45.9% of deposits from local banking institutions. The majority of such foreign currency deposits come from non-residents (c. 85%) and have so far proved resilient to recent shocks (Iraq war and Israeli conflict in Lebanon).
According to Central Bank officials, approximately 2/3rds of non-resident deposits are denominated in USD, whilst the balance is equally broken down between EURO and GBP.
Assuming that with Cyprus’ EMU entry: (a) 100% of the EUR currency deposits can be lent out under the same reserve requirements as CYP deposits, and (b) no other relaxations occur in relation to the other foreign currency deposits held by the banks, then the loan book of the three listed local banks would have the capability to expand up to an additional c. CYP 5b, Egnatia notes.
This would effectively translate to c. 7% increase in the aggregate EPS of the three listed banks in 2008 (assuming that the extra lending is all taken in FY08).
Capture market share from coops: Egnatia anticipate that market shares within the local Cypriot banking system will improve in the next couple of years in favour of banking institutions, away from cooperative credit institutions (coops). In order to conform to EU and BASEL II criteria the coops will be obliged to operate under stricter regulations concerning their capital adequacy ratios. As a result we expect coops’ market to be negatively affected, as they will have to offer less competitive prices. The management of all three listed local banks target to gain additional market share each year in consumer lending, which we believe to be a very plausible target.
Local listed banks remain well capitalised: The Central Bank of Cyprus’ (CBC) statutory Capital Adequacy ratio for the commercial banks is set at 10%, above the European Central Bank’s statutory levels of 8%. Despite these stricter criteria set by the CBC, all three major local listed banks have historically well exceeded the CBC’s statutory floor level.
With EMU integration and euro adoption the CBC can choose to lower its Statutory level towards ECB’s Statutory levels. This may free up additional resources to be used for additional expansion of the banks. Consequently, this would possibly mean an improvement in the banks’ loan to deposit ratio (and thus the market’s as a whole) as they will engage in additional lending facilities.
Profitability could thus be hiked, as NIMs would tend to improve. Even if the CBC’s statutory requirement remain unchanged, local banks still have excess liquidity funds which will allow them to proceed with their further expansion.
