The banking sector in Cyprus remains healthy with local banks maintaining adequate liquidity and capital, and thus do not need capital injections or state aid from the government, Central Bank Governor Athanasios Orphanides said during a presentation of the Central Bank's 2008 report.
“This does not mean that a rise in lending growth is forecast for 2009 as the drop in economic activity and increased uncertainty will weigh,” said Orphanides, adding that there is a significant drop in loan applications due to the slowdown in the property sector but loans are also lower as a result of tougher lending criteria applied by the banks.
While taking credit for the sound state of the Cyprus banks until the global credit crisis started end of 2007 to early-2008, Orphanides did not wish to take responsibility for any turn for the worse in the affairs of local banks, in response to a question by the Financial Mirror.
“We are following developments closely, but there is no need to intervene as banks are handling the situation well and they recently passed stress tests applied here,” said Orphanides, who has been at the helm of the Central Bank for two years and two days.
Legal opinion
Referring to the dispute over who at the Central Bank should approve or reject applications to increase stakes in the capital of Cyprus banks beyond the benchmark 10%, Orphanides said based on legal opinion received from the Central Bank’s external legal advisor, the responsibility lies solely with the Governor.
The Republic’s Law Office, however, has not yet given its verdict, which may still decide that such responsibility lies with the board of the Central Bank, which is entrusted to draft policy and for the Governor to implement it.
Low growth
Orphanides made particular reference to the two forecasts issued on Monday by the European Commission and a week before by the IMF, warning that the rate of growth in Cyprus in 2009 will be 0.3% and 1%, respectively, in sharp contrast to the government’s rosy forecasts.
“The Central Bank's projections which will be published next month are not expected to differ significantly (from the EU Commission's) forecasts,” he said.
Despite the deterioration, the Cyprus economy is faring better than other eurozone countries because of its strong fundamentals and the fact that it entered into the crisis in a very healthy state.
“We were perhaps lucky since in the run-up to euro adoption, Cyprus shaped up its finances with the government recording successive fiscal surpluses, which are now being drawn on to meet emergencies and finance stimulus schemes,” Orphanides said.
Interest rates
In trying to explain why interest rates charged by Cyprus banks are significantly higher than in other eurozone markets, Orphanides said this was partly due to local banks funding their liquidity through deposits, which at the height of the global credit crisis and competition from Greece, forced many to hike rates to defend their deposit base.
However, Orphanides aligned himself with the opposition DISY party, advising the government to accelerate the reduction in interest rates by proceeding with the issue of 3-year maturity bonds and not for 8-9 months, which prevent banks from planning ahead.
Drastic measures
Orphanides, who is a member of the European Central Bank Governing Council, called for drastic conventional and non-conventional measures and a long-term strategy to normalise the world financial system.
“The financial crisis which peaked in September-October 2008, leading to the biggest recession of the past 60 years, was the result of an underestimation of investment risks… and the lack of a powerful and effective supervisory framework.”
The ECB seems certain to cut its main policy rate by 25 basis points to a record low 1% on Thursday, but there is uncertainty over further, non-standard steps that it may announce.
Such steps could include the ECB "printing money" by expanding its balance sheet through purchases of bonds or other assets. This would mean the ECB joining other central banks, such as the U.S. Federal Reserve, in a policy of quantitative easing.
“(The) vicious cycle is not easy to overcome without drastic conventional and non-conventional measures (which) several governments and central banks have adopted and continue to adopt,” Orphanides said.
“Along with interest rate cuts and the non-conventional measures taken by central banks, there are also fiscal stimulus measures by governments. In the eurozone, this is easier to implement by countries where fiscal consolidation has taken place so that there is room for fiscal expansion,” he said.
“These decisions must be taken within a well thought-out framework. Measures to confront the crisis must be temporary and well-targeted so that countries' long term fiscal balance is not put at risk,” Orphanides said.
The 16-nation euro zone economy is not expected to recover until the second half of next year, the European Commission projected on Monday as it lowered previous GDP forecasts, reflecting the depth of the recession.
Despite positive signs, the Commission expects the eurozone economy to shrink by 4.0% this year with the overall fiscal shortfall tripling by 2010.
Orphanides said the ECB's six rate cuts since October 2008, totalling 300 basis points, coupled with liquidity injections in the interbank market, had helped to subdue financial market turmoil and keep long term inflation expectations stable.
