The Independent Commission on the Future of the Cyprus Banking Sector has today published its Final Report laying out recommendations for the recovery of the Cyprus banking industry.
The Report was commissioned by the Central Bank of Cyprus, and is the result of a year-long inquiry and more than 100 interviews in Cyprus and abroad. The four members of the Commission are independent international experts on the banking industry and on banking regulation.
The Commission’s report contains some 35 recommendations. The main ones include the following:
1. Cyprus should have a national financial services strategy to provide a framework for an industry which is of vital importance to the country both as a provider of essential services and as a potential earner of foreign business. The objective of this strategy should be to ensure that Cyprus has the resources and processes to manage a sound banking system, plus a clear understanding of the risks that go with a large dependence on banking. The absence of such a strategy was one reason why Cyprus’ banking problems got out of control.
2. The current lack of depositor confidence in banks due to the bail-in is the major issue facing the banking industry. Steady leakage of deposits continues despite the existence of capital controls. The Commission believes that the best way to restore confidence within a reasonable time frame is for the government to issue a state guarantee of all deposits in Cyprus banks, and for this to be backed by a commitment from the European authorities to provide the necessary capital and liquidity support. Without such a guarantee, uncertainty will continue to dog the Cyprus banks and the economy, causing unnecessary damage, for example by constraining the flow of credit and savings.
3. The Bank of Cyprus must return to normality as soon as possible, with a strong executive team skilled in banking recovery, in mergers and in strategy development. It must publish an up-to-date balance sheet, and produce plans for the management of its non-performing loans. The Commission recommends that these be spun off into a separate entity owned by BoC shareholders with a strong incentive to recover value.
4. Reform of the co-operative credit institutions should go further than currently envisaged by forming them into a single joint stock entity under professional central management. Only this way will the co-ops become a strong and efficiently managed commercial entity providing a full range of banking services and giving a stimulus to competition.
5. The Cyprus banking industry will have to undergo major structural reform to achieve viability under the new realities. Costs will have to be cut, branch networks reduced, and high staffing levels brought down. This implies the need for a major shift towards more remote and electronic delivery of banking services.
6. Corporate governance in banks must improve, particularly by introducing independent directors with relevant experience and by installing robust processes to control risk.
7. Reform of the banking sector must include changes to the labour market. Although the banking union has offered cuts in salaries and voluntary redundancies, the collective agreements must be reformed to give management greater control over salary costs, staffing levels, working hours and staff recruitment and promotion.
8. The Commission believes that Cyprus’ international financial services business should continue, but in an upgraded form which relies more on quality and breadth of service than on tax breaks.
9. Measures to strengthen consumer protection, such as a Financial Ombudsman and financial education, should be speeded up, and responsibility for conduct of business regulation should be made more explicit.
10. Among longer term proposals, the Commission says Cyprus should review the structure of its financial services market to ensure that competition thrives, that new competitors can gain entry, and that alternative forms of credit become available, such as a bond market.#
11. Cyprus has a fragmented system of financial supervision, with four separate bodies. The Commission recommends that these be combined into a single regulator within the Central Bank for greater efficiency.
12. Poor governance arrangements at the Central Bank of Cyprus contributed to the 2012 crisis by concentrating too much power in the hands of the Governor. The solution lies in having a stronger non-executive board membership with clearly defined board responsibilities, and a more formalised executive structure.
13. Relations between the Central Bank of Cyprus and other areas of government have not worked as well as they should. These need to be formalized in a way that establishes clearly the role and responsibilities of the parties involved, including provision for regular top level meetings and efficient flows of information.
14. Weaknesses in the supervision of Cyprus’ banks at both the macro- and micro- levels contributed to the crisis. The Commission recommends steps to strengthen these functions and enable them to operate with clearly defined processes. In line with this, the Commission notes that supervision of Cyprus’ largest banks will pass to the Single Supervisory Mechanism at the European Central Bank in Frankfurt next year, and that preparations are being made for this.
15. The audit of Cyprus banks needs to be strengthened. The Commission makes recommendations to improve oversight of the accounting profession, raise the quality of reporting by listed companies and improve relations between banks, auditors and their supervisors.
David Lascelles, the Commission’s chairman, said that while the list of recommendations looked daunting “it is in Cyprus’ power to address all of them”. He added that Cyprus was not alone in facing these issues, and that its banking crisis contains lessons that can help strengthen international best practice in areas such as the management of large banking systems and crisis recovery.
The full report can be found at www.icfcbs.org
