José Manuel Campa interview with Phileleftheros: "Cypriot banks should not be complacent"

Joint call by the Chairperson of the European Banking Authority and the Governor of the Central Bank of Cyprus, in an interview with Phileleftheros

It is clearly not random: the Chairperson of the European Banking Authority (EBA) José Manuel Campa and the Governor of the Central Bank of Cyprus (CBC) Constantinos Herodotou used almost the same words to draw the attention of Cypriot banks to the current difficult environment in which they operate. In response to questions raised by Phileleftheros, on the sidelines of the EBA Chairperson’s visit to Cyprus, Mr Campa and Mr Herodotou warned the banking system that there is no room for complacency, despite the good results of the banks in recent years. According to Mr Campa, ‘the uncertain macroeconomic environment, high interest rates, persistent inflation and weak economic growth leave no room for complacency’ as ‘these conditions may affect the borrowers’ debt repayment capacity. We have already seen some signs of deterioration in asset quality at EU level and there is a risk of contagion to bank balance sheets in the future.’ For his part, the CBC Governor told Phileleftheros that the good standing of the banks at various levels ‘would certainly justify no complacency at all. On the contrary, allowing our banking system to keep adapting to current global upheavals and international shocks requires sustained and unwavering efforts on the part of all those involved.’

In the interview published on page 10 of the Financial Edition of Phileleftheros, Mr Campa noted, among other things, that the Q1 2023 preliminary results show that the Cypriot banking sector has recorded one of the highest return on equity. He was happy to note that Cypriot banks have made progress in writing off distressed assets from their balance sheets in recent years, also stressing, though, that they need to keep up the good work in this respect, as well as that the return of Cypriot banks to profitability also needs to be pointed out. He also stressed, however, that the sudden change in the interest rate curve requires careful interest rate risk management on the part of the banks, also making this meaningful comment: ‘This development also has an impact on the banks’ funding costs and we would expect interest rates on deposits to rise, albeit from a very low level.’

Mr Constantinos Herodotou also made an interesting comment on the scheme that CBC had prepared in 2021 for the management of non-performing loans and foreclosures, which is likely to be used 2 years later through a proposal made by the governing parties, with the consent of the current administration of the Ministry of Finance. ‘The scheme is targeted and aims to put in place operational arrangements that will prevent it from being abused or circumvented. The Central Bank of Cyprus is ready, if necessary, to help further strengthen the scheme’, reassured Mr Herodotou.

The Replies of the Chairperson of EBA, José Manuel Campa

To what extent is the Cypriot banking system of concern to the EBA today? Are there still causes for concern and worry?

Cypriot banks have made progress in writing off distressed assets from their balance sheets in recent years. Non-performing loans (NPLs) are now just over EUR 1 billion or about 3% of total loans, which is significantly lower than the levels reported a few years ago. The ratio is closer to, but still higher than, the EU average of 1.8%. Cypriot banks should keep up their good work in this respect.

The improvement or return to profitability of Cypriot banks is also a fact to be noted. In fact, the preliminary results for Q1 2023 show that the Cypriot banking sector has recorded one of the highest return on equity. Profitability has benefited from rising interest rates and widening margins, coupled with low funding costs. Higher profitability has helped Cypriot banks to further improve their solvency ratios, while at the same time the sector reported very high levels of liquidity. However, the uncertain macroeconomic environment, high interest rates, persistent inflation and weak economic growth leave no room for complacency. These conditions may affect the borrowers’ debt repayment capacity. We have already seen some signs of deterioration in asset quality at EU level and there is a risk of contagion to bank balance sheets in the future. Moreover, the sudden change in the interest rate curve requires careful interest rate risk management on the part of the banks. This development also has an impact on the banks’ funding costs and we would expect interest rates on deposits to rise, albeit from a very low level. Some Cypriot banks may also need to meet their MREL requirements, and increased funding costs may make this effort more difficult.

Cypriot banks have been criticised in recent months for not increasing deposit rates. Do you believe that the relationship between interest rates on loans and deposits should be interdependent?

This phenomenon is not observed in Cyprus only. In fact, we see similar behaviour in other European countries. This phenomenon may be more visible in the euro area today. There may be several reasons for this low level of interdependence. These reasons may include available excess bank liquidity and lower dependence on deposits for bank funding. One could also cite the lack of investment alternatives for depositors, in a rather uncertain macroeconomic environment. Or there may be behaviour-related explanations, such as depositors not having had the time to react to the historically rapid pace of interest rate rises. That said, we have already seen some shift from demand deposits to time deposits, as depositors try to secure returns on their savings. In view of what we have seen in previous cycles of monetary tightening, we expect this repricing to pick up speed over the coming months.

For the Cypriot economy, the level of non‑performing loans (NPLs) is still a serious problem. If a borrower obtained the right to take legal action to challenge the foreclosure or the balance of their debt, would that development be of concern to the EBA?

As I said before, a lot of progress has been made in terms of the quality of the balance sheets of Cypriot banks. This is due to the efforts made by banks and supervisory authorities and the existence of strong political determination. Part of the work that the EBA has done with regard to NPLs includes the benchmarking of national insolvency frameworks. One of the conclusions of this work is that an effective legal system contributes to higher recovery rates and more timely recovery. I would not like to comment on the ongoing discussions regarding the Cypriot legal framework for foreclosures, but I would like to stress how important an effective judicial system is for bringing NPLs to a manageable level and keeping NPL inflows under control. And while NPLs are kept at a manageable level, one should of course not forget that EU legislation – e.g. the Mortgage Credit Directive and the requirements adopted by the EBA to support it, such as the guidelines on the treatment of borrowers in arrears – confers rights on consumers and obligations on lenders, which must also be respected.

The interview was conducted by Chrysanthos Manolis

Phileftheros (Cyprus)