Cyprus banks are enjoying soaring profits thanks to interest rate hikes by the European Central Bank (ECB). However, they are showing reluctance to support growth projects and instead prefer to deposit funds with the ECB, which offers a secure 4% return. This conservative approach is posing a challenge for policy-makers who want the banks to play a role in supporting the real economy.
Why are Cyprus banks experiencing soaring profits amid economic indifference?
Cyprus banks are seeing soaring profits due to the European Central Bank’s interest rate hikes, which have increased their net interest margins. However, they show reluctance to finance growth projects, preferring the safety of ECB deposits offering a 4% return. This conservative stance is challenging for policy-makers who want banks to support the real economy.
Financial Gains in the Shadow of ECB Policies
Cyprus banks have experienced a significant windfall following the European Central Bank’s (ECB) decision to hike interest rates in mid-2022. This monetary policy shift allowed Cypriot financial institutions to enhance their profit margins substantially. While loan rates and various banking fees have seen a considerable uptick, the banks have been less generous when it comes to increasing customer deposit rates, maintaining a notable imbalance.
The Reluctance to Support Growth
The increased profits come with a caveat—banks appear hesitant to fund projects that could bolster economic expansion. This reluctance stems from the lucrative interest banks now earn from sizeable deposits parked at the ECB. Currently, the ECB’s deposit facility offers a tempting 4 percent yearly return. This secure income stream may be discouraging banks from engaging in what they perceive as riskier project financing.
Analyzing the Financial Landscape Post-Troika Programme
Following Cyprus’s departure from the Troika’s adjustment programme in March 2016, a financially stable landscape was promised, with banks supposedly equipped to support economic recovery. Yet, the reality has deviated. Banks have been amassing excess reserves at the ECB, even when these balances earned negative interest, which was the case from December 2014 to July 2022.
By mid-2022, systemically important Cypriot banks held cash reserves exceeding their loan portfolios. Consequently, these banks had a meager return on assets, a stark contrast to other major European banks, which utilized a larger portion of their assets for interest-accruing loans.
Profits Surge Despite Static Loan Portfolios
The first nine months of 2023 told a different story, with Cypriot banks like Bank of Cyprus and Hellenic Bank reporting substantial profit growth, mainly attributed to the higher net interest income from ECB deposits. The net interest margin of these banks increased significantly, benefiting from the suppressed deposit interest rates for their customers, enhancing their profitability.
The Practical Concerns for Euro Area Policy-Makers
Policy-makers now face a dilemma: banks may prefer the safety net of ECB deposits over lending to businesses and households. This conservative approach could be detrimental amid current economic uncertainties and high ECB interest rates. There’s also the risk of banks potentially creating money by issuing loans and channeling these funds back into high-interest ECB deposits, fostering a cycle that benefits banks over their customers.
To mitigate these tendencies, it could be argued that ECB deposit rates should be adjusted to disincentivize the hoarding of excess reserves. Moreover, to stimulate the demand for loans, the ECB could consider lowering rates on its lending facilities. The core challenge for policy-makers is encouraging banks to use their resources to bolster the real economy sustainably.
The Long Shadow of the Financial Crisis
The aftermath of the 2012/2013 financial crisis has seen Cyprus banks focus on liquidating non-performing loans (NPLs) rather than investing in potential growth projects. This focus could be due to a lack of expertise in effectively assessing investment opportunities or an overreliance on collateral for loan approvals.
There is a pressing need for enhanced project financing capabilities within Cyprus, potentially through the establishment of a development-focused bank. Such an entity could spearhead the evaluation and funding of large-scale investments, such as those under the Recovery and Resilience plan.
As for the private sector debt, the banks’ sale of NPLs and associated collateral has not significantly alleviated debt burdens. Instead, these actions often result in the transfer of wealth to richer entities, rather than generating new economic value.
Bridging the Gap Between Profitability and Economic Contribution
Ultimately, banks should prioritize fostering real economic growth and delivering exceptional customer service. By reorienting their financial activities towards these ends, they can truly contribute to a thriving economy, rather than merely enhancing their own profit margins.
Quick Recap
- Cyprus banks are experiencing soaring profits due to interest rate hikes by the European Central Bank (ECB).
- However, the banks are reluctant to support growth projects and prefer to deposit funds with the ECB, which offers a secure 4% return.
- This conservative approach poses a challenge for policy-makers who want the banks to play a role in supporting the real economy.
- Cyprus banks have benefited from the ECB’s interest rate hikes, increasing their profit margins.
- Despite the surge in profits, banks are hesitant to finance projects that could promote economic expansion, opting for the safety of ECB deposits.
