By Stephen Ptohopoulos ACIB, CCBI*
Disclaimer: Views and opinions expressed are those of the author and are not necessarily those of his employer.
The aim of this article is to give an overview of some of the main issues and challenges that banks in Cyprus are likely to face and the impact they might have on their strategies.
Perhaps the first thing that springs to mind is that of non-performing loans (NPLs). Measures have effectively been put ‘on hold’ due to the negative impact of the COVID-19 pandemic on the incomes of firms and households. The key challenge for bank loan officers will be to identify which businesses are in financial distress essentially as a direct consequence of COVID-19 but are otherwise viable and which have problems that pre-date and/or go beyond the pandemic (so-called ‘zombie firms’). The banks will need to work closely with those businesses experiencing financial difficulties in the present but which have good future prospects, to help them through this difficult period. The most immediate, short term objective will be for these businesses to find ways to preserve cash-flow. The next step could be for the banks to work with these businesses to explore ways to keep them afloat until the time they can safely re-commence trading when the economy re-opens, be it by means of government financial assistance, repayment ‘holidays’, bank bridging loans or debt re-structuring, provided always that the bank is satisfied that the business is able to repay any money advanced. At the same time, as has been pointed out by Savvides¹ the demand for new bank lending is likely to remain subdued as long as levels of private debt remain high.
The low interest rate (‘lower for longer’) environment represents a big challenge for the Cypriot banks. The pressure on net interest margins (NIMs) combined with high cost structures represents a considerable constraint on bank profitability. On the cost side, banks will continue to reduce overheads, chiefly staff / payroll costs, through a combination of natural wastage and early / voluntary retirement schemes, leading to lower headcounts. The banks will need to step up efforts aimed at diversifying income, with the quest for new sources of non-interest (e.g. fee based) income, thus reducing their dependence on interest-related income. The banks will also be exploring ways to increase productivity e.g. through new ways of working, greater automation and digitisation of operations as well as business process reengineering (BPR).
¹ Stockwatch blog posted by Savvakis C. Savvides on June 6th 2017: Private debt is the problem
The consolidation of the Cyprus banking market which has been encouraged and driven by the regulators – at the Eurozone and national level – is likely to continue; mergers and acquisitions (M&A) will be explored as strategic choices for Cypriot banks, given its potential to produce cost-efficiencies while at the same time leveraging an expanded customer base and revenue streams.
The economic uncertainty and challenging operating environment faced by the banks shows why the ability to manage capital is important.
The banks in Cyprus need to consider how to remain relevant to a growing demographic that socialises, shops and transacts online, using smartphones and other devices connected to the internet. The adoption by consumers of ‘digital behaviours’ – as exemplified by the uptake of e-commerce and contact-less payments – has accelerated in response to the COVID-19 pandemic and are set to become mainstream. At the same time however the banks won’t want to alienate and neglect what (still) constitutes a sizeable part of their customer base, that still prefer ‘person-to-person’ interactions; who frequently visit the branch and still transact using cash and cheques.
The role of the branch will need to be re-considered as we enter the digital age, with its historic functions of distributing cash, processing transactions (and arguably even as the place customers call at for advice and assistance) set to diminish over time. The banks have to strike a careful balance between rationalising their branch networks and the way customers wish to interact with their bank. The banks will almost certainly be paying more attention to ‘omni-channel’ capabilities. This is about ensuring a consistent customer experience across all the delivery channels (branch, contact centres and mobile devices connected to the internet); ensuring the customer can switch effortlessly and seamlessly between channels; that channels are tailored and optimised to each customer’s individual profile, to the way they wish to interact and transact with their bank.
In recent times the banks in Cyprus (as elsewhere in the world) have been inundated with a ‘tsunami’ of new regulations. The focus of attention with respect to regulations are likely to (continue) to be those related to the combating of financial crimes, know your customer (KYC) and customer due diligence (CDD).
The future of the customer segment comprising of non-resident natural and legal persons is uncertain. This segment was very important to the market development strategies of the Cypriot banks and made a significant contribution to their profits. The Cypriot banks which continue servicing this customer segment face strong headwinds, not least of which is the need to adhere to more stringent KYC/CDD regulatory requirements. There is the risk of foreign correspondent banks taking a negative stance to this business conducted by their clients – the Cypriot banks. Unfortunately Cyprus’ citizenship and residence by investment (CRBI) scheme (‘golden passports’) has only resulted in reinforcing negative perceptions abroad and caused damage to the reputation of Cyprus as a jurisdiction. Other exogenous factors, outside the control of the banks include the geopolitical context (e.g. Cyprus getting caught in the crossfire and increasingly being forced ‘to choose sides’ between the U.S.A. and the Russian Federation), changes in the taxation environment² and calls for improved disclosure of the ultimate beneficial owners (UBOs) of legal entities (‘UBO registers’) ³.
Regulators expect banks to embed a risk culture. In a data-driven economy the significance of cybersecurity, mitigating cybercrime risks and data protection – the General Data Protection Regulation (GDPR) – cannot be understated.
It is likely that new ways of working adopted in response to the COVD-19 pandemic, notably working remotely / from home are here to stay. This will result in supervisors and managers having to find new ways to communicate with their direct reports and ensure that they remain motivated and engaged. There could also be implications in terms of locations, functions and design of bank office spaces. As we move into the digital age, like other organisations, banks will need to ensure that their people adjust to greater automation and new technology through re-skilling.
² e.g. companies incorporated in Cyprus with non-resident beneficial owners having to meet ‘substance’ requirements; multilateral level initiatives, led by the OECD (Organisation for Economic Development and Co-operation and Development), including the Standard for the Automatic Exchange of Financial Account Information in Tax Matters / Common Reporting Standard (CRS) and the Base Erosion Profit Shifting project (BEPS)
³ Recommendation 24 – Transparency and beneficial ownership of legal persons, International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation (Updated October 2020) of the Financial Action Task Force (FATF)
Ecological, Societal and [Corporate] Governance (ESG) issues are likely to move up the agenda for bank boards in the coming years. ESG is not only regulatory-driven but also increasingly is a reflection of wider changes in the social and political environments⁴. This is likely to result in the banks paying closer attention to the interests and expectations of all stakeholders (not just the investors/shareholders): employees, customers, suppliers/creditors (i.e. depositors) the local communities in which the banks operate, consumers and society at large (not forgetting taxpayers) – ‘stakeholder capitalism’. There is greater awareness within the financial services industry of linkages between ecological and environmental risks (most notably climate change) and financial results.
The banking industry in Cyprus can be characterised as one with a high concentration ratio implying low competitive rivalry. Furthermore, as the only organisations licensed to accept deposits from the public, banks in Cyprus are still to a large degree insulated from competition. However, some of the barriers to entry have weakened; new entrants and substitute products from providers in other industries (e.g. telcos, fintechs and ‘Big Tech’ firms) have made inroads into business areas (e.g. payments) that were once the exclusive domain of the banks. The banks need to formulate their strategic response to the emergence of digital marketplaces for banking and financial services – Open Banking / revised Payment Services Directive (PSD2) being the enabling regulatory frameworks.
Summarising, the banks need to respond to challenging political, economic, social and legal environments. With respect to the technological environment, they will have to formulate strategies to address the threats and opportunities of the digital age. A common, central component of these strategies is likely to be transformational change – digital transformation. The digital transformation of the banks takes in many issues such as:
- leading change and change management
- people (culture, talent)
- data architecture
- choice of ‘technology stack’
- business model
- operating model
The digital transformation of banking / financial services organisations is an important, wide ranging and topical issue in its own right and could be the subject for another article.
⁴ e.g. the financial services industry is expected to play its role and contribute to ecological initiatives such as ‘green finance’ and the de-carbonisation of the economy; sustainable development and the ‘circular’ economy
*A knowledge worker with analytical capabilities, Stephen follows developments in topics including the digital economy, digital banking, distributed ledger technologies and Blockchains; finance and economics; international trade finance and supply chain finance; the political economy and international relations. Stephen is an Associate member of the London Institute of Banking & Finance and also has the ‘Certificated’ membership status of the Chartered Banker Institute, having recently successfully completed studies for the Certificate in Bank Strategy, Operations and Technology.