financial - central bank of cyprus

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Financial Stability Report

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CENTRAL BANK OF CYPRUS

NICOSIA - CYPRUS

EUROSYSTEM

FINANCIAL STABILITY

REPORT2017

a21806059 CBC FSR report 2018_English_a1.qxp_Layout 1 04/07/18 12:16

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Prepared and published by:Macroprudential Oversight Section of the Financial Stability Department

Edited by: Publications Section, General Administration

© CENTRAL BANK OF CYPRUS, 2018

Address 80 Kennedy Ave 1076 Nicosia CyprusPostal Address P.O. Box 25529 1395 Nicosia CyprusTelephone +357 22714100Website http://www.centralbank.cy

Design and FBRH CONSULTANTS Ltd,Interactive pdf: www.fbrh.co.uk

All rights reserved.Reproduction for educational and non-commercial purposes is permitted provided that thesource is acknowledged.

ISSN ( online) 2421-857X


www.centralbank.cy

http://www.fbrh.co.uk

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CENTRAL BANK OF CYPRUS

NICOSIA - CYPRUS

FINANCIAL STABILITY

REPORT2017

EUROSYSTEM


■ FINANCIAL STABILITY REPORT 2017

4C E N T R A L B A N K O F C Y P R U S

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CONTENTS

Executive Summary 8

Financial Stability Report 91. Main Risks and Vulnerabilities 102. Overview of Financial Sector Developments and Outlook 113. Macroeconomic Environment 144. Banking Sector 215. Domestic Private Non-Financial Sector 366. Insurance Sector 417. Investment Funds and Investment Firms Sector 47

Annex Ι: Macroprudential Policy Decisions Concerning the Stability of the Financial System 53

Annex ΙΙ: Macroprudential Measures 55

Note: The cut-off date for data in this Report is 16 January 2018.




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CHARTS

3.1 Real GDP 143.2 Unemployment 143.3 Inflation rate [annual change of Harmonised Index of Consumer Prices -HICP] 153.4 Economic sentiment indicator 163.5 Aggregate debt of the public and private sectors 173.6 Debt service ratio of the private sector 173.7 Residential property price index 183.8 Yield of property rent 183.9 Real estate prices to GDP per capita 183.10 Building permits 193.11 Real estate transfers (sales) 193.12 New real estate sales contracts 193.13 Non-performing loans to NFCs by economic activity 204.1 Total consolidated assets of the banking sector 214.2 Non-performing loans, foreborne loans and loan loss provisions of the banking sector 224.3 Ratio of non-performing loans to total loans of non-financial corporations and households 224.4 Net interest margin 234.5 Cost-to-income ratio 234.6 Total profits and other items from the income statement of credit institutions 264.7 Return on equity (ROE) and return on assets (ROA) 264.8 Evolution of return on equity (ROE) 264.9 Capital adequacy ratios 274.10 Central bank funding to the banking system 285.1 Bank loans to domestic households 365.2 Non-performing loans to private individuals, foreborne loans and loan loss provisions 375.3 Household debt 385.4 Household sector's net financial assets (net worth) 385.5 Household sector's financial liabilities 385.6 Deposits of domestic households 395.7 Bank loans to domestic non-financial corporations 395.8 Non-performing loans to non-financial corporations, foreborne loans and loan loss provisions 395.9 Debt of non-financial corporations 40




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CHARTS

5.10 Net financial liabilities of the non-financial corporations sector 405.11 Deposits of domestic non-financial corporations 406.1 Solvency II balance sheet 426.2 Distribution of investments 426.3 Gross written premiums 436.4 Analysis of claims of the life business 446.5 Solvency position 457.1 Total assets of investment funds by investment policy 487.2 Asset distribution of investment funds 487.3 Distribution of ownership of investment funds by type of investor 487.4 Distribution of ownership of investment funds by geographical origin 497.5 Distribution of investors in investment funds by geographic origin and by type of investor 497.6 Distribution of assets of investment funds by geographical region 497.7 Distribution of liabilities of investment funds by geographical region 50

BOXES

1 Recent actions taken by credit institutions aimed at reducing NPLs 242 National macroprudential measure for maintaining additional liquidity by credit institutions 303 Definition of Fintech and financial innovation 35




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ABBREVIATIONS

CBC Central Bank of Cyprus CIFs Cyprus Investment FirmsCSE Cyprus Stock ExchangeCySEC Cyprus Securities and Exchange

CommissionEBA European Banking AuthorityΕCB European Central BankESRB European Systemic Risk BoardEU European UnionEurostat Statistical Office of the European

CommunityGDP Gross Domestic ProductIFRS International Financial Reporting

Standard

IFs Investment FundsLCR Liquidity Coverage RatioMFIs Monetary Financial Institutions MREL Minimum Requirement for Own

Funds and Eligible LiabilitiesNFC Non-Financial CorporationNPLs Non-Performing LoansSCR Solvency Capital RequirementSPEs Special Purpose EntitiesSRB Single Resolution BoardSREP Supervisory Review and Evaluation

ProcessSSM Single Supervisory Mechanism




Executive Summary

In 2017 the economy of Cyprus continued torecord satisfactory expansion, with real GDPrecording an increase of 3,9%, comparedwith 3,4% in 2016 and 2,0% in 2015. Thegrowth stemmed mainly from the increase inprivate investment and exports of services,particularly tourism, as well as the expansionof private consumption. The real estatemarket continued its gradual recovery in2017. Demand for real estate continued itsupward trend, facilitated by among otherfactors, low interest rates. At the same time,confidence in credit institutions increased,and is reflected in the increased liquidity andthe increase in demand for new loans, whichwere granted under the stricter regulatoryframework. The labour market was alsopositively affected by the ongoing upswingin economic activity, since a significantincrease in employment and a reduction inunemployment were observed. Overall, theeconomic recovery observed over the lastthree years has led to an improvement in themacroeconomic environment and theprospects of the economy.

Despite the improvement in macroe co -nom ic conditions, significant challengesre main for the financial sector. The particularlyhigh level of non-performing loans (NPLs) andthe high level of public and private debt,continue to be the most important vulne ra -bilities of the economy. Consequently, thereduction of public and private debt, inconjunction with the decrease of NPLs, areprerequisites for sustainable developmentand financial stability.

In the banking sector, the pace of loanrestructuring needs to be intensified and creditinstitutions must make use of all availableinstruments to effectively address the issue ofNPLs. Also, further legislative changes areneeded to make the regulatory and legislativeframework more effective. Although NPLsrecorded a decrease in absolute terms, as apercentage of total loans they remain amongthe highest in the European Union (EU) andcontinue to exert pressure on the profitabilityof credit institutions. In the first nine months of2017, the banking sector recorded losses,mainly as a result of additional provisions fordoubtful debts.

In the insurance sector, the new in sti tu tio nalframework of the EU’s Solvency II Directiveentered into force on 1 January 2016. This hasbrought significant changes in the way insurancecompanies operate as well as new challenges,such as the upgrading of cor po ra te governance,risk management and re gulatory compliance.The sector, overall, shows signs of stabilisationdue to the im pro ved macroeconomic conditions.Howe ver, the profitability of insurancecompanies, parti cu lar ly life insurance companies,co nti nues to be hampered by the prolonged lowinte rest rate environment.

The investment funds and investment firmssector has shown significant growth in recentyears and, as such, is being closely monitoredfrom a macroprudential perspective.

The proposed amendments to theregulatory and legislative framework as wellas the geopolitical developments within andoutside the EU that could potentially impactthe stability of the Cyprus financial system, arealso being monitored.

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1. Main Risks and Vulnerabilities

The following vulnerabilities have been identified as the main sources of risk for the Cyprusfinancial system, and are analysed in detail in this report.

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Vulnerabilities Overall assessment Risk outlook

1. Credit institutions’low asset quality, dueto the excessive expo -sure of the bankingsector to NPLs.

2. Weak profitabilityprospects for creditinstitutions.

3. The excessive debtof the private non-financial sector.

The excessive exposure to NPLs and the slowpace of their reduction, hamper the efforts toachieve viable growth and improve the stabi -lity of the financial system.

The hampered effectiveness of the legal frame-work, due to the complexity of the proceduresand the long time needed for cases to reachcourt, are obstacles that obstruct the efforts fora drastic reduction in the level of NPLs.

It is imperative that credit institutions intensifythe restructuring processes, apply decisivelythe insolvency framework and make use of allavailable tools to substantially reduce the levelof NPLs.

The profitability of credit institutions continuesto be under pressure and is burdened by lowinterest rate margins and increased provisionsfor doubtful debts. Credit institutions need torevise their business model in order to improvetheir profitability.

The high level of indebtedness of householdsand non-financial corporations continues to bea major challenge. The reduction of privatedebt is a prerequisite for achieving sustainableeconomic growth and for improving the stabil-ity of the financial system.

Stable vulnerability.

Increasing vulnerability.

Stable vulnerability;expected to improve.




Macroeconomic environment

The Cyprus economy continued to recordhigh growth rates and present improvedprospects. The growth stemmed mainly fromthe increase in private investment and exportsof services, particularly tourism, whichcontinues to expand at a satisfactory pace.The labour market was positively affected bythe ongoing recovery in economic activity.However, the prospects for the economy arebeset by uncertainty, with significantchallenges remaining. The very high level ofNPLs, the excessive indebtedness of thepublic and private sectors, the high, albeitimproved, level of unemployment and theslow progress of structural reforms, continueto restrict the prospects for sustained growth,creating potential risks for the economy.

Strengthening the insolvency regime,substantially improving the system of issuingand transferring title deeds and modernisingthe legal procedures would help to furtherreduce the level of NPLs and the deleveragingprocess in the private sector.

The real estate market continued itsgradual recovery in 2017, reflecting thepositive developments in the macro eco no -mic environment. Demand for real estatecontinued its upward trend in 2017Q3,supported by low interest rates and impro -ved confidence in the real estate market. Onthe supply side, activity in the constructionsector continued to recover gradually,reflecting the increase in demand. The real

estate market merits particular attention andclose monitoring as it exhibits the highestproportion of NPLs. However, the reco very inthe construction sector is expected to havea positive impact on the level of successfulrestructurings of these NPLs.

Banking sector

The banking sector continues to becharacterised by the very high level of NPLs incredit institutions' balance sheets andnegative profitability. Profitability dete rio -rated in the first nine months of 2017,compared with the same period in 2016,mainly due to the reduction in the net interestmargin, deleveraging and, in particular, theincrease in provisions for doubtful debts.

Over the 12 months to November 2017,total deposits in domestic credit insti tu -tions increased by €1,2 billion, confirmingthe strengthening of public confidence inthe banking sector. With respect to newloans, there was a gradual increase indemand, supported mainly by improveddomestic macroeconomic conditions andlow interest rates.

Despite the progress made with regard tothe reduction of NPLs, both in absolute termsand in relation to total lending, their level isstill very high and poses a major challenge tofinancial stability. Credit institutions will,therefore, need to intensify their efforts toreduce NPLs by implementing holistic andsustainable strategies.

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2. Overview of Financial Sector Developments and Outlook




Further to these challenges, the bankingsector is also faced with new regulatoryrequirements, such as the adoption of therevised International Financial ReportingStandard 91 (IFRS 9) and the introduction ofthe Minimum Requirement for Own Fundsand Eligible Liabilities2.

Domestic private non-financial sector

Domestic households and non-financialcorporations (NFCs), continue to be highlyindebted, although the latest data indicate agradual reduction in the level of their debt.More specifically, the domestic private non-financial sector3 debt decreased to 250,8%4 ofGDP at end-September 2017, a significantreduction from 270,7% in September 2016.Household debt reached 113,8% of GDP atend-September 2017, compared with 123,0%of GDP in September 2016. NFC debt reached137,0%5 of GDP at end-September 2016,compared with 147,7% in September 2016.

Total bank loans to domestic householdsand domestic NFCs6, recorded an annualincrease in November 2017. At the same time,the NPLs of the private non-financial sectorfollowed a downward trend, albeit at a veryslow pace. In absolute terms, total NPLsdecreased by €1,0 billion for domestichouseholds and €2,0 billion for NFCs betweenNovember 2016 and November 2017.

Bank deposits by households and NFCs7

increased from €28,6 billion in November2016 to €30,1 billion in November 2017, anincrease of €1,5 billion. Furthermore, it isnoted that the financial position ofhouseholds and NFCs has shown signs ofstabilisation.

Insurance sector

The year 2016, was a landmark year for theinsurance sector, due to the harmonisation ofthe insurance legislation of Cyprus with theSolvency II Directive of the EU. Following theregulatory changes introduced by theSolvency II Directive, there have beensignificant new challenges for the insurancesector, relating to capital requirements and thestatutory governance arrangements. In 2017insurance companies continued to reviewtheir governance framework as well as therisks they undertake and at the same time tocomply with the revised capital requirements.

In general, the insurance sector hasdemonstrated a high level of adaptability tothe supervisory requirements of theSolvency II Directive, compliance with whichis now the top priority of the sector. Therecovery of the Cyprus economy supportsthe positive growth rates exhibited by theinsurance sector, which is sufficientlycapitalised in its entirety.

1. International Financial Reporting Standard 9 - Financial Instruments - IFRS 9.2. Must be complied with pursuant to the Credit Institutions and Investment Companies Law, 22 (I) 2016.3. Based on quarterly non-consolidated statistical data.4. It is noted that any reference to data on deposits, loans and debt, reported in figures for domestic non-financial corporations,

does not include special purpose entities (SPEs), (mainly ship-owning companies that are registered / established in Cyprusand are classified as residents of Cyprus) because the activities of these entities are essentially with non-residents and theirconnection with the domestic economy is limited.

5. Excluding the debt of SPEs. See also footnote 4.6. Excluding the loans of SPEs. See also footnote 4.7. Excluding the deposits of SPEs. See also footnote 4.

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The key challenge facing the insurancesector is the new and stricter regulatoryregime and the compliance of insurancecompanies with the increased supervisoryrequirements imposed by the Solvency IIDirective. Since compliance with supervisoryrequirements entails a significant increase inoperating costs, insurance companies willneed to find ways to reduce their overheadsand enhance their operational efficiency.

The profitability of the insurance sector isanother major challenge, which is highlydependent on the return on investments byinsurance companies amid the prevailing lowinterest rate environment.

Investment funds and Cyprus investmentfirms sectors

The Investment Funds (IF) sector hasexperienced globally significant growth in

recent years, and this trend is expected tocontinue. Similar growth has been observedin recent years in Cyprus, as the favourabletax regime and the modernised legalframework have shown that the sector inCyprus has the potential to develop into acompetitive jurisdiction. In 2017 the IFsector in Cyprus showed signs ofstabilisation as far as its size is concerned.The IFs’ activities are increasingly beingprovided within Cyprus, and therefore theimportance of IFs to the domestic financialsector is expanding.

The Cyprus Investment Firms (CIFs) sectorhas experienced significant growth in recentyears, with the number of licensed CIFsreaching 215 on 30 June 2017. It is thereforenecessary to continue the close supervisionand oversight of investment funds and CIFs,in particular in the areas of risk mitigationmeasures and governance.

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This section examines the macroeconomicenvironment in Cyprus. In particular, itprovides a concise analysis of the growth ofthe economy, unemployment, inflation, thecurrent account balance, total public andprivate debt and the real estate market.

Domestic macroeconomic environment

In 2017 the Cyprus economy continued togrow, with GDP recording a year-on-yeargrowth of 3,9%, compared with 3,4% in 2016,and exceeding the corresponding euro areagrowth rate of 2,3% (Chart 3.1). An increase inmost of the sectors was observed, whichmainly derived from private investment andexports of services, particularly tourism, aswell as private consumption. Prospectsremain positive and, according to the mostrecent CBC projections of December 2017,real GDP growth is projected to be 3,4% for2018 and 3,2% for 2019.

The labour market has been positivelyaffected by the developments in economicactivity, albeit with some delay. As a result, theunemployment rate, based on Eurostat'sseasonally adjusted harmonised unemploy -ment index, decreased to 11,0% in November2017, compared with 13,1% for the samemonth of 2016. Despite its decreasing trendover the last three years, the unemploymentrate remains at high levels compared with theeuro area average, which decreased to 8,7%in November 2017 (Chart 3.2). According tothe latest forecasts of the CBC, the

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3. Macroeconomic Environment

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Mar. Sep.2009

Mar. Sep.2010

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014

Mar. Sep. Mar. Sep. Sep.Mar.2015 2016 2017

Cyprus European Union euro area

CHART 3.1 Real GDP(annual change, %)

Source: Eurostat.

02468

1012141618


Mar. Sep.2008

Mar. Sep.2009

Mar. Sep.2010

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014


CHART 3.2 Unemployment(1)

(as a % of the labour force)

Source: Eurostat.(1) Seasonally adjusted data.




unemployment rate in Cyprus is expected todecline further over the medium term. Thedownward trend in unemployment isexpected to improve the asset quality ofcredit institutions, as households andcorporations will be in a better position toservice their debt.

According to the Harmonised Index ofConsumer Prices (HICP), inflation has beenpositive since December 2016. As a result, thegap between domestic inflation and thecorresponding euro area inflation, decreasedin 2017 compared with 2016. Inflation in 2017reached 0,7%, compared with -1,2% in 2016,mainly due to the increase in the price ofenergy and tourism-related services. InDecember 2017, a negative inflation rate of-0,4% was recorded, lower than the euro areain the corresponding month of 2017 (1,4%)(Chart 3.3). Based on the latest forecasts ofthe CBC, inflation is expected to reach 1,3% in2018, driven mainly by the buoyant domesticeconomic activity and the increase in theprices of services.

The current account balance recorded adeficit during the first nine months of 2017,reaching €339 million, compared with asurplus of €14 million recorded in the firstnine months of 2016. The current accountbalance, adjusted for the impact of specialpurpose entities (SPEs)8, recorded a deficit of€83 million in the first nine months of 2017,

8. External statistics have been significantly affected by themethodological changes adopted with the application ofthe new statistical standards and mainly due to theinclusion of the transfer of economic ownership of mobiletransport equipment (mainly ships) of Special PurposeEntities (SPEs), which are registered in Cyprus. For theintroduction of the ESA 2010 and BPM 6 statisticalstandards, more information is provided in Box 1 of theDecember 2014 Economic Bulletin. The impact of SPEs onthe data is significant, despite the fact that theirtransactions neither affect nor are affected by theconditions of the domestic market.

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June Dec.2008

June Dec.2009

June Dec.2010

June Dec.2011

June Dec.2012

June Dec.2013

June Dec.2014

June Dec. June Dec. Dec.June2015 2016 2017

CHART 3.3 Inflation rate [annual change of HarmonisedIndex of Consumer Prices -HICP(1)](%)

Source: Eurostat.(1) HICP, (2015 = 100), monthly data.




compared with a surplus of €456 millionrecorded in the first nine months of 2016.

The current account balance to GDP ratioremained in negative territory in the first ninemonths of 2017, reaching -2,8%, comparedwith the corresponding period of 2016, whichwas 0,1%. The current account balance to GDPratio, adjusted for the impact of SPEs,recorded a deficit of 0,6% in the first ninemonths of 2017, compared with a surplus of3,4% in the same period of 2016, as a result ofthe increase in imports of goods and netpayments in the primary income account.

Economic sentiment in Cyprus, as reflectedin the Economic Sentiment Indicator (Chart3.4), has considerably improved since the endof 2012, exceeding the euro area levels. Morespecifically, the indicator increased to 117,6 inDecember 2017 compared with 113,3 for thesame month of 2016 and the historically lowof 75,7 in November 2012. The upward trendof this index reflects the continued recoveryof the Cyprus economy.

Additional information on macroeconomicdevelopments can be found in the CBC’sEconomic Bulletin9, which is publishedbiannually.

Overall debt (public and private)10

The overall debt of the public and privatesector as a percentage of GDP, continued thedownward trend that had followed since thebeginning of 2016, after the upward trendrecorded in previous years. Overall debt as apercentage of GDP reached 354,0% at end-September 2017, recording a decrease from381,3% compared with the same period of

9. Economic Bulletin December 2017: https://www.central -bank.cy/images/media/pdf/CBC%20EB%20December%202017%20ENGLISH.pdf

10. Excluding debt related to SPEs. See footnote 4.

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120Cyprus European Union euro area

June Dec.2008

June Dec.2009

June Dec.2010

June Dec.2011

June Dec.2012

June Dec.2013

June Dec.2014


CHART 3.4 Economic sentiment indicator(1),(2)

(index points)

Source: Eurostat.(1) Seasonally adjusted data.(2) The Economic Sentiment Indicator (ESI) is a composite indicator comprising fivesectoral confidence indicators with different weights: industrial confidence indicator,services confidence indicator, consumer confidence indicator, construction confidenceindicator and retail trade confidence indicator.The ESI is calculated as an index with anaverage of 100 and a standard deviation of 10 at a fixed standard sampling period.




2016. NFCs continue to account for the largestshare in the overall debt (amounting to137,0% in September 2017 and 147,7% inSeptember 2016), followed by households(amounting to 113,8% in September 2017 and123,0% in September 2016) and generalgovernment (amounting to 103,2% inSeptember 2017 and 110,6% in September2016) (Chart 3.5). According to the mostrecent Eurostat data, Cyprus had the largestannual decrease in public debt (7,4% inSeptember 2017), among the 28 memberstates of the EU. However, the public debt ofCyprus as a percentage of GDP in September2017 remained higher than the corre spon -ding ratios for the euro area (88,1%) and theEU (82,5%).

It is noted that the private sector debtservice ratio11,12, i.e. debt repayments as apercentage of the annual total private sectorincome, continued its downward trend since2014Q2, reaching 23,6% in September 2017(Chart 3.6).

Further analysis on the level of debt andlending to the domestic non-financial privatesector is set out in Part 5 of this Report, entitled'Domestic private non-financial sector'.

Real estate market

During 2017, the real estate marketcontinued its gradual recovery, supported

11. Debt Service Ratio of households and non-financialcorporations, excluding SPEs, is calculated using thefollowing formula where, DSR is the debt service ratio, DSCis the debt service cost, D is the total credit stock, i is theaverage annual interest rate in the stock, s is the averageresidual maturity of the stock in years, Y is the total annualincome and t is the time expressed in quarters. Due tounavailability of quarterly data for Y, GDP is used.

DSCt itDtDSRt = = Yt (1 – (1 + it)–st)Yt

12. See footnote 4.

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Mar. June Sep. Dec.2014



Mar. June Sep.2017

general government

households

non-!nancial corporations

aggregate debt (annual change, %) (right-hand scale)aggregate private sector debt (annual change, %) (right-hand scale)

CHART 3.5 Aggregate debt of the public andprivate sectors(1)

(as % of GDP)

Sources: CBC, Eurostat.(1) Excluding SPEs.

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34




Mar. June Sep.2017

households and non-?nancial corporations aggregate (1)

CHART 3.6 Debt service ratio of the private sector(as % of GDP)

Sources: CBC, Eurostat.(1) Aggregate includes households, non-financial corporations excluding SPEs, otherfinancial intermediaries, insurance corporations and pension funds.




by the positive developments in theeconomy. In particular, the CBC’s residentialproperty price index (houses andapartments), recorded for the thirdconsecutive quarter an annual increase of1,4% in 2017Q3 (Chart 3.7). However, theprice-to-rent ratio recorded no substantialchange in 2017Q2, with rental yieldfluctuating at around 2,1% for houses, 4,1%for apartments, 5,7% for shops, 4,3% forwarehouses and 4,9% for offices (Chart 3.8).Similarly, the price-to-GDP per capita ratioin all property categories remained stableduring the period from 2015Q4 to 2017Q2,reflecting the stabilisation of property prices(Chart 3.9).

Demand for properties continued itsupward trend in 2017Q3, supported by lowinterest rates and improved confidence inthe real estate market. According to theCBC’s Bank Lending Survey, net demand forloans from households for housing purposes,continued to record an increase in 2017Q3.The total number of building permits issuedin the first ten months of 2017 increased to4.817, compared with 4.350 building permitsissued during the same period in 2016 (anannual increase of 10,7%). The total value ofbuilding permits and the total area coveredof the property for which a building permitwas granted, recorded an annual increase of37,8% and 35,5%, respectively, in the first tenmonths of 2017 (Chart 3.10, p. 19).Confidence in the real estate market appearsto be improving, as evidenced by theincrease in the number of new real estatetransfers (sales) both by residents and non-residents (Chart 3.11, p. 19).

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Mar. Sep.2008

Mar. Sep.2009

Mar. Sep.2010

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014


CHART 3.7 Residential property price index(annual change, %)

Source: CBC.

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8

housesapartments

retailo:ces

warehouses

June Dec.2010

June Dec.2011

June Dec.2012

June Dec.2013

June Dec.2014

June Dec. June Dec. June2015 2016 2017

CHART 3.8 Yield of property rent(1)

Source: RICS.(1) The ratio of annual rent to the price.

0102030405060708090

housesapartments

retailo<ces

warehouses

June Dec.2010

June Dec.2011

June Dec.2012

June Dec.2013

June Dec.2014


CHART 3.9 Real estate prices to GDP per capita(1)

Sources: RICS, Eurostat.(1) The ratio of average purchase price to GDP per capita.




Investments from non-residents continuedto increase in comparison with the previousyear, with an increase of 32,5% in 2017, asevidenced by the number of sales contractsfiled with the Department of Lands andSurveys. These investments represent 27,5%of the total number of sales contracts filed for2017 (Chart 3.12).

Incentives provided to date seem to havesignificantly contributed to the increase indemand for properties. In particular, theabolition of property tax from 2017 as well asthe extension of the measure concerning thereduction of transfer fees, have contributedto the improvement in confidence in the realestate market and to increased demand forproperties.

On the supply-side, activity in theconstruction sector continued its gradualrecovery, due to increased demand. Inparticular, the construction production indexrecorded an annual increase of 12,8% in2017Q3 compared with a 10,7% annualincrease recorded in 2016Q3. The sectoralindices of the construction production indexindicate that civil engineering projects(concerning open areas and generally anyproject which is not considered as a building)recorded an annual increase in value of 13,6%in 2017Q3, followed by the construction ofbuildings (detached houses, residentialapartment blocks and non-residentialbuildings) with an annual increase of 12,6%.

Despite the overall improvement in thereal estate market, as indicated by thestabilisation in property prices and increaseddemand, challenges still remain. Theconstruction sector and the real estate

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60

80

100

120

140

160

180value area number

June Dec.2009

June Dec.2010

June Dec.2011

June Dec.2012

June Dec.2013


Dec. June. Oct.2017

CHART 3.10 Building permits(annual change, %)

Source: CyStat.

-60

-40

-20

0

20

40

60

80

-70

-20

30

80

130

180

230

280

330

total value (€) of real estate transfers registered at the Department of Lands and Surveys

total number of new real estate transfers (sales) (right-hand scale)

June Dec.2009

June Dec.2010

June Dec.2011

June Dec.2012

June Dec.2013

June Dec.2014


CHART 3.11 Real estate transfers (sales)(annual change, %)

Source: Departmentof Lands and Surveys.

-80-60-40-20

020406080

100120140160180

total number of new sales contractsnew sales contracts with non-residentsnew sales contracts with residents

June Dec.2009

June Dec.2010

June Dec.2011

June Dec.2012

June Dec.2013

June Dec.2014


CHART 3.12 New real estate sales contracts(annual change, %)

Source: Departmentof Lands and Surveys.




management sector recorded the highestproportion of NPLs of NFCs in September2017, standing at 32,4% and 15,6%,respectively, from 34,7% and 18,4%,respectively, in September 2016 (Chart 3.13).It is noted that 50,0% of total NPLs ofhouseholds as at end-September 2017,related to NPLs for housing purposes.

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manufacturing

real estate management activities

wholesale and retail trade, repair of motor vehicles and motorcycles

construction professional, scientiJc and technical activities

accommodation and food services activities

other

32,412,53,9

8,1

7,6

20,0 15,6

CHART 3.13 Non-performing loans to NFCs byeconomic activity(end of September 2017, %)

Source: CBC.




This section presents a concise analysis of thestructure, financial position and regulatoryframework of the Cyprus banking sector aswell as of international developments. Theanalysis is based on the latest availablesupervisory data submitted to the CBC bycredit institutions.

Structural developments in the bankingsector

The deleveraging process of credit institutionsled to a reduction in the total consolidatedassets of the sector by 57% during the periodDecember 2010 – September 2017, while theratio of total assets as a percentage of GDPdecreased to 356% at the end of September2017, from 368% at the end of September2016 and 805% at the end of December 2010(Chart 4.1). While there has been progress inthe reduction of the number of branches andemployees in the largest domestic creditinstitutions, the banking sector is stillconsidered to be very large in comparisonwith the size of the island’s economy. At thesame time, the leverage ratio decreased from10,4% in September 2016 to 8,5% inSeptember 2017.

Financial position

Credit and loan portfolio quality

The high level of NPLs remains the mainvulnerability of the banking sector in Cyprus.

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4. Banking Sector

0

100

200

300

400

500

600

700

800

0

20

40

60

80

100

120

140

160

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014

Mar. Sep.2015

Mar. Sep.2016

Mar. Sep.2017

subsidiaries and branches of foreign credit institutions

domestic credit institutions

banking sector (% of GDP, right-hand scale)

domestic credit institutions (% of GDP, right-hand scale)

CHART 4.1 Total consolidated assets of thebanking sector(€ billion, % of GDP)

Source: CBC.




Although there is an improvement in thequality of the loan portfolio, the slow progressrecorded in reducing the level of NPLs posessignificant challenges to the stability of thefinancial system.

In particular, NPLs as a percentage of totalloans decreased to 42,6% at the end ofNovember 2017, compared with 47,2%recorded at the end of November 2016 (Chart4.2). In absolute terms, total NPLs decreasedby €2,9 billion to €21,5 billion betweenNovember 2016 and November 2017. Thedecrease was mainly due to the reduction ofNPLs in the non-financial corporations sector,through the debt-to-asset swap schemes andthe restructurings of NPLs (Chart 4.3).

In the banking sector, credit institutionsneed to make use of all available tools toaddress decisively the problem of NPLs.Further legislative changes are also needed tomake the regulatory and legislativeframework more effective.

The percentage of restructured loans inrelation to total lending to the domesticprivate sector declined to 24,5% inNovember 2017, compared with 27,0%recorded in November 2016. The slowprogress in the reduction of NPLs, reflectsthe lengthy and inefficient court proceduresas well as the undeveloped secondarymarket for the sale of NPLs.

At the same time, the ratio of loan lossprovisions for doubtful debts as a per -centage of total NPLs increased sig nificantlyto 46,4% in November 2017, compared with38,3% in November 2016, as a result of creditinstitutions' efforts to drastically addresstheir NPLs.

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10152025303540455055

non-performing loans (% of total loans)loan loss provisions (% of total non-performing loans)proportion of exposures with forbearance measures (% of total loans)

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014


CHART 4.2 Non-performing loans, foreborne loansand loan loss provisions of the banking sector(%)

Sources: CBC, supervisory data.

45

50

55

60

65

Mar. June Sep. Dec.Dec.20152014


Mar. June Sep.2017

non-Inancial corporations households

CHART 4.3 Ratio of non-performing loans to totalloans of non-financial corporations andhouseholds(%)

Source: CBC.Note: Excluding loans to central banks and credit institutions.




The effective management of NPLs,remains the main priority of credit institutionsand of the Single Supervisory Mechanism.Box 1 (p. 24) sets out the recent actions takenby credit institutions aimed at reducing NPLs.

Income and profitability

Credit institutions recorded a furtherdeterioration in profitability during the periodJanuary - September 2017 in comparison withthe corresponding period of 2016, mainly dueto the decrease in net interest income andincreased provisions for doubtful debts.

In particular, the net interest margindecreased from 2,64% in the first nine monthsof 2016 to 2,38% in the first nine months of2017 and the net interest income decreasedby €158 million to €1.125 million (Chart 4.4).In general, the ability of credit institutions togenerate profits remained limited.

Credit institutions can improve theirprofitability by increasing their revenues andfurther reducing their operating costs. Thecost-to-income ratio of credit institutionsdeclined in the first nine months of 2017, andreached 48,7%, from 52,3% during thecorresponding period of 2016 (Chart 4.5). Inthis respect, the indicators of customers bycredit institution and by branch as well asassets per credit institution employee inCyprus, are still significantly lower than therespective average for the euro area.

Credit institutions recorded significantlyincreased provisions in relation to total NPLs,during the period January – September 2017.As a result of the Supervisory Review andEvaluation Process (SREP), the ratio of loan

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0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

net interest margin

interest income/average interest-bearing assets (right-hand scale)

interest expense/average interest-bearing assets (right-hand scale)

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014


CHART 4.4 Net interest margin(%)

Source: CBC.

30

35

40

45

50

55

60

65

70Cyprus euro area

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014


CHART 4.5 Cost-to-income ratio(%)

Sources: CBC, ECB.Note: The cost-to-income ratio is calculated as the ratio of operating expenses to operatingincome of the banking sector.




Box 1: Recent actions taken by creditinstitutions aimed at reducing NPLs

A multi-dimensional approach wasadopted after the financial crisis in order toreduce NPLs. This includes, inter alia,restructurings, the creation of specialisedproperty management units whichundertake the management of the realestate properties acquired by creditinstitutions through debt-to-asset swapschemes, and the use of the legislativeframework relating to insolvency andforeclosures. However, these measureshave so far not produced the desiredresults. For example, the legislativeframework on foreclosures, has so far beenused more as a measure of pressure onborrowers to come to the negotiatingtable, rather than as a measure for therecovery of arrears.

During 2017, credit institutionscontinued to make strong efforts toaddress the problem of the high level ofNPLs. In particular, credit institutions, intheir effort to accelerate the process ofreducing NPLs, have adopted newstrategies, such as the sale of loans, thecreation of joint ventures with specialisedcompanies for the management of NPLsand the purchase of properties owned byborrowers with the aim of renting it tothem after repaying their loans.

The sale of loans to third-parties,provides credit institutions with anadditional option for the management andreduction of NPLs. Credit institutions thathave high levels of NPLs on their balance

sheets may enter into agreements withindependent companies for the sale ofNPLs. In particular, in 2017 one of thelargest credit institutions completed thesale of a portfolio consisting of NPLs. Whenusing this tool, credit institutions shouldconsider how their profitability and capitalbase may be affected, as a result of theprice that will be paid when the selectedloans are sold. Depending on the use ofthis tool, transfer of risks from creditinstitutions to the buyers can be achieved,thus improving the balance sheet of creditinstitutions.

The creation of a platform for themanagement of NPLs, via the formation ofpartnerships with specialised debt servicecompanies, is another attempt by creditinstitutions to reduce their NPLs. Inparticular, three of the largest creditinstitutions have already set up suchpartnerships. The establishment ofpartnerships is expected to have a positiveimpact on the operational effectiveness ofcredit institutions. It will also enable creditinstitutions to obtain expertise and it willfacilitate the development of a secondarymarket for the sale of NPLs.

At the European level, on 8 March 2018the European Banking Authority (EBA)launched a public consultation in relationto its guidelines to credit institutions forthe effective management of NPLs. Theseguidelines target credit institutions thatrecord high levels of NPLs, aiming toachieve their sustainable reduction as wellas to enhance the resilience of theirbalance sheets. Furthermore, the EBA

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developed templates aimed at thepresentation of comparable andstandardised data of NPLs from creditinstitutions to potential investors. Theadoption of these templates by creditinstitutions on a voluntary basis couldtrigger transactions in NPLs and contributeto the development of the secondarymarket for the sale of NPLs.

In this respect, the creation of a nationalNPL platform for the management of NPLscould be useful, as it would help inaddressing some of the challenges arisingfrom the underdeveloped secondarymarket. In particular, the establishment ofa national NPL management platform isexpected to present a consolidated pictureof the data relating to the NPLs, throughthe use of harmonised templates.Furthermore, this platform will be moreaccessible as it will act as a contact pointfor potential investors in NPLs, allowingeasier access to the data of NPLs andimproving transparency.

Credit institutions must intensify theirefforts for the reduction of NPLs by

implementing viable strategies. Legislativearrangements are also needed to make theinsolvency framework more effective.Furthermore, the approval of the law forthe conduct of securitisation by creditinstitutions, is expected to facilitate in theacceleration of the process of thereduction of NPLs, as it will add one moretool for the sale of loans.

The radical reduction in NPLs,regardless of the solution applied by thecredit institution in each case, entails costsas there are no painless solutions. Creditinstitutions should consider the sharing ofthe costs that arise during the applicationof any agreement with the borrower,between the credit institution and theborrower, taking into account the specificcharacteristics of each case.

The acceleration in the improvement ofthe low asset quality of credit institutionsis a key priority for them and supervisorsand is a prerequisite for increasing theirprofitability in order to achieve sustainablegrowth and for improving the stability ofthe financial system.

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loss provisions increased from 32% at the endof the year 2014, to 37% at the end of 2015,41% at the end of 2016 and 46,5% inNovember 2017. The three largest creditinstitutions have booked provisions in relationto their total NPLs of the order of 45,5% andthis coverage rate is now comparable to theEU average. The loan loss provisions of thebanking sector at the end of November 2017amounted to €10 billion.

The increase in provisions was recordedprior to the application of InternationalFinancial Reporting Standard 9 (IFRS 9) (p. 31),which from 1 January 2018 requires creditinstitutions to recognise additional futurelosses on their loans.

According to the most recent data, totalloss before tax and after provisions fordoubtful debts for the first nine months of2017 amounted to €535 million comparedwith a profit of €318 million for the first ninemonths of 2016 (Chart 4.6). In the first ninemonths of 2017, the profitability of creditinstitutions, which can be measured by thereturn on assets and return on equity,recorded a significant decrease (Chart 4.7).On an annual basis, the return on assets ratio(after taxes and provisions) declined to -1,3% as at 30 September 2017 from 0,5% at30 September 2016. The return on assetsratio is particularly low at 1,4% as at thesame date, even if it is calculated on thebasis of profit before provisions for doubtfuldebts. The return on equity ratio declinedsignificantly to -12,5% in the first ninemonths of 2017, compared with 4,8% in thecorresponding period of 2016 (Chart 4.8). Itis noted that at 30 September 2017 the euro

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-5-4-3-2-101234

total operating expensesnet fee and commission income impairments and provisions

trading and foreign exchange results

net interest income

net proJts / (losses) after tax and discontinued operationspre-tax proJts / (losses) from continuing operations

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014


CHART 4.6 Total profits and other items from theincome statement of credit institutions(€ billion)

Source: CBC.

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-120-100

-80-60-40-20

02040

return on equity (ROE) (after tax)return on assets (ROA) (after tax) (right-hand scale)

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014


CHART 4.7 Return on equity (ROE) and return onassets (ROA)(%)

Source: CBC.Note: The return on equity is calculated as the ratio of net income (profit) to equity. Thereturn on assets is calculated as the ratio of net income to assets.

4,8 -3,2

0,12,1 -15,0

-0,7 -0,7

-12,5

-15

-10

-5

0

5

10

increasedecreaseROE level

ROESeptember

2016

net interestincome

net non-

interestincome

operatingexpenses

provisionsand

impairments

other pro*t(loss)

own funds

ROESeptember

2017

CHART 4.8 Evolution of return on equity (ROE)(September 2016 -September 2017, %)

Source: CBC.




area median of the return on assets ratio(after taxes and provisions) was 0,6% and ofthe return on equity ratio (after taxes andprovisions) was 7,7%.

Credit institutions should continue theirefforts for the improvement of theirprofitability and focus on quality and theenhancement of the services they offer tocustomers. Furthermore, credit institutionsneed to end their loss-making operationsand diversify the range of services they offer,for example by using technological toolsthat could lead to new, more profitablebusiness models.

Capital adequacy

The total capital adequacy ratio declined from16,9% in September 2016 to 16,3% inSeptember 2017. Despite the losses recordedin the period January – September 2017, thecapital of credit institutions remained abovethe minimum required capital adequacy ratio.However, the regulatory capital of creditinstitutions decreased due to additionalprovisions for doubtful debts, with theconsolidated Common Equity Tier 1 (CET1)ratio decreasing to 15% in September 2017from 16% in September 2016, and remainingvulnerable in case further losses are recorded(Chart 4.9).

The slow process in the reduction of NPLshas negatively affected the credit institutions'capital adequacy ratio. Credit institutions thatmade progress in cleaning their balancesheets recorded a decline in their Tier 1 capitalratio, due to losses arising from increasedprovisions for doubtful debts. It is noted that

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overall capital adequacy ratio common equity tier 1 capital ratiotier 1 capital ratio (1)

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014


CHART 4.9 Capital adequacy ratios(%)

Source: CBC.(1) The definition of Common Equity Tier 1 was introduced with the adoption of theCapital Requirements Regulation. Prior to this, the Core Tier 1 capital ratio was usedas an approximation.




some of the largest credit institutions inCyprus have already initiated the process forcapital issuance, in order to strengthen theirown funds and capital adequacy.

Funding and liquidity

The dependence of credit institutions onfunding from the European Central Bank (ECB),stabilised at €0,8 billion in September 2017,decreasing by €1,1 billion from September2016. It is noted that the emergency liquidityassistance (ELA) was fully repaid in January2017, in comparison with the peak of €11,4billion in April 2013 (Chart 4.10).

The improved confidence in the financialsystem, has allowed credit institutions tobroaden their deposit base and improve theirliquidity. The broadening of the deposit baseand the parallel decrease in total loans, led toa further decline in the ratio of loans todeposits from 113,9% in November 2016 to106,1% in November 2017. The ratio of loansto deposits has clearly improved incomparison with the historically high level of138,9% recorded in January 2015.

Liquidity risk continues to be closelymonitored, due to the substantial dependenceof credit institutions on short-term depositsfrom households and corporates. It is noted thaton 31 December 2017, all national prudentialliquidity requirements were abolished in the EUand since 1 January 2018 the LiquidityCoverage Requirement (LCR) has been fullyphased-in in the EU, including Cyprus.

With the abolition of national prudentialliquidity requirements, significant excessliquidity was recorded by Cyprus’s credit

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Mar. Sep.2011

Mar. Sep.2012

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Eurosystem regular re?nancing operations

emergency liquidity assistance

CHART 4.10 Central bank funding to the bankingsystem(€ billion)

Source: CBC.




institutions, due to differences between thenational prudential liquidity requirementsand the liquidity coverage ratio. The CBC, withthe aim of constraining the excess liquiditythat would arise and its gradual release,activated a national macroprudential measurefor maintaining additional liquidity beyond100% of the LCR that is now in force for allcredit institutions in the EU. Box 2 (p. 30) setsout more details in relation to this nationalmacroprudential measure.

Deposits

Total deposits of the banking system ofCyprus recorded a net increase of €1.176million during the 12 months to November2017, in comparison with a net increase of€3.101 million for the same period in 2016.The level of deposits in November 2017,amounted to €49,2 billion. The annual growthrate of deposits amounted to 2,4%, comparedwith 6,8% in November 2016. The increase indeposits highlights the increasing depositors'confidence in the banking system of Cyprus.

Loans

Total lending of the banking system of Cyprus,recorded a net decrease of €885 millionduring the 12 months to November 2017, incomparison with a net decrease of €6.394million for the same period of 2016. Theannual growth rate of loans recorded adecrease of -1,6% in November 2017, incomparison with a decline of -10,4% inNovember 2016, reflecting the slowdown inthe downward trend of lending. The level of

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Box 2: National macroprudentialmeasure for maintaining additionalliquidity by credit institutions

On 13 November 2017, the CBC, inaccordance with the powers vested in it bythe Macroprudential Oversight ofInstitutions Law as the designated authorityof Cyprus for the implementation of theCapital Requirements Regulation (CRR) ofthe EU, decided to adopt a nationalmacroprudential measure. Under thismeasure, it is required to maintainadditional liquidity (LCR add-on) for thosecredit institutions operating in the domesticmarket and for which the CBC considersthat the risks they face are significantlyaffected by the conditions in the domesticeconomy13. The implementation of themeasure was finalised on 21 December2017 with the successful completion of theprocedures set out in article 5 of the SingleSupervisory Mechanism Regulation andarticle 458 of the CRR.

This macroprudential measure aims atmanaging the significant excess liquiditythat arose due to the differences betweenthe national prudential liquidityrequirements that were abolished on 31December 2017, as required under theprovisions of article 412 of the CRR, and the100% of the Liquidity Coverage Ratio (fullyphased-in LCR) that must be maintained inaccordance with the provisions of article

460 of the CRR. The design of themacroprudential measure provides for agradual release of the excess liquidity. Thiswill be achieved by a 50% reduction of theLCR add-on rates on 1 July 2018 and theircomplete abolition on 31 December 2018.

The national macroprudential measurecomprises:1. additional liquidity requirements in the

form of add-on rates on some of theparameters used in the calculation ofthe Liquidity Coverage Ratio (LCR),defined in the Commission’s DelegatedRegulation (EU) 2015/61;

2. additional liquidity requirements in theform of add-on rates on some depositcategories that are used in thecalculation of this ratio.

This macroprudential measure is of atemporary nature, with a duration of oneyear, and was implemented on 1 January2018.

As a result of this decision, creditinstitutions that are established in Cyprusmust, during 2018, maintain:1. 100% of the Liquidity Coverage Ratio

(fully phased-in LCR), in accordancewith article 460 of the CRR, that appliesto all EU credit institutions;

2. the additional liquidity requirement(LCR add-ons) that must be met inaccordance with this nationalmacroprudential measure.

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13. As a result, the measure applies to all credit institutions established in Cyprus, other than RCB Bank Ltd.




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total loans in November 2017, amounted to€52,1 billion, compared with €53,9 billion inNovember 2016.

Regarding new lending to households andcorporates of the euro area, a gradual increasein both demand and supply has beenrecorded. New lending (excluding re ne -gotiations) amounted to €2,3 billion in thefirst nine months of 2017 and €2,9 billion forthe whole of 2016, an increase compared with€2,0 billion for the whole of 2015, raising theexpectations that new lending will alsocontinue to increase in 2018 thus contributingto the financing of economic growth. Theincrease in new lending, is mainly driven bythe improved domestic macroeconomicconditions and the low lending rates.

Credit institutions are increasinglysearching for new lending and investmentopportunities, given the ample liquidity intheir balance sheets and the need to improvetheir financial performance. In this context, itis important to maintain prudent standardsand strict lending criteria. Thus, particularattention is required regarding the utilisationof liquidity and the avoidance of loans orinvestments that carry a high level of risk.

Developments in the regulatoryframework

Constantly changing and more stringentsupervisory requirements as well as changes inaccounting standards are a regulatory risk tocredit institutions and result in a significantincrease in their financing costs. With theshaping of the new Basel Committee fra -mework, additional regulatory and su per visory




arrangements have entered into force. Theadoption of the revised IFRS 9 for bookingprovisions based on expected losses and theintroduction of the Minimum Requirement forOwn Funds and Eligible Liabilities – MREL,which will require the issue of capital / bondsby each credit institution for the absorption oflosses in case of resolution, are two of the mainregulatory developments as well as majorchallenges for the financial sector.

The application of the new IFRS 9 as of 1January 2018, requires credit institutions torecognise future losses for all their advancesas well as for their NPLs. IFRS 9 is expected tonegatively affect the profitability andregulatory capital of credit institutions. For thepurpose of normalising the impact on theregulatory capital of credit institutions, the EUhas granted a transitional period during whichEU credit institutions will be able to allocatethe costs over a five-year period. IFRS 9obliges credit institutions to classify theiradvances into three categories / stagesdepending on the credit risk they bear at thereporting date.

The practical application of IFRS 9 isparticularly demanding. Significant effortsshould be undertaken by credit institutions tocollect high quality data and develop internalmodels for assessing credit risk and theimpact of IFRS 9.

The MREL represents one of the key toolsfor strengthening the resilience andresolution of credit institutions by allowingresolution authorities to preserve the criticalfunctions of credit institutions and to restoretheir capital position after resolution. MREL isprovided in the EU Directive 2014/59/EU on

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the recovery and resolution of creditinstitutions and investment firms (BankRecovery and Resolution Directive – BRRD),which has been transposed into the Cyprusnational law through the Resolution of CreditInstitutions and Investment Firms Law,22(I)/2016. Pursuant to Law 22(I)/2016, theCBC is the resolution authority in Cyprus forcredit institutions and for certain CIFs.

The setting of the final MREL targets is partof a process and policy decisions of the SingleResolution Board (SRB) in co-operation withthe national resolution authorities. Decisionson the specific MREL targets will be reviewedannually. In this context, the SRB will take intoaccount any relevant supervisory decisionaffecting credit institutions that fall within itsremit or any change in the financial structureand risk profile of credit institutions. SRBpolicies are the basis for the adoption ofbinding MREL targets for credit institutionswithin the scope of the SRB.

In 2017 credit institutions were notified ofbank specific MREL targets set by the SRB incooperation with the national resolutionauthorities, which for the majority of thelargest and most complex banking groups arebinding, while for the other credit institutions,based on specific criteria, the relevantobjectives will continue to be non-binding /informative. Based on the most recent SRBpolicy, any credit institution that does notfulfil the binding target has been granted aspecific deadline for meeting the target, witha maximum duration of four years (bank-specific transition period). Under the sameSRB policy, no binding targets have been setfor Cyprus credit institutions.

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The final binding MREL targets areexpected to be set at a fairly high level. Giventhe underdeveloped bond market in Cyprus,credit institutions should, in due course, seekways to issue bonds timely, in order to fulfilthe binding MREL target that will be imposedupon them.

Developments at the EU andinternational level

Fintech

In recent years, there has been a rapidincrease in technology driven innovation infinancial services, more widely known asFintech. Box 3 (p. 35) expands upon thedefinition of Fintech and the positive effectsof technological innovation. The Fintechsector offers several prospects but also posesrisks to the financial system. However, at thisstage, there is limited availability of officialdata on the use of Fintech services by financialinstitutions, both in Cyprus and abroad.Therefore, it is not easy to perform an in-depth analysis of the impact of Fintech on thestability of the financial sector.

2018 EU-wide stress test

The stress testing exercise conducted by theEBA, started in January 2018 and its results willbe published in November 2018. The exercisewill involve 48 credit institutions covering70% of the EU banking sector.

Cyprus credit institutions will notparticipate in the stress testing exercise,because they do not meet the eligibility

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criteria due to their relatively small size. At thesame time, the stress testing exercise will beperformed for the remaining credit institutionsthat are under the direct supervision of theECB's Single Supervisory Mechanism (SSM),including the four significant institutions inCyprus and the results will be used in thesupervisory review and evaluation process(SREP) of the ECB’s SSM.

The 2018 stress testing exercise willprimarily focus on assessing the impact of riskfactors on the capital adequacy of creditinstitutions and on NPLs.

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Box 3: Definition of Fintech andfinancial innovation

Fintech is defined by the Financial StabilityBoard as the “technology-enabledinnovation in financial services that couldresult in new business models,applications, processes or products with anassociated material effect on the provisionof financial services”. This definitionencompasses a wide range of innovations,services and products and, as a result, it isnot always easy to distinguish whether aservice meets the definition of Fintech.

The Fintech sector has the potential to

change financial intermediation channelsand create new commercial practices andproducts. Technological innovations makeit possible to change the way usersconduct their financial transactions, oftenreplacing traditional financial institutions.At the same time, innovations in theFintech sector result in quicker and moreaccurate assessment of information byfinancial institutions, reducing the risksincurred by financial institutions and fasterprocessing of their transactions. Thisentails lower operating costs for financialinstitutions and improvements incustomer service.




This section presents a concise analysis of thelevel of indebtedness and the financialposition of the private non-financial sector ofCyprus. Additional information on the level ofdebt and the financial position of the mainborrowers of the financial system of Cyprus isset out in the Household and Non-FinancialCorporations Indebtedness Report14, publi -shed every quarter.

The analysis is based on the latest availabledata from various sources, mainly frommonthly balance sheet data submitted bymonetary financial institutions (MFIs)15 to theCBC and from the quarterly financial accounts.With regard to euro area comparisons, data ismainly sourced from the ECB Statistical DataWarehouse (SDW) and from Eurostat

a) Household sector

Bank loans

Based on the ECB methodology16, total bankloans to domestic households increased on anannual basis by 0,3% in November 2017,compared with an increase in the respectiveeuro area average of 3,1% in the same month(Chart 5.1).

14. Household and Non-Financial Corporations IndebtednessReport, October 2017, CBC, https://www.central bank.cy/images/media/pdf/Household%20and%20NFC%20indebtedness%20report%20for%20October%202017_EN.pdf.

15. MFIs in Cyprus include all credit institutions operating inCyprus, excluding the CBC.

16. The calculation of annual growth rates for monthly MFIbalance sheet statistics is based on the ECB methodology,which takes into account net transactions but excludesreclassifications /other adjustments, revaluations andexchange rate adjustments.

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5. Domestic Private Non-Financial Sector

-16

-12

-8

-4

0

4

8

12

16

total loans to domestic householdsconsumer credit

loans for house purchaseother loans

euro area total loans to households

Mar. Sep.2011

Mar. Sep.2012

Sep. Mar. Sep.20102009

Mar. Sep.2013

Mar. Sep.2014


CHART 5.1 Bank loans to domestic households(annual change, %)

Sources: CBC, ECB.




NPLs

Based on the most recent consolidatedstatistical data, NPLs as a percentage of totalloans to domestic households reached 52,8%at end-November 2017, exhibiting a decreaseof 54,9% since November 2016 (Chart 5.2). Inabsolute numbers, households’ NPLsdecreased by €1,0 billion between November2016 and November 2017. At the same time,loan loss provisions as a percentage of NPLsto domestic households (coverage ratio)increased to 41,5% in November 2017,compared with 36,0% in November 2016.

The proportion of exposures withforbearance measures, i.e. restructured loansas a percentage of total loans to domestichouseholds, reached 27,5% as at end-November 2017, compared with 27,3% as atend-November 2016 (Chart 5.2). The netbalance of restructured loans at the end ofeach month is affected, further to the newrestructurings, by repayments and themigration of loans from the non-performingcategory to the performing category, as aresult of the expiration of the monitoringperiod17. Consequently, because of themigration of loans from the non-performingcategory to the performing category, a furtherdecline in NPLs is expected. It is noted that,despite the fact that the ratio of restructuredloans as a percentage of total loans todomestic households has increased, thereduction in their level due to the successfulrestructurings is anticipated to be gradual andtake long, considering the NPL definition.

17. In case an NPL is restructured, it is not automaticallytransferred to performing loans, but remains undermonitoring for a period of at least 12 months, providedthat the borrower pays the instalments without delaysunder the new repayment schedule.

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101418222630343842465054

non-performing loans to private individuals (as a % of total loans to private individuals)provisions on loans to private individuals (as a % of non-performing loans to private individuals)proportion of exposures with forbearance measures (as a % of total loans to private individuals)

Dec. Mar. June20152014

Sep. Dec. Mar. June2016

Sep. Sep.Dec. Mar. June2017

CHART 5.2 Non-performing loans to privateindividuals, foreborne loans and loan loss provisions(%)

Source: CBC.




Furthermore, the number of restructuringshas decreased due to the fact that theremaining NPLs are mostly terminated loansthat need to be treated differently.

Debt

Household debt decreased to 113,8% of GDPat end-September 2017 from 123,0% of GDPat end-September 2016 (Chart 5.3). Thisdevelopment indicates that althoughdomestic households remain over‐indebted,there has been a marked improvement.Moreover, although the household debt ratiois higher that the respective euro area average(57,9% of GDP in September 2017), it must benoted that domestic households have apositive net financial position, i.e. the financialassets held (e.g. cash, deposits in creditinstitutions, investments in financialinstruments) exceed their liabilities towardscredit institutions.

Financial position

The household sector’s net financial positiondecreased to 106,8% of GDP in September2017 compared with 108,9% in September2016. This ratio continues to remainsignificantly below the respective euro areaaverage, which reached 148,9% in September2017 (Chart 5.4).

It is noted that households’ financialliabilities as a percentage of financial assetsdecreased marginally to 55,6% in Septem -ber 2017, from 56,8% in September 2016(Chart 5.5).

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5060708090

100110120130140

Cyprus euro area

Mar. Sep.2011

Mar. Sep.2012


Mar. Sep.2013

Mar. Sep.2014


CHART 5.3 Household debt(as % of GDP)

Sources: CBC, Eurostat, ECB.

100

110

120

130

140

150

160Cyprus euro area

Mar. Sep.2011

Mar. Sep.2012


Mar. Sep.2013

Mar. Sep.2014


CHART 5.4 Household sector's net financial assets (networth)(as % of GDP)

Sources: CBC, Eurostat, ECB.

30323436384042444648505254565860

Cyprus euro area

Mar. Sep.2011

Mar. Sep.2012


Mar. Sep.2013

Mar. Sep.2014


CHART 5.5 Household sector's financial liabilities(% of financial assets)

Sources: CBC, ECB.




Deposits

Based on the ECB methodology, deposits ofdomestic households continued to increaseand reached €23,3 billion in November 2017,compared with €22,8 billion in November2016, recording an annual growth of 2,3%(Chart 5.6), registering steady positive annualgrowth rates since September 2015.

b) Non-financial corporations sector

Bank loans18

According to the ECB methodology, totalbank loans to domestic NFCs, recorded anannual increase of 0,4% in November 2017,compared with an increase of 1,8% in therespective euro area average over the sameperiod (Chart 5.7).

NPLs

The level of NPLs of NFCs declined. The latestavailable consolidated prudential supervisorydata show that the NPLs of NFCs decreased by€2 billion between November 2016 andNovember 2017. Total loans to NFCs decreasedby €1,3 billion during the same period. As aresult, the ratio of NPLs as a percentage ofNFCs’ total loans, declined from 54,9% inNovember 2016 to 48,4% in November 2017(Chart 5.8). At the same time, loan lossprovisions as a percentage of NPLs of NFCsincreased to 52,3% in November 2017,compared with 40,3% in November 2016.

The proportion of exposures withforbearance measures, i.e. restructured loans

18. Excluding loans to SPEs. See footnote 4.

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-10-8-6-4-202468

Cyprus euro area

Mar. Sep.2011

Mar. Sep.2012


Mar. Sep.2013

Mar. Sep.2014


CHART 5.6 Deposits of domestic households(annual change, %)

Sources: CBC, ECB.

-8-4048

1216202428

Cyprus euro area

Mar. Sep.2011

Mar. Sep.2012


Mar. Sep.2013

Mar. Sep.2014


CHART 5.7 Bank loans to domestic non-financialcorporations(annual change, %)

Sources: CBC, ECB.

προς μη χρηματοοικονομικές επιχειρήσεις (

010203040506070

non-performing loans to non-'nancial corporations (as % of total loans to non-'nancial corporations)provisions on loans to non-'nancial corporations (as % of non-performing loans to non-'nancial corporations)exposures with forbearance measures (as % of total loans to non-'nancial corporations)

Mar. June20152014

Sep. Dec.Dec. Mar. June2016

Sep. Dec. Mar. June2017

Sep.

CHART 5.8 Non-performing loans to non-financialcorporations, foreborne loans and loan lossprovisions(%)

Source: CBC.




as a percentage of total loans to NFCs, hasfollowed a downward trend from 34,8% inNovember 2016 to 30,4% in November2017(Chart 5.8, p. 39).

Debt19

NFC debt as a percentage of GDP reached137,0% in September 2017, decreasing from147,7% in September 2016 (Chart 5.9). Thus,domestic NFCs remain heavily indebted,despite the downward trend in their debt.

Financial position20

The net financial position of NFCs as apercentage of GDP is negative (i.e. thefinancial liabilities are larger than the financialassets) and decreased to 123,6% at end-September 2017, from 135,5% atend-September 2016 (Chart 5.10). The ratio offinancial liabilities to financial assetsdecreased to 153,9% in 2017Q3, comparedwith 158,5% in 2016Q3. These indicators showthat the financial position of NFCs remainsweak, but some improvement has beenobserved.

Deposits21

Based on the ECB methodology, deposits ofdomestic NFCs, reached €6,8 billion inNovember 2017 compared with €5,8 billion inNovember 2016, exhibiting a significantannual increase of 18,1% in November 2017,compared with an annual increase of 22,0% inNovember 2016 (Chart 5.11).

19. Excluding debt of SPEs. See footnote 4.20. Excluding SPEs. See footnote 4.21. Excluding deposits of SPEs. See footnote 4.

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80

100

120

140

160

180Cyprus euro area




Mar. June Sep.2017

CHART 5.9 Debt of non-financial corporations(1)

(ως %του ΑΕΠ)

Sources: CBC, Εurostat, ECB.(1) Excluding SPEs.

80

100

120

140

160

180Cyprus euro area




Mar. June Sep.2017

CHART 5.10 Net financial liabilities of the non-financialcorporations sector(1)

(as % of GDP)

Sources: CBC, Eurostat, ECB.(1) Excluding SPEs.

-15-10

-505

101520253035

Cyprus euro area




Mar. June Sep.2017

CHART 5.11 Deposits of domestic non-financialcorporations(annual change, %)

Sources: CBC, ECB.




This section examines the main de ve -lopments in the insurance sector andeva luates the potential risks it faces. Theanalysis focuses on the 32 insurance co mpa -nies operating in Cyprus, which aresu pervised microprudentially by the Su -perintendent of Insurance and are operatingin Cyprus or abroad.

The analysis of the sector is based on thequarterly Quantitative Reporting Templates(QRTs) as at 30 September 2017, which weresubmitted by the insurance companies andwere provided to the CBC by theSuperintendent of Insurance.

Financial position and solvency

Assets and investments

The total assets of the insurance companies ofthe Cyprus insurance sector increased from€3,8 billion in December 2016 to €3,9 billionin September 2017. On the other hand, thetotal liabilities of all insurance companiesamounted to €2,5 billion in September 2017.As a result, the assets of insurance companiesexceeded their liabilities by €1,4 billion inSeptember 2017, which is much higher thanthe Solvency Capital Requirement (SCR)required under the EU Solvency II Directive,which was €504 million.

The assets of insurance companies,excluding unit-linked funds22, amounted to€2,6 billion in September 2017, of which thebiggest part, amounting to €1,8 billion, was

22. Where the policyholders assume the investment risk.

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6. Insurance Sector




in the ‘’investments’’ category. Thedistribution of total assets and liabilities isshown in Chart 6.1. In particular, bondsconstituted the largest single component ofinvestments23 in September 2017 andamounted to €787 million (43%), of which€482 million (26%) was in corporate bondsand €305 million (17%) in government bonds.These high ratios, which do not include unit-linked investment funds, demonstrate theimportance of insurance companies inproviding financing to both governmentsand businesses. Investments in collectiveinvestment funds amounted to €496 million(27% of investments), followed by investmentin shares and participations at €227 million(12% of investments) and deposits at €206million (11% of investments) (Chart 6.2). Inrecent years, there has been a significantincrease of investments in collectiveinvestment funds, due to the higher returnsthey generate compared with other assets.Investment diversification is crucial in thecontext of the EU Solvency II Directive, due tothe high capital charge required in the eventof insufficient investment diversification.

In addition to these investments, insurancecompanies managed €1,3 billion of unit-linked funds. Other smaller, but important,categories of assets were cash, customer andinsurer balances and recoveries from re-insurers.

While the improvement in the economicclimate supported the insurance sector, theprolonged low-interest rate environmentcontinues to burden the sector's profitabilityprospects – particularly life insurance

23. Not including unit linked investment funds.

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0 5 10 15 20 25 30 35

property (excluding property for own use)

equity and participations

government bonds

corporate bonds

collective investment funds

deposits other than cash equivalents

οther investments

December 2016 September 2017

CHART 6.2 Distribution of investments(1)

(%)

Sources: ICCS, CBC calculations.(1) Relates to investments where the insurer bears the investment risk (excluding theinvestments of unit linked funds).

769

1.268

1.839

0

500

1.000

1.500

2.000

2.500

3.000

3.500

4.000

0

500

1.000

1.500

2.000

2.500

3.000

3.500

4.000

Assets

1.001

504

981

1.390

Liabilities

investments excluding unit linked funds

other assets

investments of unitlinked funds

technical provisions

other liabilities

solvency capitalrequirement (SCR)

available assets

CHART 6.1 Solvency II balance sheet(€ thousands)

Sources: ICCS, CBC calculations.




companies – and is one of the major concerns,since interest rates on deposits and returns oninvestment remain low. It is noted that theprofitability of insurance companies isincreasingly dependent on the return on theirinvestments. This risk is amplified as insurancecompanies may seek alternative sources ofinvestment with increased expected returnsbut also with increased risk.

Production of premiums, revenues andexpenses

The production of gross premiums in the firstnine months of 2017 increased, indicatingthat the reversal of the economic climate andthe restoration of confidence in the Cypruseconomy have brought the sector back topositive growth. In particular, total grosswritten premiums for the first nine months of2017 amounted to €683 million comparedwith €604 million for the first nine months of2016 (Chart 6.3).

Total gross written premiums of lifeinsurance companies24 for the first ninemonths of 2017 showed a significant increaseof 11% compared with the first nine monthsof 2016, while in the non-life insurancecompanies25, there was an even largerincrease of 14%. The production of newrevenue (contracts) in the life insurance sector,increased by 10%.

In the non-life sector, the gross cost ratio26

improved, recording a decrease from 33% forthe whole of 2016 to 30% for the first ninemonths of 2017, while in the life sector, this

24. Excluding accident and health insurance premiums for lifeinsurance companies.

25. Including accident and health insurance premiums for lifeinsurance companies.

26. It depicts the ratio of expenses to gross premiums written.

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-15

-10

-5

0

5

10

15

0

100

200

300

400

500

600

700

800

900

real GDP (annual change, %)(right-hand scale)

gross written premiums - non-lifegross written premiums - life

Dec.2011

Dec.2012

Dec.2013

Dec.2008

Dec.2009

Dec.2010

Dec.2014

Dec.2015

Dec.2016

Sep.2017

CHART 6.3 Gross written premiums(€ million, annual change, %)

Sources: ICCS, CBC calculations.Note: Data for September 2017 relates to the gross written premiums for nine months(January-September 2017) while the data for December relates to written premiums for thewhole year.




ratio remained at 22%, reflecting insurancecompanies' efforts to reduce costs andenhance their operational efficiency.

The challenge for all insurance companiesis to increase their revenues, reduce theircosts and increase their operationalefficiency. For life insurance companies inparticular, the challenge is to maintainexisting contracts while generating newrevenues, which are the key driver for theirfuture profitability, given the long-termhorizon of the life insurance sector.

Medical insurance is a major part ofinsurance premium income for both life andnon-life insurance companies. The imple -mentation of the General Health InsuranceSystem (GHIS) is expected to lead to areduction in the turnover and income ofinsurance companies, in particular of grouphealth plans, as employers may reduce staffcoverage given that they will have to cover thecost of their staff's participation in the GHIS.

Analysis of insurance policy claims

In the non-life sector, the Gross ClaimsIndex27 recorded a decrease from 58% for thewhole of 2016, to 53% for the first ninemonths of 2017.

In the life sector, the Gross Claims Indexrecorded a decrease from 88% for the wholeof 2016 to 73% for the first nine months of2017. Redemptions and cancellations of lifeinsurance policies, which had risen sharply inrecent years due to the financial crisis,stabilised at pre-crisis levels (Chart 6.4).

27. It depicts the relationship between claims that accrued togross accrued premiums.

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024681012141618

0

20

40

60

80

100

120

140

surrenders other insured events

deathmaturities

unemployment rate (%, monthly average) (right-hand scale)

Dec.2011

Dec.2012

Dec.2013

Dec.2008

Dec.2009

Dec.2010

Dec.2014

Dec.2015

Dec.2016

Sep.2017

CHART 6.4 Analysis of claims of the life business(% of gross premiums, %)

Sources: ICCS, CBC calculations.




Solvency position

From 1 January 2016, the framework forcalculating the capital requirements ofinsurance companies has been amended.Based on the Solvency II Directive of the EU,the solvency ratio, which equals to the assetsavailable to the SCR of a company, increasedto 273% in September 2017 from 268% inSeptember 2016 (Chart 6.5). Although theinsurance sector is sufficiently capitalised inits entirety, there are some insurancecompanies that are at the capital requirementlimit, i.e. where their capital adequacy is closeto 100%.

Life insurance companies, due to thenature of their operations, have a higheraverage solvency ratio (318%) compared withthe corresponding average index for non-lifeinsurance companies (234%).

Overall assessment and outlook of theinsurance sector

The important role of insurance companies inmitigating risks, providing coverage againstfuture loss-events and the restoration oflosses is widely recognised. Through coverageof risks, insurance companies help tosafeguard the stability of the financial positionof households and of the balance sheets ofbusinesses. They are institutional investors inequities, government bonds and corporatebonds, and because of the large size of theirinvestments in financial markets, they play animportant role in enhancing the stability ofthe financial system.

In the case of life insurance companies in

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50

100

150

200

250

300

350

solvency ratio - life

solvency ratio - non-lifesolvency ratio - total


Mar. June Sep.2017

CHART 6.5 Solvency position(%)

Source: ICCS.




particular, their investment policy is guided bythe need to ensure adequate and predictablecash flows over time. Their balance sheets, asopposed to the balance sheets of creditinstitutions, consist of relatively long-terminvestments that protect insurancecompanies from the risk of illiquidity whenthey are called to pay the insured at the expiryof a life insurance policy. As a result, lifeinsurance companies tend to have a long-term investment horizon and can act as astable and secure source of investment intimes of crisis.

The insurance sector can, however, also bea source of vulnerability for the financialsystem. As institutional investors, insurancecompanies have substantial links with the restof the financial sector through their holdingsin equity of financial corporations and viceversa, which can cause transmission risks withwidespread consequences.

At the same time, the insolvency of a majorinsurance company may create financialstability concerns. In this regard, the CBCconsiders necessary the introduction of acredible and reliable institutional frameworkfor the recovery and resolution of insurancecompanies and supports that this issue isswiftly addressed at the EU level.

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This section reviews developments in thedomestic IFs and CIFs sectors. The assessmentis based on data provided directly by the IFsto the CBC and on supervisory data submittedto the CBC.

IFs do not guarantee that the setinvestment objective will be met, since therisk underlying their activities is borne by theholders of the participation units.

A potential deterioration in the financialcondition or capital position of CIFs managingthe investments of IFs, is not expected tonegatively impact the assets of the IFs theymanage.

Investment funds sector

The IFs sector in Cyprus comprises:(a) Alternative Investment Funds and Under -

takings for Collective Investment inTrans ferable Securities (UCITSs) resident inCyprus, which are regulated and super -vised by CySEC, and

(b) Investment companies which are listed onthe Cyprus Stock Exchange (CSE).

The IFs are categorised in open-ended funds,whose units or shares are, at the request of theholders, repurchased or redeemed, directly orindirectly, using the undertaking’s assets andin close-ended funds, which have a fixednumber of issued shares and whoseshareholders have to buy or sell existingshares when entering or leaving the IF.

As at September 2017, the domestic IF

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7. Investment Funds and Investment Firms Sector




sector comprises 108 reporting entities (90 inSeptember 2016) with total assets of €2,7billion (€2,5 billion in September 2016) (Chart7.1). On the same date, open-ended IFsrepresented 84,2% of the total assets ofdomestic IFs, while close-ended IFsrepresented 15,8% of the total assets ofdomestic IFs (September 2016: 81,3% and18,7% respectively).

The resident IF sector has expandedconsiderably - more than doubling in sizesince 2008 - but remains very small comparedwith the total assets of the financial sector. Theratio of IFs' assets to GDP was 14,5% inSeptember 2017 (14,0% in September 2016).Investments in shares and other participationsrepresent approximately 75,0% of the totalsector’s investment assets under ma na ge -ment in September 2017 (75,7% in September2016) (Chart 7.2).

As at 30 September 2017, domestic IFswere mostly owned by NFCs, which owned45,6% of the shares of these funds, with otherfinancial intermediaries also having asubstantial share (24,7%). At the end ofSeptember 2017 the landscape changedcompared with the same date of 2016, wherethe IFs were mostly owned by NFCs, whichowned 36,8% of the shares of these funds,with other financial intermediaries also havinga substantial share (30,6%) (Chart 7.3).

There are two notable features regardingthe domestic IFs that are important forsystemic risk analysis:(i) the ownership of the IFs, and(ii) the amount of their investments in the

domestic market.

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depositscash shares and other

equityother assetsloans

securities other than sharesnon-Enancial assets

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014

Mar. Sep.2015

Mar. Sep.2016

Mar. Sep.2017

CHART 7.2 Asset distribution of investment funds(%)

Source: CBC.

0

20

40

60

80

100

120

00,20,40,60,81,01,21,41,61,82,02,22,42,62,83,03,2

mutual fundsequity mixedreal estate

bondother

number of reporting entities (right-hand scale)

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014

Mar. Sep.2015

Mar. Sep.2016

Mar. Sep.2017

CHART 7.1 Total assets of investment funds byinvestment policy(€ billion, number of reporting entities)

Source: CBC.Note: From September 2014 onwards, 'other' also includes 'mutual funds'.

0102030405060708090

100

other

non-Knancial corporations other monetary Knancial institutions (MFIs)other Knancial intermediaries

households insurers and pension funds

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014

Mar. Sep.2015

Mar. Sep.2016

Mar. Sep.2017

CHART 7.3 Distribution of ownership of investmentfunds by type of investor(%)

Source: CBC.




The majority of investors were domesticresidents with holdings standing at 56,7% ofthe total capital of IFs as at September 2017.Non-euro area investors held 38,0% of thecapital of IFs (Chart 7.4). Euro area investorsowned the remaining 5,3% of the capital ofIFs. As at September 2016, the largest part ofinvestors were non-euro area residentsholding 46,7% of IFs’ capital. Domesticinvestors followed, with holdings of 44,0%,while euro area investors held 9,3% of capital.Based on the above, it is evident that there isa structural shift in the ownership of IFs,increasing the sector’s importance for thedomestic economy.

Focusing on domestic investors, inSeptember 2017 the largest share of holdingswas by NFCs, reaching 66,7% of total shares(September 2016: 67,4%). For euro areainvestors, the holdings were more diversified,mainly between NFCs (43,4%) andhouseholds (32,1%) and there were structuralchanges compared with 2016, where NFCsheld 30,5% of shares, households held 23,3%of shares and other financial intermediariesheld 33,1% of shares. As far as non-euro areainvestors are concerned, the largest share ofholdings was by other financialintermediaries, reaching 62,1% of shares(September 2016: 58,3%). This breakdown ofownership is illustrated in Chart 7.5.

In the first nine months of 2017, themajority of assets were invested domesticallyand in the euro area, i.e. the assets (e.g.securities, loans, deposits) of IFs arepredominantly located within the euro area orwithin Cyprus (Chart 7.6). Holdings of equitywere the dominant form of investment, with

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domestic residentsrest of the world residents

euro area residents

Mar. Sep.2011

Mar. Sep.2012

Mar. Sep.2013

Mar. Sep.2014

Mar. Sep.2015

Mar. Sep.2016

Mar. Sep.2017

CHART 7.4 Distribution of ownership of investmentfunds by geographical origin(%)

Source: CBC.

0102030405060708090

100

Domestic residents (57%)

Euro area residents (5%)

Rest of the world residents (38%)

other

non-Knancial corporations other monetary Knancial institutions (MFIs)other Knancial intermediaries

households insurers and pension funds

CHART 7.5 Distribution of investors in investmentfunds by geographic origin and by type of investor(end of September 2017, %)

Source: CBC.

euro area rest of the worlddomestic

September 2017September 2016

34,9 30,1

35,0

28,9 30,8

40,3

CHART 7.6 Distribution of assets of investment funds bygeographical region(%)

Source: CBC.




a skew towards shares quoted in markets inother euro area countries (49,8% inSeptember 2017 compared with 44,9% inSeptember 2016) and shares on the CSE(24,6% in September 2017 compared with25,9% in September 2016).

A significant proportion of assets is locateddomestically, while liabilities, such as theownership of equity shares in IFs, are alsomostly located domestically (Chart 7.7).Therefore, there are direct linkages with thedomestic financial system and the economy.However, they are not very significant due tothe small overall size of the IFs sectorcompared with total financial sector assets.Furthermore, since the participation of theother domestic financial intermediaries,insurance companies and MFIs in domestic IFsis limited, any deterioration in the returns ofIFs’ investments is not expected to have amaterial direct effect on the domesticfinancial sector.

Based on the above, the risks to thestability of the financial system of Cyprusstemming from domestic IFs remain limited.The sector shows signs of stabilisation interms of its size and will continue to bemonitored and supervised macroprudentiallyby the CBC.

Furthermore, the sector is susceptible toexternal and regulatory developments and atpresent, global and domestic IFs face a periodof uncertainty owing to possible regulatorychanges and geopolitical developments. Apart of the non-credit financial institutionssector is subject to new supervisoryarrangements, through the collection ofstatistical data, disclosure rules, market

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September 2017September 2016

euro area rest of the worlddomestic not classiBed

39,0

16,036,6

8,4 42,65,1

3,6

48,7

CHART 7.7 Distribution of liabilities of investmentfunds by geographical region(%)

Source: CBC.




integrity rules and rules for collectiveinvestment undertakings.

Overall, while the sector is susceptible toexternal developments and changing investorpreferences, it does not pose a significant riskto the domestic macro-financial environment,given its relatively small size. However, therapid growth of the sector in recent years andlinks to both the economy and the financialsector, warrant the continuous monitoring ofdevelopments and the macroprudentialoversight of the sector.

Cyprus investment firms sector

The CIFs sector consists of the firms providingthe investment services listed in theInvestment Services and Activities andRegulated Markets Law, and which aresupervised by CySEC.

The sector experienced rapid growthduring recent years, with the number oflicenced CIFs reaching 215 on 30 June 2017,compared with 191 on 30 June 2016. Formacroprudential oversight purposes, the 82CIFs that provided the investment services ofdealing on own account and underwriting offinancial instruments and / or placing offinancial instruments on a firm commitmentbasis are of particular interest (30 June 2016:69 CIFs).

The total assets of the 82 CIFs amounted to€11,1 billion in December 2016, exhibiting adecrease of 21,1% compared with December2015. The total assets of the 82 CIFsrepresented 3,7% of the total assets of theCyprus financial sector in December 2016, or61,1% of GDP. The nominal value of the over-

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the-counter derivatives held by the 82 CIFs on31 December 2016 showed an annualdecrease of 29,5%, reaching €90,5 billion.

The interconnectedness of the above CIFswith the EU financial system remained limited,since on 31 December 2016 only 13,5% oftheir total assets related to the EU intra-financial system assets, including the financialsystem of Cyprus (31 December 2015: 10,7%).A similar picture emerges on the liability sideof the above CIFs, since their EU intra-financialsystem liabilities are limited to 10,8% of theirtotal assets (31 December 2015: 6,2%).

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Annex Ι: Macroprudential Policy DecisionsConcerning the Stability of the Financial System28

28. One of the main responsibilities of the CBC, is the macroprudential oversight of the financial system, with the ultimate objectiveto contribute towards safeguarding the stability of the financial system. Financial system means all financial institutions,markets, financial products and financial market infrastructures. Financial institution means any credit institution, financialconglomerate, payment institution, electronic money institution, insurance undertaking, re-insurance undertaking, insuranceintermediary, occupational retirement benefit institution, investment firm (i.e. CIF) or collective investment undertaking orother institution, an enterprise or entity having a principal activity of a similar nature established in the Republic and authorisedby a competent authority of the Republic or operating in the Republic.




The CBC follows an active macroprudentialpolicy. The macroprudential policy decisionstaken by the CBC during 2017 pertaining tothe stability of the financial system as well asthe macroprudential instruments that havebeen activated, are set out below.

During 2017 the CBC:1. Reset the O-SII capital buffer for the other

systemically important credit institutionsthat they have to meet from 2019 and forthe systemically important CIFs that theyhave to meet from 1 October 2017.

2. Set the countercyclical capital buffer rateat 0% of risk weighted assets of eachlicenced credit institution and certain CIFs.The level of the countercyclical capitalbuffer is re-evaluated and set quarterly.The deviation of the indicator of bankcredit to GDP for Cyprus from its long-termtrend remains negative.

3. Decided, based on the powers vested in itby article 5(2) of the MacroprudentialOversight of Institutions Law, 6(I) 2015, toexempt certain small and medium-sizedCIFs from the requirement to maintain theinstitution specific countercyclical capitalbuffer for 2017.

4. Designated the Russian Federation as amaterial third country for the bankingsystem of Cyprus for 2017, in relation to therecognition and the setting of the

countercyclical capital buffer for exposuresto each material third country and decidedthat the CBC will not monitor the risksrelated with any undue credit expansion inthe Russian Federation, given that theRussian Federation is already beingmonitored for these risks by the EuropeanSystemic Risk Board.

5. Defined its policy in relation to theevaluation of the cross border effects of themacroprudential policy measures and theirvoluntary reciprocity. The CBC also definedits policy that sets the procedures that theCBC needs to follow when a request for thereciprocation of a macroprudentialmeasure that is submitted by a memberstate, is recommended by the EuropeanSystemic Risk Board to be adopted by othermember states.

6. Adopted, on the basis of reciprocity, twomacroprudential policy measures thatwere adopted by the National Bank ofBelgium and the Bank of Estonia. Thesewere applied retrospectively by the CBCfrom 24 June 2016 and 24 September2016, respectively.

7. Activated on 21 December 2017 a nationalmacroprudential measure for themaintenance of additional liquidity bycredit institutions for the period 1 January2018 to 31 December 2018.

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Annex ΙΙ: Macroprudential Measures




29. On 1 August 2017, Reserve Invest (Cyprus) Ltd renounced its investment firm license and effective from that day, the CentralBank of Cyprus no longer considers it as an O-SII institution.

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Macroprudential Level Notesmeasure

Loan to Value, LTV

Debt Service ToIncome ratio, DSTΙ

CountercyclicalCapital Buffer (CCyB)

Other SystemicallyImportantInstitutions buffer –(O-SII buffer)

Adoption of anationalmacroprudentialmeasure to maintainadditional liquidityrequirements forcredit institutions.

80% in the case the credit facility is grantedfor financing the primary permanent resi-dence of the borrower.

70% for all other property financing cases.

The total debt servicing amount should notexceed 80% of the applicant’s net disposableincome.

In the case of loans in foreign Currency, thetotal debt servicing amount should not ex-ceed 65% of the applicant’s net disposable in-come.

0% of the total risk exposure amount of li-cenced credit institutions, and of each CyprusInvestment Firm that has not been exemptedby the CBC due to its small or medium size.

Bank of Cyprus: 2,0%RCB Bank Ltd: 1,5%Hellenic Bank: 1,0%Cooperative Cyprus Bank: 1,0%Αlpha Bank Cyprus: 0,5%Eurobank Cyprus: 0,5%

SIB (Cyprus) Limited: 1,5%Renaissance Securities (Cyprus): 1,5%Alfa Capital Holdings (Cyprus): 0,5%Reserve Invest (Cyprus) Ltd29: 0,5%

Additional liquidity requirements in the formof LCR add-on rates on some of the parame-ters used in the calculation of the LiquidityCoverage Ratio (LCR).

Furthermore, this measure provides for a 50%reduction of the LCR add-on rates on 1 July

Revised CBC Directive2016.

Assessed on a quarterlybasis, by analysing a set ofindicators.

The CCyB requirementcame into force on 1 Jan-uary 2016.

Annual reassessment.

For credit institutions, therequirement to maintainthe O-SII buffer require-ment will be phased-infrom 1 January 2019 to 1January 2022.

The O-SII buffer require-ment for investment firmsis applicable as of 1 October 2017.

This national macropru-dential measure is of atemporary nature, with aduration of one year, andwas implemented on 1January 2018.




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Macroprudential Level Notesmeasure

Reciprocity ofmacroprudentialmeasures - Belgium

Reciprocity ofmacroprudentialmeasures - Estonia

2018 and their complete abolition on 31 De-cember 2018.

5% risk-weight add-on to Belgian mortgageloan exposures of credit institutions.

Adoption of 1% systemic risk buffer rate onall exposures of credit institutions and invest-ment firms located in Estonia.

The CBC’s decision toadopt on the basis of reci-procity the macropruden-tial measure that wasadopted by the NationalBank of Belgium enteredinto force on 24 June2016.

The CBC’s decision toadopt on the basis of reci-procity the macropruden-tial measure that wasadopted by Eesti Pank en-tered into force on 24 Sep-tember 2016.


financial - central bank of cyprus

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