THE BANKING SYSTEM OF CYPRUS Also by Kate Phylaktis FINANCIAL DATA OF BANKS AND OTHER FINANCIAL INSTITUTIONS INTERNATIONAL FINANCE AND THE LESS DEVELOPED COUNTRIES (editor with M. Pradhan) The Banking System of Cyprus Past, Present and Future Kate Phylaktis Reader in International Finance Director of the Research Centre in Financial Development City University Business School London palgrave macmillan © Kate Phylaktis 1995 Softcover reprint of the hardcover 1st edition 1995 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London WIP 9HE. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations ofthe country of origin. First published 1995 by MACMILLAN PRESS LTD Houndmills, Basingstoke, Hampshire RG21 2XS and London Companies and representatives throughout the world ISBN 978-1-349-12870-9 ISBN 978-1-349-12868-6 (eBook) DOI 10.1007/978-1-349-12868-6 A catalogue record for this book is available from the British Library. \0 9 8 7 6 5 4 3 2 I 04 03 02 01 00 99 98 97 96 95 To my family Contents Preface xi PART I THE PAST 1 The Origins of Modern Banking in Cyprus 5 1 The Establishment of the First Bank 5 2 The Development of Local Banking Institutions 8 3 A Comparison of Banking Strategies of Local and Foreign Banks 10 4 The Stability of the Banking System 15 5 In the Aftermath of the Banking Crisis 16 6 The Decline of the Foreign Banks 18 2 The Financing of Agriculture 23 1 The Farmers and their Produce 23 2 The Financing Requirements of Farmers 24 3 Financing Agriculture at the End of the Nineteenth Century and Early Twentieth century 26 4 The Development of the Co-operative Movement 29 5 The Establishment of the Agricultural Bank 31 6 The Establishment of the Central Co-operative Bank 35 7 Some Remarks on the Development of Co-operation 37 3 Banking without a Central Bank 42 1 The Monetary and Banking System 42 2 Performance of Central Banking Functions 44 3 Cyprus Banking, a Satellite of the English Banking System 45 PART II THE PRESENT 4 The Central Bank of Cyprus 53 1 Reasons for Establishing the Central Bank of Cyprus 53 2 The Establishment of the Bank 58 vii viii Contents 3 The Relation Between the Central Bank and the Money Banks 59 4 Monetary Policy in the Early Years 62 5 Monetary Policy: 1974-80 65 6 Monetary Policy: 1981 to the Present 67 7 Central Bank Performance 71 5 The Banking System during Independence 76 1 Introduction 76 2 The Growth of the Commercial Banking Sector 76 2.1 Liabilities 77 2.2 Assets 83 2.3 Factors which contributed to the expansion of the commercial banking sector 84 3 The Commercial Banks 85 3.1 The Bank of Cyprus 85 3.2 The Cyprus Popular Bank 87 3.3 The Hellenic Bank 88 3.4 Barclays Bank 88 3.5 The National Bank of Greece 88 3.6 The Arab Bank 89 3.7 Lombard Natwest Bank 89 3.8 Relative size and performance 89 3.9 Developments in banking structure 93 4 Other Financial Institutions 95 4.1 The Cyprus Development Bank 99 4.2 The Mortgage Bank of Cyprus 102 4.3 Housing Finance Corporation 102 6 Co-operative Societies: Growth and Crisis 105 1 Introduction 105 2 The Growth of the Co-operative Movement 105 3 The Central Co-operative Bank III 3.1 Developments: 1963 to 1979 III 3.2 The legal structure governing the co-operative movement 112 3.3 The crisis 114 4 Final remarks 117 Contents ix PART ill THE FUTURE 7 Cyprus: An Emerging Offshore Banking and Financial Centre 125 1 Characteristics of Cyprus as an Offshore Banking and Financial Centre 125 2 A Comparison of the Experience of Cyprus and Bahrain as Offshore Banking Centres 128 2.1 Developments in offshore banking activities in Cyprus 128 2.2 Bahrain as an offshore banking centre 129 3 Prospects for Offshore Banking Business in Cyprus 130 4 Some Final Remarks 132 8 The Existing Regulatory Framework of the Banking System and Prospective Changes 134 1 Existing Prudential Regulations and Legal Framework 134 2 The EC Banking Directives 137 2.1 The second Banking Co-ordinate Directive 137 2.2 Directive on the annual accounts and consolidated accounts of banks and other financial institutions 138 2.3 Commission's recommendation on monitoring and controlling large exposures of credit institutions 139 2.4 Directive on a solvency ratio for credit institutions 139 2.5 Directive on own funds 140 2.6 Directive concerning the reorganisation and the winding-up of credit institutions and deposit-guarantee schemes 141 3 Comparison of EC Directives with the Proposed Cyprus Banking Bill 141 3.1 Limitations on credit facilities 141 3.2 Limitations on shareholding 142 3.3 Regulations on minimum capital 142 3.4 Regulations on capital adequacy 142 3.5 Liquidity requirements 142 3.6 Publications of accounts 142 3.7 Deposit guarantee schemes 143 4 Further Comments on the Proposed Cyprus Banking Bill 143 x Contents 9 Banking in Cyprus in the 1990s 145 Main Characteristics of the Current Banking Industry 145 l.1 Private ownership 145 1.2 A substantial semi-informal sector 146 1.3 A highly concentrated commercial banking sector 146 1.4 A saturated banking sector 147 1.5 A profitable commercial banking sector 147 1.6 Substantial conduct regulation 147 2 Effects of Domestic Deregulation 148 3 Effects of Adopting the EC Banking Directives 151 4 Abolition of Foreign Exchange Controls 153 5 Final Remarks 153 Index 159 Preface This book is intended to be a comprehensive study of the banking system in Cyprus from the time that the first bank was founded on the island in 1864. The aim is to present not only the history of banking over this one hundred and thirty year period but a thorough analytical discussion as well. In addition, I examine likely future developments in the banking industry of Cyprus. I hope that the book be of value to students, academics and practitioners. Undergraduate and postgraduate students taking financial development courses will find both the general analysis and that specific to Cyprus on the development of financial structures of great interest. At the same time, academics and banking practitioners who are interested in the onshore and offshore banking activities on the island will find the book informative on both past developments and the present situation. The motivations for writing this book have been many. Through my visits to the banks in Cyprus in the early 19808, I became aware of the lack of a comprehensive study of the banking system on the island despite the many Cypriot academics and scholars in Cyprus and the rest of the world. At the same time, I was becoming interested in the financial aspects of developing countries as a result of my research and teaching responsibilities. It became clear to me that undertaking a study of banking in Cyprus would give me the opportunity to examine the development of the financial structure of a small economy and indeed of an ex-British colony. Very few authoritative studies have been written on these topics. Finally, the most important reason for this research was a desire to offer something tangible, however small, to my native country. Being a member of a University Department of Banking and Finance gave me a comparative advantage over others in this field of research. I am greatly indebted to the Cyprus Popular Bank for the financial and other support that it has given to me. Indeed the book could not have been made possible without its kind assistance. The subject was first raised with Mr Kikis N. Lazarides, the Chairman of the Bank, in the mid-1980s. The initial proposal was to write a short book on the historical development of the banking system in Cyprus. Through the years, however, the book evolved into a comprehensive study not only xi XII Preface of the development of the banking system but also of its current state and future prospects. I would like to thank in particular the following members of the Bank: Mr Panayiotis Mallis who was always ready to discuss innumerable issues that emerged during the writing of the book; Alecos Sergides, who although no longer with the Bank, provided me with invaluable help in collecting and discussing the information used in the book, especially the historical material; and Niki Papadopoulou and Yiannis Tirkides for assisting me in the later stages of my research. I am also grateful to many other people who helped me either by providing information or in giving their comments on earlier drafts of the manuscript. The book benefited enormously from the comments of Christopher Clay (who also provided me with some important documents from the surviving archives of the Imperial Ottoman Bank), Forest Capie, Geoffrey Jones, Leslie Presnell and Geoffrey Wood. I am also indebted to the Cyprus Public Records Office, the Bank of Cyprus, the Cyprus Popular Bank and the Ionian Bank for permission to use their archives.