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Dr. Elina Christofides
Partner, Advisory
Dr. Elina Christofides is an Advisory Partner, in charge of banking, at PwC Cyprus, who has been advising banking institutions, supervisory authorities and other clients in the financial services industry with a focus on governance, risk and regulatory compliance.
She has over 20 years of experience in the sector both in an advisory capacity and from her prior roles at major global banking institutions in London. Elina studied Civil and Structural Engineering at the University of Cambridge, Trinity College, receiving a Master’s Degree (MEng). She then continued her studies at Imperial College London, where she obtained a doctorate (PhD) in Quantitative Finance.
Mr Christos Pieridis
Director, Advisory
Christos Pieridis is a Director in the Advisory department of PwC Cyprus focusing on risk and regulation. With over 13 years of practical experience in an advisory capacity on a number of assignments in the banking sector, Christos guides organisations through the complex nuances of banking risks and regulations. He serves as a trusted advisor to banking institutions by offering advice and support in the interpretation of regulations, risk management and mitigation and the quantification of risks with the use of advanced analytics. Christos studied Accounting and Finance and acquired his Master’s degree in Finance, at Lancaster University.
He is also a qualified Chartered Accountant (ACA) and a member of the Institute of Chartered Accountants of England and Wales (ICAEW) and the Institute of Certified Public Accountant of Cyprus.
Transforming Banking: Navigating the Challenges & Embracing Change
Digitisation, operational resilience and sustainability will be the drivers of the continuous transformational journey of the banking sector in Cyprus in the decade ahead.
INTRODUCTION
Cyprus has a strong and flexible, serviced-based economy, with a quite diversified tertiary sector that comprises approximately 85% of GVA. The banking industry is a key component of the financial services industry, supporting the economy’s performance. Indeed, the robustness of the banking industry acts as a key driver toward the country’s growth, resilience and prosperity.
In the not-so-distant past, the sector was grappling with the aftershocks of a severe crisis, while navigating the complex waters of new regulations, profitability concerns and heavy operational costs. Yet, the sector has recovered and with a transformed business model, it is pursuing new sources of value while preparing to face the new challenges unfolding.
With the echoes of the disrupting forces of the past fading, the recent global shocks have been unfolding successively and their impact has been persistent in the economic sectors affected, highly impacting the global and the European economy. These shocks create an environment characterised by uncertainty and volatility, with risks materialising with a slowdown of economic activity mainly driven by the immense inflationary pressures and the rising interest rates.
Amidst the continuous waves of shocks and high uncertainty, the Cypriot economy has demonstrated significant resilience to these shocks including the COVID-19 pandemic crisis, the recent energy pressures and the geopolitical conflicts unfolding. According to the European Commission (EC), Cyprus’ growth is expected to slow down in 2023 and 2024 to 2.4% and 2.8% respectively, after a robust growth of 5.1% in 2022.
The rising interest rates witnessed since July 2022, in an effort to ease inflationary pressures, have benefited the Cyprus banking sector as they have become a significant source of profit due to the excess liquidity the sector enjoys. Indicatively, based on the European Banking Authority (EBA) Risk Dashboard for Q3 2023, the sector enjoyed significant excess liquidity with the average liquidity coverage ratio standing at approximately 347%, compared to a European Union (EU) average of 161%. As a result, most banks are recording strong profits.
However, the higher interest rates, coupled with the elevated prices, are expected to negatively affect household disposable income, corporate investment and residential construction for domestic demand, as well as demand for new lending. Lower demand for loans and stricter lending criteria, are expected to further reduce economic activity going forward, albeit growth is expected to remain stronger compared to EU peers.
In addition to the recent shocks, significant developments in the banking landscape ranging from the rising supervisory expectations for sustainable financing linked with Environmental Social and Governance (ESG) criteria, the ongoing digital transformation and key regulatory developments, are expected to further shape the sector in the short to medium term.
KEY DEVELOPMENTS SHAPING THE FUTURE OF THE CYPRUS BANKING SECTOR
ESG and Sustainable Banking
ESG has been evolving as a key theme for nearly two decades, at least since the topic was highlighted in a 2006 United Nations report on principles for responsible investment. Attention has intensified, as evidence of climate change has increased. The growing attention and urgency have not only raised concerns about the ‘E’ in ESG, but have also added to interest in whether companies and in particular banking institutions are being responsible stakeholders and applying practices that conform with both the letter and the spirit of the principles promoting environmental goals.
The need to focus on ESG is only expected to increase as more states and organisations commit to net-zero targets and regulators are stepping up pressure for businesses to be more sustainable. Likewise, investors say they prefer to put money into businesses with a strong ESG profile (even if investors aren’t yet willing to sacrifice much return to do so). In the recent PwC Global Investor Survey, global investors placed climate risk amongst the top five threats that their business will be exposed to in the coming periods. In parallel, customers, employees, and potential employees are evaluating companies on ESG criteria, urged on by activists and other social forces.
During the last few years, regulations and guidelines published in the area of ESG have impacted the banking industry as well. The EC mandated a high-level expert group to develop recommendations for the design of a sustainable financial system that served as the basis for an action plan. In 2018 the EU published its action plan on financing sustainable growth. This action plan recognises that the shift of capital flows towards more sustainable activities needs to have a holistic understanding of the sustainability of activities and investments.
With environmental, social and governance standards becoming increasingly critical to banks’ reputation and licence to operate, the multidimensional ESG ecosystem needs to be translated into banking institutions’ strategic approaches. The areas that are expected to be impacted are numerous ranging from new loan originations and ongoing monitoring, reporting requirements and disclosures to investors, to risk management and operational aspects.
So what does ESG really mean for Cypriot banks? Financially the sector will need to reshape its investment strategies, directing funds towards more environmentally and socially responsible initiatives and projects. To achieve this, banks will need to be in a position to evaluate risks, including climate and environmental ones, and take measures to adequately mitigate material risks that arise in their books. This will significantly impact operations as well, as new processes will need to be adopted and the workforce will need to be educated and re-skilled to understand and quantify these risks and communicate their implications to their clients. Institutions will also need to look inwards, in the way they adopt sustainable practices, reduce their carbon footprint and promote ethical business conduct.
The Cyprus banking sector is making significant investments in the area of ESG, in an effort to tackle the strategic, financial and operational aspects of this complex topic. All of the major banks of the island are investing in their data and reporting capabilities, in the training of employees and customers, in risk management practices and product design, and of course in shifting the strategic vision of the institutions towards sustainable outcomes and practices.
Digital Transformation
The COVID-19 pandemic significantly accelerated the need for digital banking services on a global scale. In parallel, the introduction of new market participants, such as FinTech and BigTech companies, in the otherwise traditional and difficult to enter banking market, has further exacerbated the need for banking institutions to accelerate the pace of their digital transformation.
The benefits of this ongoing transformation are multilayered. Increased operational efficiencies directly translate to reductions of costs in a sector that is still healing from the impact of the latest financial crisis; diversification of revenue with new innovative services and new channels for sales is positively influencing growth potential; while transformation of legacy systems and processes is enabling banks to better identify opportunities and challenges and better capitalise and mitigate these respectively.
The journey for banking institutions has not been without its challenges. According to a report published by Workday and PwC, two common blockers for digital transformation are poor implementation of new technologies and the lack of a coordinated strategy. Another critical part of such journeys is strong cybersecurity practices in which banks need to continuously invest and proactively deploy to mitigate the elevated regulatory, operational and reputational risks at hand.
Cyprus banking institutions are investing heavily in a number of areas to reap the benefits of such transformations and to safeguard their market positions. Key investments are being made in the area of data and analytics with an objective to drive innovation and decision making. Data points from different sources within institutions are pulled together to better understand financial performance of products and services, employee activity, costs of operations and of course customer behaviour. The insights from this unified view of information allow banking institutions to make informed decisions in relation to strategy, risk management, product development as well as marketing. Moreover, banks are investing in the development of the digital economy by creating new platforms linking customers and businesses.
The speed at which decisions are made is also crucial for institutions, both in terms of strategic planning and in terms of client experience and satisfaction. In the “new normal” consumers are no longer willing to wait, as other providers offer real-time or near real-time information and outcomes. This is where the cloud comes into play, since it has enabled institutions to deploy services and applications faster, while scalability can be achieved with ease.
An important aspect of digital transformation relates to a key pillar of productivity in banking institutions, their workforce. Cypriot banks are currently focused on the upskilling of their workforce with new technical skills as well as new soft skills including advanced collaboration, change programmes that relate to new tools and core systems, and the mastering of digital labour in the form of Artificial Intelligence (AI) tools.
Digital transformation is expected to remain in the spotlight both at an international and at a local level in the years to come, as mobile banking becomes the preferred channel for clients and as national borders become less relevant in servicing clients within the EU.
The Regulatory Avalanche
Developments in the regulatory space have been continuous since the global financial crisis, with the overall objectives as per the ECB focusing on the safety and soundness of the banking system and on increasing financial integration and stability. In alignment with these objectives, the banking sector in Cyprus has come a long way since the financial crisis of the last decade. According to data from the EBA, banks have solid capitalisation buffers with Tier 1 Capital standing at 21%, with the sector returning a sizable profit both in 2022 and in the first three quarters of 2023.
The current supervisory priorities, as identified by the ECB for the years 2024 to 2026, cover the resilience of banking institutions to macro-financial and geopolitical shocks, the effective remediation of shortcomings in governance and the management of climate-related and environmental risks, and lastly further progress in digital transformation and enhancement of operational resilience frameworks.
Banking institutions in Cyprus are currently facing a number of obligations in relation to upcoming regulatory deadlines, which impact operations, risk management and their strategy. The areas that institutions are currently focusing on in the face of regulatory expectations and requirements are diverse and range from ESG, with the implementations of the Corporate Sustainability Reporting Directive (CSRD) and the ECB guide on climate-related and environmental risks, enhancements in their digital transformation strategy and operational resilience, investments in data governance for more effective data aggregation and reporting, and of course the finalisation of the Basel III implementation in the EU.
In the area of ESG, Cyprus banks are investing heavily with multi-year compliance projects that cover the requirements in this space. Reporting requirements are becoming increasingly detailed with the introduction of CSRD and the IFRS Sustainability Disclosure Standards. Risk management is also impacted with the introduction of the ECB guide on climate-related and environmental risks, that covers expectations ranging from business models and strategy, to risk appetite, governance and risk management.
On operational resilience, the Digital Operational Resilience Act (DORA) was recently introduced, which is an EU legislation that sets specific rules for banks on Information and Communication Technology (ICT) risk management capabilities, testing, third party risk monitoring and incident reporting. The requirements will apply from the start of 2025, while multiple regulatory and implementing technical standards are expected to be issued by supervisory authorities within 2024.
Basel III also entails significant changes, as compliance is expected to be more complicated than initially anticipated. The latest proposal introduces a number of refinements and modifications that will require banks to adjust their controls, calculations, processes and data, which could strain resources across all three lines of defence. Additionally, and more importantly, banks will likely need to update their capital allocation strategies as a result of the changes in the regulatory capital calculations, whilst evaluating the potential benefits of adopting internal models for certain portfolios as part of their capital strategy.
At the centre of all of the aforementioned areas are the data aggregation and reporting capabilities of banks, which need to be further enhanced to accommodate the new and ever-evolving regulatory and internal requirements in a flexible and agile manner. Simultaneously, data governance considerations need to be taken into account since banks need to rigorously adhere to strict privacy requirements, ensuring data is secure, confidential and used responsibly.
CONCLUSION
In the wake of a tumultuous period marked by the financial crisis, stringent regulations, profitability woes, the COVID-19 pandemic and the geopolitical conflicts unfolding, the banking sector in Cyprus has emerged from the storm stronger and more resilient. Overcoming the successive challenges was not easy nor without a cost, but the industry has rebounded. This hard-earned stability and the current profitability can become a bedrock upon which the economy of Cyprus can rely and thrive.
The sector has been navigating the complex landscape of regulations and is continuously adapting to new rules and guidelines with agility and speed. In parallel, embracing digitisation and technological innovation has been one of the cornerstones of this recovery. With an eye on the evolving customer behaviours and the changing business environment, banks in Cyprus are strategically transforming their operations. This transformation has not only streamlined processes but also enhanced customer experiences, ensuring the sector can remain relevant and responsive to the ever-changing needs of its customer base.
The current period is considered a period of stability for the Cyprus banking sector, as also evidenced by reports from the International Monetary Fund (IMF) and the European Commission (EC), as well as by a series of credit rating upgrades. The industry is not just focused on short-term gains but it has committed to longer-term, responsible investments. Demonstrating the longer-term nature of the strategy of banks, we see investments in green and socially responsible products that align the growth of the sector with the principles of environmental and social responsibility.
In the words of an ancient proverb, “The best way to predict the future is to create it”. From the current starting point and building on the dedication, resilience and innovative spirit of their people, the sector can actively shape the future of Cyprus.
