Representatives of the European Central Bank’s Single Supervisory Mechanism (SSM), the European Stability Mechanism (ESM) and the rating agency Moody’s, emphasised that the European banking sector shows resilience, despite the increase in interest rates and the many challenges of recent years, such as pandemic, the war in Ukraine, high inflation, the energy crisis and recent developments in the Middle East.

Elizabeth McCaul, member of the European Central Bank’s(ECB) supervisory board, noted that overall, the European banking system remains resilient, and banks under ECB supervision have “comfortable” capital and liquidity ratios. The average CET1 ratio of major credit institutions was 15.7 per cent in Q2 2023, she noted.
She added that the banks’ profitability is also up, with annual return on equity up 10 per cent from 7.6 per cent last year, mainly due to an increase in net interest margins. “From a financial stability perspective, these increases are very welcome,” she said, also suggesting that the results of recent stress tests of the European banking sector show that the banking system can withstand even a severe economic downturn. However, she emphasised that this is not a moment for complacency. “Banks need to remain vigilant and monitor and adjust their risk scenarios, they need to be open, able to clearly see any vulnerabilities in the economy as a whole and understand that they are operating within a fast-moving macroeconomic environment,” she said.

She also added that the normalisation of monetary policy was faster and stronger than expected, as household and business savings have fallen, market competition for funding may increase further, and property prices are falling. These factors, she said, must be taken into account by banks in their risk scenarios.
McCaul concluded that the banking sector remains resilient in the current environment of increased interest rates, “but we also know that there is weaker demand for loans and we see an increase in funding costs and we see asset quality deterioration as areas that may pose an external risk to profitability of banks in the future”.

Asked if lessons had been learned by both supervisors and banks since the 2010 crisis, she said the lessons had been incorporated into the regulatory framework.
“The key is not to forget those lessons. It is important that we continue to meet the (supervisory) requirements,” she noted.

Wim Van Aken, head of the ESM’s post-programme surveillance mission in Cyprus, said most forecasts of the economic outlook were made before recent developments, which add pressure to inflation, weigh on the economic outlook and could have an impact on growth, noting that forecasts have been revised downward so far. Despite growing economic uncertainty, the economy appears resilient, Van Aken said, noting that this is true for both the Eurozone and Cyprus.
He said that Cyprus has enjoyed a strong economic performance and the economic projections for Cyprus remain relatively robust. They are higher in terms of growth than euro area average and average inflation is projected to drop significantly in 2023 and to go lower than in euro area.

Cyprus has also been fiscally prudent and able to create fiscal space, Van Aken noted, adding that this is the result of cautious use of energy measures to support households, while also noting that public debt in Cyprus continues to decline. He stressed that one reason for Cyprus being in such good position relates to the reform efforts that have been taken over the last decade. He underlined that in Cyprus, the banking sector reported the strongest position in a decade. Higher rates have boosted earnings, they drive solvency ratios above the euro area average and, so far, assets’ quality has remained resilient, he said. “Since the financial crisis, Cypriot banks have significantly de-risked their balance sheets”, he noted, adding that rating agencies have upgraded Cypriot banks.

However, he stressed that while the reduction of legacy NPLs in Cyprus has been significant on banks’ balance sheets, they still stay high compared to the EU average. Moreover, he said that NPLs outside the banking system remain very high and they weigh on banks new lending opportunities and profitability, as borrowers are not able to return to banks as viable clients. “NPLs resolution in Cyprus critically depends on the effectiveness of the foreclosure framework. Numerous legislative proposals that could undermine the effectiveness of the foreclosure framework and the lack of its implementation are concerning,” he noted. On the other hand, he pointed out as positive news Cyprus returning to an investment grade by all major rating agencies. “This is a major achievement and a moment of celebration for the country, because it has meant many efforts of the people of Cyprus to get here,” he said, adding that for EMS this is a reflection of the efforts that have been made and is a great step forward.

He noted, though, that positive momentum is only the first step. It means that Cyprus’ governments need to continue using this space in order to keep the positive momentum. That means continued efforts of fiscal responsibility, a stable financial sector and reform implementation under the country’s reform plan. Overall, Van Aken said that in the mid-term, Cyprus can continue focusing on fiscal prudence and show fiscal buffers which could mitigate the expected slowdown of the economy in the current uncertainty.

In the long-term, investing in modernising the economy, through investments to digital technologies and innovations is essential, he said.
Finally, to preserve future economic growth in Cyprus, early adaptation actions regarding climate change are important for the economy’s resilience, he concluded.Simon Ainsworth, an associate managing director co-responsible for Moody’s EMEA Insurance ratings, said that elevated core inflation means that central banks cannot yet be certain that they have achieved their mandate and so “we expect restrictive policy stunt to be maintained throughout next year”.
He noted that so far ECB’s monetary policy has been effective, with deposits and lending rates leading banks to tighten their lending criteria. High interest rates are expected to result in a fallen loan demand, he said. He agreed that Cypriot economy remains resilient, despite external shocks. “Moody’s expects a GDP growth of 2.8 per cent next year,” he said, noting however that Cyprus’ small and saturated banking sector, the banks’ small loan book and low fee income component will limit their long-term business and profit growth opportunities in the domestic market.

On the upside, he said that in Cyprus, where residual assets remain high, initial indications are of a limited impact on Cypriot banks’ assets quality.
He noted that banks are protected by strong capital buffers, which rose after the reforms following the global financial crisis. More importantly, he said, this capital is now predominantly comprised of very high-quality common equity. He noted that Bank of Cyprus posted a common equity tier 1 ratio of 16 per cent and a leverage ratio of 7.2 per cent, well above the minimum and the euro average. Hellenic Bank has even more respectable ratios of 20 and 10 per cent respectively, he said. “An improved profitability, which we think is likely to peak next year, will fade away over time”, he said, pointing out that conservative loan appetite may limit the role the banks have to play in facilitating growth.