2012 - central bank...quarter of 2011. after the marginally positive growth of 0,5% in 2011, gdp...

© CENTRAL BANK OF CYPRUS, 2013

Address 80 Kennedy Avenue 1076 Nicosia Cyprus

Postal Address P.O. Box 25529 1395 Nicosia Cyprus

Telephone +357 22714100

Website http://www.centralbank.gov.cy

Edited by the Communications Unit

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

ISSN (Online) 1986-1044

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A N N U A L R E P O R T 2 0 1 2

CONTENTS

1. Ιntroduction by the Governor 6

2. Management and Organisation of the Bank 8

2.1 Board of directors 8 2.2 Senior management team 2012 10 2.3 Organisational chart, December 2012 11

3. Economic Developments 12 International economic developments 12 Domestic developments 13 Monetary developments 13 Interest rates 14 Inflation 16 Demand 16 Production 17 Current account balance 17 Financing of the current account deficit 18 Exchange rates 18 Labour market, production and labour costs 18 Public finances 20 Projections 22

4. Functions of the Bank 25

4.1 Regulation and Supervision of the Banking Sector 25 Supervision of banking institutions 25 Developments in the regulatory framework and operation of banks 25 • Amendment of the Banking Law 25 • Amendment of the Directive to Banks for the Supplementary Supervision of Banks that belong to a Financial Conglomerate (FICOD) 26 • Amendment of The Framework of Principles of Operation and Criteria of Assessment of Banks’ Organisational Structure, Internal Governance and Internal Control Systems Directive, 2006 - 2012 26 • Circular Letter for the Submission of Returns Regarding the Remuneration of Banks’ Staff 26 • Granting of Government Guarantees for the Conclusion of Loans and/or the Issue of Bonds by Credit Institutions Law, 2012 27 • Amendment of the Special Tax on Credit Institutions Law 27 • Amendment of the Management of Financial Crises Law 27 • Directive on the Conditions of Offering of Investment or Ancillary Services and the Performance of Investment Activities by Banks 27 Developments in the banking sector 28 Cooperation with other domestic and foreign supervisory authorities 29

4.2 Financial Stability 30 Macro-prudential oversight 30 Reporting of Cyprus banking sector data and financial indicators to international organisations 30 Participation in the committees and substructures of the European Systemic Risk Board, the European System of Central Banks and the EU 31 Participation in meetings with representatives of international organisations 31 Regulatory framework for crisis management and resolution 31 Administration of the Deposit Protection Fund and the Investor Compensation Fund for Clients of Banks 32 Deposit Protection Scheme (DPS) 32 Investor Compensation Fund for Clients of Banks (ICFCB) 33

4.3 Licensing 33 Banks 34 Payment institutions 34 Electronic money institutions 35 International collective investment schemes 35

4.4 Payment and Settlement Systems 35 Legal framework 36 Payment and securities settlement systems operating in Cyprus 36 Single Euro Payments Area (SEPA) 36

3C E N T R A L B A N K O F C Y P R U S

Oversight of payment and settlement systems 37 T2S (TARGET2 Securities) 37 TARGET2 37 Cheque truncation 37 Efforts to reduce the use of cheques as a payment instrument 38 Central Information Register for Issuers of Dishonoured Cheques (CIR) 38

4.5 Euro Banknotes and Coins 38 Legal framework 38 Cash cycle 38 Counterfeit euro banknotes and coins detected in Cyprus during 2012 39 Numismatic matters 39 • Commemorativecoin 39 • Collectorcoin 39 • Collectorset 40 Withdrawal of the Cyprus pound 40

4.6 Activities in the Financial Markets 40

4.6.1 Management of reserves and other activities 40 Participation in the management of the foreign exchange reserves of the ECB 41 Participation in IMF programmes 41

4.6.2 Implementation of monetary policy 41

4.7 Financial Risks Management 42 CBC investment activities 42 • Interestraterisk 42 • Creditrisk 43 • Foreignexchangerisk 43 Implementation of monetary policy and other credit providing operations 43

4.8 Economic Research and Related Activities 43 Economic Bulletin 44 Book on the Cyprus economy 44 Governor’s support and participation in the committees and working groups of the ESCB 44 Other research activities 45 Visits of foreign experts and public communication 46

4.9 Statistics 47 Statistical obligations 47 Monetary and financial statistics 47 External statistics 48 Government finance and general economic statistics 48 Securities statistics 49 Statistical publications 49 Cooperation with Cystat 50

4.10 Information Technology 50 Infrastructure projects 51 IT systems implementation/maintenance projects 51 IT systems security 52

4.11 Human Resources, Organisation and Methods 52 Human resource management 52 Human resources development 52 Labour relations 53 Administration issues 53 Organisational matters 53

4.12 Health and Safety 53

4.13 Security and Premises 53

5. Financial Statements 2012 57 Balance sheet as at 31 December 2012 58 Income and expenditure account for the period 1 Jan. 2012 - 31 Dec. 2012 60 Notes to the financial statements 61 Independent Auditor’s Report 77

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TABLES

3.1 Loans to domestic households 14

3.2 Deposits from domestic households 14

3.3 Economic activity in basic sectors, at market prices of 2005 17

3.4 Balance of payments 19

3.5 Accounts of general government 21

3.6 Central Bank of Cyprus projections 23

CHARTS

3.1 GDP in selected countries 12

3.2 Inflationinselectedcountries 12

3.3 MFI interest rates on euro-denominated loans (new business) to euro area residents 15

3.4 Euro area MFI interest rates on euro-denominated deposits (new business) by euro area residents 15

3.5 InflationinCyprusandtheeuroarea 16

3.6 Selected exchange rates against the euro 18

3.7 Real and nominal effective exchange rates of the Cyprus currency (IMF weights) 18

3.8 Employment and unemployment 20

3.9 Compensation per employee, productivity and unit labour cost 20

3.10 General government consolidated gross debt (as a percentage of GDP) 22

TABLES AND CHARTS


Note: The cut-off date for the statistics included in this report was 31 January 2013.

ABBREVIATIONS

BIS Bank for International Settlements

CBC Central Bank of Cyprus

CDCR Central Depository and Central Registry of the Cyprus Stock Exchange

CIR Central Information Register for Issuers of Dishonoured Cheques

CSDB Centralised Securities Database

CSE Cyprus Stock Exchange

Cystat Statistical Service of the Republic of Cyprus

DPF Deposit Protection Fund

DPS Deposit Protection Scheme

ECB European Central Bank

ECOFIN Economic and Financial Affairs Council

EMU European and Monetary Union

ERM ΙΙ Exchange Rate Mechanism ΙΙ

ESA 95 European System of Accounts 1995

ESCB European System of Central Banks

ESRB European Systemic Risk Board

EU European Union

Eurostat StatisticalOfficeoftheEuropeanUnion

GDP Gross Domestic Product

HICP Harmonised Index of Consumer Prices

ICFCB Investor Compensation Fund for Clients of Banks

IMF International Monetary Fund

MFI(s) Monetary Financial Insitution(s)

MOF Ministry of Finance

NFCs Non-Financial Corporations

SBP Strategic Benchmark Portofolios

SEPA Single Euro Payments Area

SMP Securities Markets Programme

TARGET2 Second-generation TARGET system

VAT Value Added Tax

CONVENTIONS

£ Cyprus pound

€ Euro

ST£ Pound sterling

Thousands, millions and billions are separated by a dot (.) and decimals are separated by a comma (,). In some cases the totals in the tables may not add up due to rounding.

ABBREVIATIONS AND CONVENTIONS

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6

The Cypriot economy faces significant challenges. The preliminary agreement that was reached last November after intensive negotiations between the Cypriot authorities (the Government and the Central Bank of Cyprus) and the “Troika” (European Commission, the ECB and the IMF) is expected to be instrumental in addressing these challenges. The finalisation of the agreement and the adoption and implementation of the envisaged measures will help restore confidence and reduce the uncertainty in the medium term, thus supporting economic recovery. The CBC believes that, in general, the agreement is the best that could have been achieved under the circumstances and that the decisive implementation of this agreement is of the utmost importance for the future of our economy. More specifically, the measures included in the agreement aim to achieve the consolidation, restructuring and recapitalisation of the banking sector, the reduction of the budget deficit and public debt as well as the implementation of a series of structural reforms along the agreed timetables. These measures will lay the foundations for the gradual recovery of the economy and the reduction in unemployment as well as ensuring sustainable growth in the longer term. As regards current economic developments, the Cypriot economy has been in recession since the third quarter of 2011. After the marginally positive growth of 0,5% in 2011, GDP recorded a reduction of 2,3% in 2012. The continuing decline in GDP is mainly driven by the large contraction in private investment, mainly construction, as well as the reduction in private and public consumption. The significant fall in output is reflected in a marked increase in the unemployment rate to levels unprecedented for Cyprus. This picture is confirmed by all the standard confidence indicators, i.e. services, industry, retail, consumption

and construction, all of which registered a significant deterioration both in 2011 and 2012. Short - term forecasts for economic activity are also not encouraging, given the high degree of uncertainty that prevails. Nevertheless, the decisive implementation of the measures included in the preliminary agreement with the Troika, will, despite their short-term impact, reduce uncertainty and help overcome current economic and financial challenges in the medium term. Furthermore, the discovery of natural gas in the Exclusive Economic Zone of Cyprus is an additional positive development for the long - term prospects for our economy. As regards the Cypriot banking system, the situation also deteriorated significantly in 2012, mainly due to the higher provisions for loan portfolios in Greece and Cyprus, as well as the losses from the haircut of Greek government debt to which the two major Cypriot banks were extensively exposed. The tight links with the Greek economy continue to play an important role and the ongoing deleveraging process in the domestic banking sector continues to have a significant impact on short-term growth. To tackle the negative developments and the uncertainty prevailing in the banking sector, the CBC is committed to rigorous reform and restructuring of the system. The objectives are for the sector to become smaller, sounder and more resilient. In particular, the CBC in consultation with the Troika has assigned to an external consulting firm the task of conducting a due diligence review of the credit portfolios of a sample of banks and cooperative credit institutions (coops), which on aggregate represent the largest part of the sector. The review includes both an accounting evaluation and an assessment of the economic value of banks’ assets. The exercise will form the basis for a bank-by-bank stress test using a baseline and adverse

1. ΙNTRODUCTION BY THE GOVERNOR


macroeconomic scenario. This stress test will build on the top-down exercise used to determine the overall size of the capital back-stop facility along with the capital needs of each participating institution. The aim is to establish the specific capital needs of each bank or coop with a view to recapitalisation or resolution, if necessary. The CBC has also appointed an Independent Commission on the Future of the Cyprus Banking Sector to examine and recommend concrete proposals regarding: (1) the size and structure of the

sector; (2) the strengthening of prudential regulation and supervision; and (3) the promotion of competition for the benefit of consumers and businesses. In the face of the difficult economic decisions that lie ahead of us, prudency, determination and responsibility are of utmost importance. If the necessary consensus and understanding of all stakeholders prevails, then the country will be able to overcome the current difficulties and the economy will recover in the not so distant future.

Panicos DemetriadesGovernor

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2. MANAGEMENT AND ORGANISATION OF THE BANK2.1 BOARD OF DIRECTORS

Athanasios Orphanides Governor and Chairman until 2 May 2012.

Panicos Demetriades Governor and Chairman from 3 May 2012.

Marios KlitouCEO of Baker Tilly Klitou, a firm of auditors, accountants and business consultants. Fellow of both the Institute of Chartered Accountants in England and Wales and the Association of Chartered Certified Accountants of the UK. Locally, he is a member of the Institute of Certified Public Accountants of Cyprus (ICPAC) and a Member of ICPAC’s International Business, Shipping and Foreign Investments Committee. He is also a Member of the Chamber of Financial Auditors of Romania (CAFR) and a Member of the Body of Expert Accountants and Chartered Accountants in Romania (CECCAR). He is a member of the Council and the Treasurer of the Cyprus Investment Promotion Agency (second term). He also served as a member of the Council of Economic Advisers of the President of the Republic of Cyprus from 2003 to 2008 and on the Board of the Cyprus Development Bank Ltd from 2005 to 2008. In 2011 he was elected Member of the EMEA Regional

Advisory Council of Baker Tilly International. He was a member of the CBC’s Board from April 2008 until December 2012.

Nicos Constantinou BSc in information systems and an MBA from the UK. He is a Fellow Member of the UK’s Association of Chartered Certified Accountants (FCCA) and a Member of the Institute of Certified Public Accountants of Cyprus. Since 2002, he is managing partner in an audit and consultancy practice and the International Franchise Director of an international retail business. He holds senior advisory positions in a number of international companies based in Europe and Asia. He was appointed to the CBC’s Board in December 2008.

Andreas Matsis Entrepreneur and Vice President of the Cyprus Chamber of Commerce and Industry. Served as President of the Famagusta Chamber of Commerce and Industry between 2002 and 2008. He also served on the CBC’s Monetary Policy Committee between 2000 and 2007. He was appointed to the CBC’s Board of Directors in December 2008.

Marios Klitou

(until 5 December 2012)

NicosConstantinou

AndreasMatsis

Panicos Demetriades

Athanasios Orphanides

(from 3 May 2012)(until 2 May 2012)


Haralambos Akhniotis He was first appointed to the CBC in 1963. Between 1992 and 2002 he was Chief Senior Manager of the Economic Research and Management Services Division and from 2002 to 2009 he served as Adviser to the Governor of the CBC. Between 2000 and 2007 he was a member of the CBC’s Monetary Policy Committee and was also responsible for Cyprus’s pre-accession negotiations for the chapter on Economic and Monetary Union. He also served as alternate to the Governor in the ECB’s General and Governing Councils between 2004 and 2009. He was appointed to the CBC’s Board in May 2009.

Louis ChristofidesLouis Christofides received his Ph.D from the University of British Columbia in 1973. Between 1972 and 2002 he was on the faculty of the University of Guelph, Canada, serving as Chair of the Department of Economics between 1987 and 1997. Between 2002 and 2006 he served as Chair of the Department of Economics, University of Cyprus and has been Dean of the University’s Faculty of Economics and Management since 2006. Professor Christofides is a Research Associate of CESifo and a Research Fellow of IZA. He has served as a referee for numerous

academic journals, universities and granting agencies in Canada, the US and the EU, and as a consultant to the governments of Canada and the EU. He is currently Editor of the refereed journal Ekonomia, published by the Cyprus Economic Society and the Department of Economics, University of Cyprus. Since 2011, he has been serving as a member of the Cyprus Scientific Council. He was appointed to the CBC’s Board in November 2011.

HaralambosAkhniotis

LouisChristofides

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2.2 SENIOR MANAGEMENT TEAM 2012

P. DemetriadesGovernor

(from 3 May 2012)

Α. OrphanidesGovernor

(until 2 May 2012)

C. PoullisSenior Director

(Retired on 28 August 2012)

•BankSupervision & Regulation Department

•LicensingSection

K. ZingasSenior Director

•DomesticBankingOperations Department•TechnicalSupport

Section

P. FrankSenior Director

•StatisticsDepartment•Information

Technology Department •AccountingServices

& Budget Section

G. SyrichasSenior Director

•EconomicResearchDepartment

C. PapadopoulosSenior Director

•FinancialMarketsDepartment

•PaymentSystemsDepartment

•RiskManagementOffice

S. StavrinakisSenior Director

•BankSupervision& Regulation Department

•FinancialStabilityDepartment

•LicensingSection•European

& International Affairs Unit


2.3

ORG

AN

ISAT

ION

AL

CHA

RT

DEC

EMBE

R 20

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International economic developmentsIn 2012 the global economic recovery lost its momentum amid deteriorating market confidence. The worsening of the debt crisis in the euro area, especially during the first half of the year, the continuing uncertainty about the debt crisis and the long-term sustainability of the euro, are some of the reasons for the poor economic performance of the European Union (EU) in 2012. At the same time, economic activity in the US and the UK fluctuated at lower than expected levels, with high unemployment and sluggish consumption. Moreover, the problem of the so-called “fiscal cliff” remained the focal point in the US after the presidential election. This problem relates to the risk that a simultaneous expiry of tax breaks and the introduction of tax increases and spending cuts that were due at the end of 2012 would possibly push back the US economy into recession. This resulted in an increase in uncertainty in international markets. In Japan, after positive GDP growth in the first half of the year, the country returned to negative growth in the third quarter as a result of reduced exports and political tensions between Japan and China. The deepening of the debt crisis, the increased concerns about the long-term sustainability of the euro area and the slowdown in economic activity, led to new significant institutional policy decisions during the second half of 2012 by EU governments. Among other things, it was decided to establish the Single Supervisory Mechanism (SSM) with a view to facilitating the direct recapitalisation of banks by the European Stability Mechanism (ESM). In September the ECB announced its Outright Monetary Transactions (OMT) programme, which provides for the purchase of government bonds of euro area countries in the secondary market under strict conditionality.

Based on the most recent forecasts, GDP in 2012 is estimated to have shrunk by 0,4% and by 0,2% in the euro area and the UK, respectively, while in the US and in Japan it is estimated to have increased by 2,2% and 1,9%, respectively (Chart 3.1). Annual inflation in the developed economies recorded a gradual increase since August 2012, mainly due to developments in energy prices, but overall it remained lower than the 2011 levels. More specifically, annual inflation averaged 2,4%, 2,1%, 2,7% and -0,1% in the euro area, the US, the UK and Japan, respectively (Chart 3.2). In light of the above developments, the major central banks maintained their interest rates at low levels, while injecting

3. Economic Developments


significant liquidity into the banking system through conventional and non-conventional monetary policy measures. Taking into account the subdued inflationary pressures and the adverse economic growth and credit conditions, the ECB reduced its key interest rates by 25 basis points in July 2012. More specifically, the ECB lowered its main refinancing rate to 0,75%, its marginal facility rate to 1,50% and its interest rate on deposit facility to 0%, as from 11 July 2012. Up until the cut-off date for data in this Report, the Fed and the Bank of England maintained their key interest rates unchanged at between 0%-0,25% and 0,5%, respectively. The aforementioned institutional policy decisions and the further easing of monetary policy through conventional and non-conventional policy measures were received positively and helped alleviate strains in financial markets during the second half of 2012. This was reflected in an appreciation of the euro, a fall in government bond yields and a decrease in the price of gold in the fourth quarter of the year compared with the third quarter of 2012. Since the beginning of the year under review, the DJ Eurostoxx, S&P500 and Nikkei indices recorded a rise, recovering the losses experienced in mid-2012. Nevertheless, downside risks to the outlook for the global economic recovery remain and are mainly related to the uncertainty in resolving the debt crisis in the euro area, the geopolitical tensions and the fiscal policy decisions in the US. The latest forecasts by international agencies and analysts for 2013 point to negative GDP growth of 0,1% in the euro area and positive growth of 2,1% in

the US, 0,9% in the UK and 0,9% in Japan. Inflation in 2013 is expected at 1,8% in the euro area, 1,9% in the US and 2,5% in the UK. In contrast, inflation in Japan is expected to remain negative at -0,1% (Charts 3.1 and 3.2, p. 12).

Domestic developmentsMonetary developments1,2

In 2012 the growth of loans to the domestic private sector experienced a significant slowdown, reaching 1,4% in December 2012 compared with 4,9% in December 2011. This mainly reflected the large deceleration recorded in the most important categories of loans to households and non-financial corporations (NFCs). The deceleration is related to the prolonged uncertainty in the financial environment, both domestically and internationally, the downturn in domestic economic activity and the high cost of borrowing. More specifically, the annual growth rate of loans to domestic NFCs exhibited one of the lowest growth rates over the last years, reaching 1,1% in December 2012 compared with 5,1% in December 2011. Loans to domestic households recorded a similar trend (Table 3.1, p. 14), registering a growth of 1,9% in December 2012 compared with an increase of 4,9% in the corresponding month of 2011. It should be noted that from all household loan categories, loans to households for house purchase experienced the largest slowdown, recording a historic low growth rate of 0,9% in December 2012 compared with 5% in the corresponding month of 2011. With regard to domestic private sector deposits3,

1. All monetary data, including interest rates, refer to data excluding the CBC and/or the Eurosystem. It should also be noted that all data analysed in this section refer to domestic residents of Cyprus and exclude organisations or corporations without a physical presence on the island (“brass plate” entities). The “brass plate” entities are excluded in order to present domestic developments more clearly and achieve comparability of historical data.

2. For details please refer to the CBC publication Monetary and Financial Statistics, which is available on the CBC website.3. Excluding deposits from MFIs and deposits of the Central Government.

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the annual growth rate continued to decelerate, reaching 0,9% in December 2012 from 1,1% in December 2011. This deceleration was partly due to the slowdown recorded in the annual growth of deposits by domestic NFCs, which registered a reduction of 6,1% in December 2012 compared with an increase of 2,1% in the corresponding period of 2011. Deposits by domestic households, which constitute the largest share of deposits in the private sector, also followed a significant decelerating trend (Table 3.2). Specifically, the annual growth rate of the aforementioned categories slowed down to 1,6% in December 2012 compared with an increase of 2,9% in December 2011. It should be noted that low growth rates were recorded in deposits with agreed maturity, while negative growth rates were recorded in deposits redeemable at notice.

Interest ratesFinancial developments in 2012 also led to an increasing upward pressure on interest rates. As a result, during the year under review all interest rates on new loans and deposits to households and NFCs in Cyprus remained at the high levels recorded

in the second half of 2011, although towards the end of 2012 some categories exhibited a slight decrease. Moreover, the annual average difference between lending rates in Cyprus and the euro area widened further in 2012, compared with 2011, with the exception of the slight decrease of the gap in the cost of borrowing for consumption purposes. Similarly, the gap between deposit rates during the period under review increased due to higher increases recorded in the corresponding rates in Cyprus, reflecting the fact that domestic credit institutions had increased their deposit rates as part of their recapitalisation and liquidity efforts. Indicatively, the average interest rate on loans up to €1 million4 to NFCs in Cyprus registered a slight decrease, from 7,39% in December 2011 to 7,29% in December 2012, remaining however at high levels. In the euro area, the corresponding further decrease in the aforementioned average rate widened the gap against the equivalent rate in Cyprus in 2012 to 321 basis points from 297 basis points in 2011 (Chart

4. With a floating rate and up to 1 year initial rate of fixation.

TABLE 3.1 Loans to domestic households (1), (2)

Domestic households 100,0 4,9 1,9

1. Consumer credit 14,0 -0,6 -1,0

2. Lending for house purchase 53,1 5,0 0,9

3. Other lending 32,9 7,2 4,7

Source: CBC. (1) Sectoral classification is based on ESA 95. (2) Including non-profit institutions serving households. (3) As at the end of the last month available. Figures may not add up due to rounding.

Outstanding balance as %

of total (3)

Annual percentage

change

2012 2011 2012 Dec. Dec. Dec.

Domestic households 100,0 2,9 1,6

Overnight 14,4 2,0 -0,9

With agreed maturity 77,7 4,2 3,7

up to 2 years 72,6 3,4 2,4

over 2 years 5,1 20,3 27,8

Redeemable at notice 7,9 -5,1 -12,5

up to 3 months 5,6 -6,9 -16,8

over 3 months 2,4 0,5 -0,6

Outstanding balance as %

of total (3)

Annual percentage

change

2012 2011 2012 Dec. Dec. Dec.

TABLE 3.2 Deposits from domestic households (1), (2)

Source: CBC. (1) Sectoral classification is based on ESA 95. (2) Including non-profit institutions serving households. (3) As at the end of the last month available. Figures may not add up due to rounding.


3.3). The average rate on new loans to households for housing purposes5 followed a similar pattern, reaching 5,32% at the end of 2012 compared with 5,73% at the end of 2011 (Chart 3.3). The corresponding average rate in the euro area recorded a further decline towards the end of 2012, reaching 2,86% in December 2012 from 3,49% in December 2011. With regard to deposits, the average rate on new deposits of NFCs in Cyprus with agreed maturity

up to 1 year (Chart 3.4) increased from 3,71% in December 2011 to 4,10% in December 2012, while the corresponding rate in the euro area fell from 1,53% at the end of 2011 to 1,08% at the end of 2012. An increase was also recorded in the average rate on new deposits from households in Cyprus with agreed maturity up to one year, while the decrease recorded in the corresponding rate in the euro area widened the respective gap in 2012 to 161 basis points compared with 148 basis points in 2011.

5. With a floating rate and up to 1 year initial rate of fixation.

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InflationIn 2012 the Harmonised Index of Consumer Prices (HICP) in Cyprus recorded an increase of 3,1% compared with 3,5% in 2011 (Chart 3.5). The deceleration of inflation in 2012 was mainly due to the smaller annual percentage increase in the prices of energy, the base effect of the increase in the VAT on foodstuff and pharmaceuticals in January 2011, as well as the downward pressure on prices, primarily in the retail trade, owing to the domestic recession. More specifically, as far as the energy component is concerned, the increase in international oil prices and the VAT increase from 15% to 17% in March 2012 exerted an upward pressure on the index. However, the downward base effect ensuing from the relatively much higher annual oil prices increases in 2011 outweighed the aforementioned upward impact and, therefore, energy prices increased by 14,1% in 2012, as opposed to 18,1% in 2011. Food prices in 2012 increased by 3,1% compared with an increase of 5,1% in 2011. The decrease in food inflation was due to the significantly lower processed food inflation reflecting the base effect of the increase

of the VAT on foodstuff and pharmaceuticals from 0% to 5% in January 2011, as well as the moderate increases in the prices of key categories of this component, due to the intensifying competition between supermarkets. As regards unprocessed food, inflation in 2012 stood at 4,5% from 3,8% in 2011. The acceleration of unprocessed food inflation is due to the significant annual percentages increases in the prices of vegetables. Non-energy industrial goods inflation stood at -0,4% in 2012 compared with 1,2% in 2011. This negative trend is indicative of the downward price pressure in retail trade as a consequence of the contraction of private consumption. The prices of services registered an increase of 2,6% in 2012 compared with 1,1% in 2011. The methodological change in the calculation of the weights for the compilation of the HICP had a significant impact on services inflation of approximately 1 percentage point while, according to the Statistical Service of Cyprus, the aforementioned methodological change’s impact on headline inflation in 2012 was around 0,4 percentage points. Adjusting for the impact of the methodological change, domestic inflation in 2012 was slightly above its euro area counterpart, despite the deceleration in the last four months of the year. The reading, however, is different if we examine inflation excluding energy and food. Adjusting for the impact of the methodological change, it is estimated to be in the order of 1,2% for Cyprus, compared with 1,5% in the euro area.

DemandPreliminary data for 2012 point to a GDP contraction of 2,3%, compared with a marginal increase of 0,5% in 2011. Focusing on the first nine months of 2012, for which detailed analytical data is available, a


contraction of 2% was recorded compared with an expansion of 1% the corresponding period last year. More specifically, in the first nine months of 2012 domestic demand recorded a contraction of 7,5%, reflecting the reduction in public expenditure mainly as a result of the fiscal consolidation programme implemented, the reduction in gross fixed capital formation and a reduction in private consumption. Furthermore, imports of goods and services decreased by 9,1% compared with a 0,6% during the corresponding period of 2011. Exports of goods and services rose by 3,1% compared with a 4,3% increase in the corresponding period of 2011, mainly as a result of the increase in revenue recorded from tourism and merchanting.

ProductionMost sectors of production recorded a contraction in the first nine months of 2012, (Table 3.3) with the construction sector recording the largest losses. More specifically, the construction sector continued the downward trend which started in 2009, exhibiting a reduction of 19,4% compared with a decrease of 8,1% in the corresponding period of 2011. The wholesale

and retail trade, hotels and restaurants, transportation and storage sector recorded a contraction of the order of 2,6%, while tourism recorded positive growth rates. Furthermore, the financial and insurance sector recorded a 1,6% increase, compared with a 2,3% increase recorded in the corresponding period in 2011, partly reflecting the deceleration in the rate of increase of loans.

Current account balanceAccording to the latest available CBC data, in the first nine months of 2012 a significant improvement was recorded in the goods and services balance. Analytically, the goods’ trade balance decreased from a deficit of 24,4% of GDP in the first nine months of 2011 to 21,9% of GDP in the corresponding period of 2012, reflecting the lower level of domestic demand (Table 3.4, p. 19). The surplus in the services balance, on which historically the Cyprus economy depends in order to partly cover the deficits in the trade balance, registered an increase of the order of €161,7 million thus reaching 19,9% of GDP during the first nine months of 2012 compared with a surplus of 18,6% of GDP for the corresponding period of 2011. This

TABLE 3.3 Economic activity in basic sectors, at market prices of 2005(chain linking method, annual percentage change)

Wholesale and retail trade, Transport and storage, Accommodation and food

services activities ConstructionFinancial and insurance

activities

Q1 2010 -12,1 -0,3 -1,3

Q2 2010 -8,3 -0,3 2,8

Q3 2010 -5,8 1,6 5,3

Q4 2010 -6,5 2,1 5,8

Q1 2011 -5,1 0,9 2,7

Q2 2011 -3,2 1,3 1,3

Q3 2011 -17,3 0,4 3,0

Q4 2011 -16,6 -3,4 2,7

Q1 2012 -17,0 -3,3 2,4

Q2 2012 -21,0 -2,9 1,7

Q3 2012 -20,2 -1,9 0,8

Source: Cystat.

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improvement can be attributed to the increased revenues from tourism and from other business services. Despite the above developments, the current account deficit increased to €1.018,1 million or 7,6% of GDP from a deficit of €875,9 million or 6,5% of GDP in the corresponding period of 2011. This deterioration is solely due to the worsening of the income account which reflects the increased losses of branches and subsidiaries of Cypriot firms, mainly banks, abroad.

Financing of the current account deficitThe financing of the current account deficit during 2011 was mainly through the category “portfolio investment”, which may be attributed to the increased net inflows stemming from the liquidation of portfolio investments in shares issued by non-residents. The percentage of financing through the category “portfolio investment” reached 32% of GDP, while the financing from foreign direct investment, which in the past constituted the main source of financing of the current account deficit, reached only 2,1% of GDP for 2011. In the first nine months of 2012

the current account deficit was financed mostly by foreign direct investment and portfolio investment.

Exchange rates In 2012 the euro depreciated against the other major currencies. Specifically, it weakened by 7,6% both against the dollar and the yen and by 6,5% vis-à-vis sterling (Chart 3.6). As regards the real effective exchange rate of Cyprus6, it depreciated by 2,9% during the first 11 months of 2012 compared to the corresponding period of 2011. This can be attributed to the path of the euro vis-à-vis the other major currencies (Chart 3.7).

Labour market, production and labour costsEmployment recorded a significant, although gradual, deterioration, decreasing by 2,5%, 2,9% and 3,2% in the first three quarters of 2012, respectively. It should be noted that in the corresponding quarters of 2011 employment recorded an increase of 1,1%, 0,8% and 0,5%, respectively. For the full year of 2012 employment is expected to decrease further, mainly

6. The weighted average of a country’s currency in relation to an index or basket of currencies adjusted for the effects of inflation. The weights are determined by comparing the trade balance in terms of a country’s currency in relation to every other country within the index.


TABLE 3.4 Balance of payments (€ million)

2011 (Jan.-Sep.) 2012 (Jan.-Sep.)

DEBIT DEBITCREDIT CREDITNET NET

CURRENT ACCOUNT 7.643,8 8.519,7 -875,9 7.739,1 8.757,3 -1.018,1

GOODS, SERVICES AND INCOME 7.192,3 7.940,2 -747,9 7.287,9 8.183,0 -895,1

GOODS AND SERVICES 5.613,7 6.396,6 -782,9 5.928,6 6.189,6 -261,0

GOODS 1.056,7 4.342,7 -3.286,0 1.091,6 4.017,2 -2.925,7

SERVICES 4.557,0 2.054,0 2.503,0 4.837,0 2.172,3 2.664,7

Transport 1.073,9 879,9 194,0 1.058,0 897,0 161,0

Travel 1.531,4 733,5 797,9 1.690,9 772,0 919,0

Communications services 27,2 64,1 -36,8 36,2 60,0 -23,8

Construction services 26,3 11,1 15,2 63,6 7,9 55,8

Insurance services 18,7 27,0 -8,3 24,8 25,2 -0,4

Financial services 493,0 81,7 411,3 433,7 110,5 323,1

Computer and information services 30,8 15,6 15,1 33,9 18,2 15,7

Royalties and licence fees 1,4 16,4 -15,0 1,0 18,3 -17,3

Other business services 1.242,8 150,2 1.092,6 1.404,9 200,4 1.204,6

Personal, cultural and recreational services 20,0 34,4 -14,5 22,9 38,7 -15,8

Government services, n.i.e. 91,4 40,0 51,5 67,2 24,3 42,9

Services not allocated 0,0 0,0 0,0 0,0 0,0 0,0

INCOME 1.578,6 1.543,6 35,0 1.359,3 1.993,4 -634,1

Compensation of employees 17,9 156,3 -138,4 16,0 233,3 -217,3

Investment income 1.560,7 1.387,3 173,4 1.343,3 1.760,1 -416,8

Direct investment income 23,1 149,0 -125,9 -542,4 287,6 -830,0

Portfolio investment income 624,5 337,2 287,2 509,7 162,2 347,5

Other investment income 913,2 901,1 12,1 1.376,0 1.310,3 65,7

CURRENT TRANSFERS 451,5 579,5 -128,0 451,3 574,3 -123,0

General government 113,9 187,7 -73,8 100,6 159,3 -58,7

Other sectors 337,6 391,8 -54,2 350,7 415,0 -64,4

CAPITAL AND FINANCIAL ACCOUNT 1.010,7 1.122,3

Capital account 46,9 16,9 30,0 29,2 15,2 14,0

Financial account 980,7 1.108,3

Direct investment 368,6 1.064,2

Abroad -377,8 556,0

In Cyprus 746,5 508,2

Portfolio investment 4.942,1 1.331,3

Assets 4.781,2 2.700,1

Liabilities 160,9 -1.368,7

Financial derivatives -353,3 -377,5

Other investment -3.965,5 -958,8

Assets -5.492,0 -6.614,1

Liabilities 1.526,5 5.655,3

Officialreserveassets -11,2 49,0

NET ERRORS AND OMISSIONS -134,9 -104,2

Source: CBC.

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affected by the subdued economic activity. Unemployment as recorded by the Labour Force Survey (LFS), reached 12,1% in the third quarter of 2012 (53.437 unemployed persons), compared with 7,8% in the corresponding period in 2011 (Chart 3.8). The deterioration recorded is mainly the result of the subdued economic activity and the inability of the labour market to absorb both the unemployed and the newcomers. During the same period, the number of unemployed persons reached 35.605, 8.090 more than the corresponding period in 2011. More recent data for the whole of 2012 indicate a further increase in the number of unemployed persons, which increased to 36.362. The sectors of the economy affected most are trade, construction and manufacturing, hotels and restaurants as well as newcomers. The subdued economic activity also affected the compensation per employee, which decelerated significantly in the first nine months of 2012, registering an increase of 1,5% compared with a 3,4% increase in the corresponding period in 2011. As a result, unit labour costs in 2012 are expected to

decelerate accordingly (Chart 3.9).

Public finances In 2011 the general government deficit-to-GDP ratio reached 6,3%. The most recent government and European Commission forecasts for 2012 point to a ratio of 5,2% and 5,3%, respectively. The government’s forecast includes measures that have been agreed in principle with the Troika in the context of the Republic of Cyprus’ application for financial assistance. According to the most recent Cystat data on general government revenue and expenditure, the deficit-to-GDP ratio reached 3,3% in the first nine months of 2012 compared with a ratio of 3% compared with the corresponding period of the previous year (Table 3.5, p. 21). Based on Ministry of Finance data covering the central government accounts in cash terms, the deficit-to-GDP ratio exhibited an improvement over the first 11 months of 2012 reaching 4,2% compared with a deficit ratio of 4,6% during the corresponding period of 20117. The general government consolidated gross debt

7. According to the most recent data published following the cut-off date for the statistics included in this report, the deficit-to-GDP ratio in cash terms reached 4,9% for the entire year compared with a deficit of 6% of GDP for 2011.


as a percentage of GDP stood at 71,1% at the end of 2011, while for 2012 this is projected to increase further to 85,8% according to the most recent government projection. The respective European Commission projection is much more pessimistic and points to a gross debt-to-GDP ratio of 89,7%. Based on the most recent available preliminary data published by the Ministry of Finance, the general government consolidated gross debt as a percentage of GDP reached 84,9% at the end of the third quarter of 2012. This is mainly attributed to the issuance of a government bond for the recapitalisation of a bank, the increase in the cost of borrowing as well as the deterioration in the primary deficit and

macroeconomic conditions (Chart 3.10, p. 22). According to preliminary Cystat data, general government revenue exhibited an annual reduction of 1,5% over the first nine months of 2012 given the contraction in economic activity and despite the adoption of a number of fiscal consolidation measures as from the second half of 2011 (Table 3.5). This annual reduction materialised despite the fact that a significant annual growth in total public revenues of 9,5% was registered in the first quarter of 2012 due to one-off revenues resulting from the special settlement of tax obligations that had been accumulated by the end of 2008. The aforementioned adverse revenue

TABLE 3.5 Accounts of general government

Jan.-Sep. 2011 Jan.-Sep. 2012 Change (€ million) (€ million) %

EXPENDITURE

Intermediate consumption 641,2 619,7 -3,4

Grossfixedcapitalformation 401,7 305,9 -23,8

Compensation of employees 2.007,1 2.040,6 1,7

Other taxes on production 0,4 0,3 -25,0

Subsidies payable 40,4 68,4 69,3

Interest paid 350,7 470,6 34,2

Socialbenefits 1.919,9 1.923,6 0,2

Other current transfers 331,9 275,1 -17,1

Capital transfers payable 96,6 54,9 -43,2

Total expenditure 5.789,9 5.759,1 -0,5

Total expenditure as a % of GDP 32,2 32,5

REVENUE

Marketoutput&outputforownfinaluse 322,9 366,4 13,5

Taxes on production and imports 1.929,8 1.898,4 -1,6

of which VAT 1.128,4 1.097,1 -2,8

Property income receivable 109,0 89,5 -17,9

Current taxes on income, wealth, etc. 1.511,1 1.449,4 -4,1

Social contributions receivable 1.247,0 1.213,7 -2,7

Other current transfers receivable 125,5 149,4 19,0

Capital transfers receivable 4,6 3,5 -23,9

Total revenue 5.249,9 5.170,3 -1,5

Total revenue as a % of GDP 29,2 29,2

Surplus (+) / Deficit (-) -540,0 -588,8

Surplus (+) / Deficit (-) % of GDP -3,0 -3,3

Source: Cystat.

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developments are reversed to some extent when Ministry of Finance data for the first eleven months of 2012 is taken into account, pointing to a marginal annual reduction in total public revenue of 0,5% in cash terms. Total general government expenditure exhibited a marginal annual reduction of 0,5% over the first nine months of 2012, mainly as the result of the 23,8% reduction in expenditure on gross fixed capital formation, which was partly offset by increases in other items of expenditure. For instance, the increase of 34,2% in expenditure for interest payments, primarily due to the servicing of the Russian loan, the annual increase in compensation of employees by 1,7% reflecting the wave of early retirements as well as the significant annual increase in subsidies for public transport and agricultural purposes. The aforementioned expenditure reduction is stronger when more recent Ministry of Finance data for the first 11 months of 2012 covering the central government in cash terms is taken into account, pointing to an annual reduction of 1,7% in total public expenditure.

Projections8

According to the December 2012 CBC projections, GDP is projected to contract by 3,5% in 2013 and by a further 1,3% in 2014 (Table 3.6, p. 23). Inflation in Cyprus is projected to decelerate to 1,5% in 2013, mainly reflecting the expected decline in oil prices, while in 2014 inflation is projected to further decelerate to 1,3% (Table 3.6, p. 23). The above mentioned projections for GDP are subject to much uncertainty, with downside risks weighing larger than a more positive outcome than

those projected. The likely worse than projected impact of the application of the fiscal consolidation measures included in the Memorandum of Understanding may affect negatively the GDP projections. In such a case, despite the improvement in confidence, public consumption and public investment may be reduced with a multiplier impact on private consumption, unemployment and GDP. Further reduction in construction activity may limit growth prospects even more through an impact on household wealth. On the other hand, GDP outcome could prove better than projected if the economies of our trading partners recover faster than expected or in the case where the economic climate improves more than anticipated following the signature of the Memorandum of Understanding. The latter could possibly lead to a faster exit from the crisis than that which is expected in the basic scenario of the projections. The most important upside risks for the inflation outlook relate to the possibility of indirect and second round effects of the increase in electricity prices and higher oil prices and/or a depreciation of the euro

8. These projections do not reflect developments that occurred after the cut-off date for the statistics, particularly the Eurogroup decision of 25 March 2013.


against the dollar, as well as the possibility of further increases in indirect taxation and administered prices in the context of fiscal consolidation. As regards the downside risks to the inflation outlook, these include the possibility of a more severe and protracted contraction of domestic economic activity and of a more intense impact of fiscal consolidation and rising unemployment on real disposable income. Furthermore, a possible aggravation of the external environment may contain demand for services and thereby reinforce the downward pressure on prices. Overall, risks to the modal forecast of HICP and HICP excluding energy are slightly tilted to the upside.

2011 2012f 2013f 2014f

TABLE 3.6 Central Bank of Cyprus projections(annual change,%)

HICP

December Projections 2012 3,5 3,1 1,5 1,3

June Projections 2012 3,5 3,2 1,3 -

GDP

December Projections 2012 0,5 -2,4 -3,5 -1,3

June Projections 2012 0,5 -1,1 0,4 -

Sources: Cystat, CBC.

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4.1 Regulation and Supervision of the Banking Sector

Supervision of banking institutions Under the Central Bank of Cyprus Law, 2002-2007 and the Banking Laws, 1997-2012, the CBC is the competent authority for the supervision and regulation of banks, including the granting of licenses for the carrying on of banking business. In light of the continuing global economic instability, the CBC’s supervisory role is of particular importance. In exercising its supervisory role, the CBC is guided by the recommendations of the Basel Committee on Banking Supervision, the guidelines issued by the European Banking Authority (EBA) and the rules of the EU which promote the adoption of best practices and standards for banking supervision. In this connection, various directives, circulars and guidelines regarding prudential supervision are issued by the CBC to all banks operating in Cyprus. The supervision of banks incorporated in Cyprus, including both their domestic and foreign subsidiaries and branches, is exercised by the CBC on a consolidated basis. The supervision of banks is carried out by using two methods that complement each other: (a) off-site monitoring of banks’ compliance with CBC directives, circulars and guidelines through the analysis of various periodic prudential returns submitted to the CBC, covering an extensive range of banking operations; and (b) on-site examinations, which aim at evaluating the financial condition of banks, assessing the level of risks they undertake and the adequacy of management of those risks. More specifically, on-site examinations focus on areas such as the management, organisational structure, internal audit, risk management (credit, liquidity, interest rate, foreign exchange, etc), profitability/performance, adequacy of provisions for doubtful debts, provision

of investment services and activities and issues relating to capital adequacy and compliance with CBC’s directives, circulars and guidelines.

Developments in the regulatory framework and operation of banks • Amendment of the Banking Law In 2012 the Banking Law was amended for the purpose of transposing the provisions of EU Directive 2010/78/EC (known as Omnibus), to the extent that these relate to the CBC and the operations of banks, and consequently EU Directive 2006/48/EC (known as the CRD). Omnibus is based on the new supervisory structure of the financial sector designed on the basis of the recommendations made in the de Larosière Report for the establishment of the European System of Financial Supervisors (ESFS) that comprises the European Systemic Risk Board and the three European supervisory authorities: EBA, European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority. The aim of the new system, which was directly implemented by the issue of European regulations, is the upgrading of the quality, cooperation, coordination, consistency and trust between the national competent supervisory authorities, the strengthening of the oversight of cross-border groups and the establishment of a European single rule book applicable to all financial institutions in the internal market. The main provisions of Omnibus, which were transposed into the Banking Law, refer to the relationship between the CBC and the EBA. These are summarised below:

(a) Notification of the EBA by the CBC, inter alia, of the terms for granting a banking license, revocation of a banking license and the implementation of prudential steps in emergency situations in order to protect the interests of depositors, investors and other persons to

4. Functions of the Bank

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whom services are provided.

(b) Cooperation of the CBC with EBA in such areas as compliance with EBA guidelines and recommendations, participation in the activities of the EBA and the conclusion of cooperation agreements for the exchange of information with the competent authorities of third countries.

(c) Mediation by the EBA in cases of disagreement with other competent authorities.

• Amendment of the Directive to Banks for the Supplementary Supervision of Banks that belong to a Financial Conglomerate (FICOD) During 2012 the provisions of the Omnibus directive that amends EU Directive 2002/87/EC (known as FICOD) for the supplementary supervision of credit institutions, insurance undertakings and investment entities that belong to a financial conglomerate, were transposed into the CBC Financial Conglomerates Directive. The main amendments in this directive relate to the following:

(a) Notification of the Joint Committee of the European Supervisory Authorities of the identification of a financial conglomerate, the appointment of a coordinator and the submission to the Joint Committee of relevant information.

(b) Settlement of disagreements between cross-border competent authorities.

(c) Development of adequate arrangements and recovery and resolution plans, within the risk management framework.

(d) Submission of necessary data to the European

Systemic Risk Board and to the European Supervisory Authorities either directly or through the Joint Committee.

• Amendment of The Framework of Principles of Operation and Criteria of Assessment of Banks’ Organisational Structure, Internal Governance and Internal Control Systems Directive, 2006 - 2012 In January 2012, the CBC proceeded with the amendment of the above mentioned directives. The amendment relates primarily to: (a) the repeal of the responsibility of the Internal Audit Unit (IAU) for the rating and assessment, every 18 months, of at least 70% of the credit facilities granted; and (b) the specification of the minimum requirements / contents of the annual report submitted by the Head of the IAU to the Board of Directors through the Audit Committee, a copy of which is submitted to the CBC. • Circular Letter for the Submission of Returns Regarding the Remuneration of Banks’ StaffIn September 2012, a circular letter was sent to all banks incorporated in Cyprus requiring the submission of returns regarding the remuneration of their members of staff. This obligation is derived from the relevant guidelines published by the EBA (EBA Guidelines on the Remuneration Benchmarking Exercise and EBA Guidelines on the Data Collection Exercise Regarding High Earners). According to the EBA guidelines, banks are required to submit the above returns by the end of June every year to their national supervisory authorities, which, in turn, are required to transmit the said returns to the EBA by the end of August of the same year. Regarding the first submission of returns, the EBA decided that these should be transmitted by the national supervisory authorities to the EBA by the end


of December 2012 and will relate to fixed and variable remuneration awarded to members of staff for the years 2010 and 2011.

• Granting of Government Guarantees for the Conclusion of Loans and/or the Issue of Bonds by Credit Institutions Law, 2012 In November 2012, the House of Representatives approved the above Law that empowers the Minister of Finance to proceed with the granting, on behalf of credit institutions, of government guarantees up to a total amount of €6 billion for the conclusion of loans and/or the issue of bonds by credit institutions (banks and cooperative credit institutions), including subsidiaries of foreign credit institutions, with the objective of enhancing the liquidity of the real economy. The government guarantees are granted against the payment by the credit institution of an appropriate commission and, as a general rule, with the provision of adequate collateral for the benefit of the Government, in the form of pledge and/or assignment of collateral for the full coverage of the amount of government guarantees allocated to the credit institution. The collateral portfolios are kept at the CBC or the Authority for the Supervision of Cooperative Societies which undertake the responsibility of monitoring the collateral portfolio, throughout the period of government guarantees, in order to ensure that the adjusted value of the collateral fully covers the amount of the government guarantees granted. The procedure, the terms of granting the government guarantees, the level of the commission, the type and adequacy of collateral, the criterion concerning the allocation of the government guarantees and the monitoring and coordination procedures for the correct and effective application

of the provisions of this Law, including the set up of a competent Coordination Committee, are prescribed in a Decree of the Minister that was issued pursuant to the said Law. • Amendment of the Special Tax on Credit Institutions Law In 2012 the Special Tax on Credit Institutions Law was amended, with retroactive application from 2011, with the deletion of the clauses providing that the levy paid shall not exceed the 20% of the taxable income of the bank and the provision to refund the bank with any excess levy paid in such cases. Also, as of 2013, the rate of bank levy increases from 0,095% to 0,11% and the application of the Law is extended indefinitely.

• Amendment of the Management of Financial Crises Law In 2012 the Management of Financial Crises Law was amended, with the extension of the application of the Law to 30 April 2013. Also, within the context of the support measure for the provision of capital against equivalent participation of the Republic in the financial institutions’ ownership structure, the Council of Ministers may also proceed with the underwriting of a rights issue of shares in full. Subsequently, in both cases, the distribution of shares of the beneficiary financial institution is undertaken in priority to: (a) the existing shareholders, (b) a financial institution, (c) the public through public tender, and (d) to a limited group of people with private placement.

• Directive on the Conditions of Offering of Investment or Ancillary Services and the Performance of Investment Activities by Banks In September and November 2012, the European Securities and Markets Authority issued guidelines

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relating to certain aspects of MiFID suitability requirements and the compliance function requirements, which should be applied by banks when providing investment services. The CBC issued a circular to banks requesting the application of these guidelines.

Developments in the banking sectorThe year under review was a milestone for the Cyprus banking system due to the economic developments in Cyprus and Greece and also due to the developments in the broader European environment. More specifically, the intensive discussions with the Troika and the deterioration of the economic conditions in Cyprus and Greece were the main developments of 2012. In the wider European environment, the observed escalation of the sovereign debt crisis in the euro area led both the European Union and the ECB to take specific decisions in order to deal with the crisis and break the vicious circle between banks and sovereign debt, e.g. the establishment of a Single Supervisory Mechanism for the banks under the auspices of the ECB, which shall act in cooperation with the national competent authorities of the member states of the European Union. More specifically, in June 2012, the Cyprus government applied for financial assistance from the European Stability Mechanism (European Commission and ECB) and the IMF. The application was driven by the state’s inability to access the international capital markets, which hindered its ability to support the country’s two biggest banks, Bank of Cyprus and Laiki Bank. In this respect, the efforts of the two banks to raise capital from private sources combined with their deleveraging actions proved inadequate in meeting the minimum core tier 1 ratio (CT1) target of 9% by 30 June 2012, which was set by the EBA. The capital

shortfall of the two banks as at 30 June 2012, which was calculated for the purposes of the recapitalisation exercise of banks undertaken by the EBA, exceeded 10% of GDP. As early as the beginning of 2011, the markets had discounted the contingent liabilities of the state in relation to the capital shortfalls of its banks. The result was the restriction of the state’s access to the international capital markets with adverse consequences in its ability to borrow or refinance its existing debt obligations. In May 2012, Laiki Bank applied and received state aid of €1,8 billion through the issue of new capital. In June 2012, Bank of Cyprus informed the CBC that, in accordance with its preliminary estimations, it was in need of €500 million of state aid. In light of the above, the CBC’s contribution was important in reaching a preliminary agreement to a programme with the Troika by which the banking sector will be resolved, restructured and recapitalised. The programme, among other things, provides for the strengthening of the supervisory and regulatory framework and for addressing banks’ capital shortfalls. The objective is to make the banking system healthier, more competitive and preserve its stability. Moreover, during 2012 the macroeconomic environment in Cyprus and Greece significantly deteriorated. The adverse economic conditions and the haircut imposed on Greek government bonds contributed to the significant increase in the provisions for doubtful debts, which resulted in the banking system suffering significant losses in the year under review. As far as liquidity is concerned, in 2012 further pressure was evident on the liquidity buffers of the banking system due to the adverse domestic macroeconomic environment, the increase of non-performing loans and the reduction in the market


value of sovereign bonds held by banks. The political instability in Greece during the first half of the year had a negative impact on the liquidity of Cypriot banks that operate in that market. The return of political stability in the country led to the normalisation of the liquidity position in Greece. Moreover, it must be noted that the cost of raising additional liquidity through new deposits remains higher than in other euro area countries. At the European level, distressed sovereign bond spreads decreased significantly due to the decision taken by the ECB on 6 September 2012 according to which the latter may purchase short-term sovereign bonds if the relevant member states have entered an adjustment programme. It must be noted that before the aforementioned decision was taken, the sovereign bond spreads of countries facing fiscal problems or problems emanating from their banking systems had significantly increased. In addition, a very important development was the determination shown by the heads of the euro area countries to take all actions needed to break the vicious circle between banks and sovereign debt, as explicitly expressed in the Head of States Summit of June 2012, and reaffirmed in the Head of States Summit of October 2012, which showed their commitment to encounter the economic crisis effectively. Within this context, the EU ministers of finance agreed on 12 December 2012 to establish a single supervisory mechanism under the auspices of the ECB. The establishment of the single supervisory mechanism is a prerequisite for the provision of direct bank recapitalisation from the European Stability Mechanism, subject to a prior political decision. Moreover, the European Commission and the European Council disclosed the roadmap leading to the European Economic and Monetary Union. The rapidly changing environment, as described

above, is expected to present challenges in 2013 as well. There is no other alternative but to proceed with planned structural reforms to Cyprus’s banking system. The ultimate objective is to preserve financial stability, restore confidence in the system and to safeguard the banks’ capacity to provide the necessary support to households and businesses, thus contributing to the recovery and growth of the economy.

Cooperation with other domestic and foreign supervisory authoritiesDuring 2012 the CBC, on the basis of the memorandum of understanding signed between the supervisory authorities of Cyprus’s financial sector in November 2003, continued its regular meetings with the other supervisory authorities for the purpose of exchanging information and cooperating on issues of common interest. As regards cooperation with foreign supervisory authorities, the CBC continued to participate actively in the meetings of the EBA and its working groups. Their main objective is to advise the European Commission on supervisory and regulatory issues concerning the banking sector and contribute to the consistent application of Community legislation as well as the convergence of supervisory practices by member states. Particular importance is placed by the CBC in developing bilateral ties and contacts mainly with: (i) supervisory authorities which supervise banks that offer services in Cyprus through subsidiaries or branches or on a cross-border basis without establishment, and (ii) supervisory authorities of countries where subsidiaries and branches of Cypriot banks are operating. In line with the above, the CBC pursues the negotiation and signing of memoranda of understanding in the field of banking supervision

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with foreign supervisory authorities. This policy is in line with the relevant recommendations of the Basel Committee on Banking Supervision, which aim at ensuring effective supervision of the cross-border activities of banks. The total number of memoranda of understanding already signed in the field of banking supervision between the CBC and other overseas supervisory/regulatory authorities has reached 30.

4.2 Financial StabilityMacro-prudential oversightIn exercising its role of contributing to the safeguarding of the stability of the financial system, the CBC, inter alia, regularly monitors and analyses the cyclical and structural developments in the financial system as well as developments in the wider macroeconomic environment, with a view to identifying, monitoring and assessing potential risks to financial stability. The main focus is on the banking sector, which constitutes the largest component of the broader Cyprus financial system and the primary potential channel for the propagation of risk within the financial system and to the economy. In addition, developments in the non-bank financial sector, especially in the insurance sector, are monitored, while the risks facing these financial institutions and their interlinkages with banks are analysed. Moreover, an assessment of the risks stemming from financial markets and market infrastructures is carried out. In parallel, macroeconomic conditions and risks are analysed, by focusing on developments in the household, non-financial corporate and real estate sectors, while an assessment of the risks to financial stability originating from these sectors is performed. Macro-prudential oversight is complimentary to the micro-prudential supervision of individual banking and other financial institutions conducted by the CBC and the other competent financial

supervisory authorities in the country, respectively.

Reporting of Cyprus banking sector data and financial indicators to international organisationsIn 2012 the CBC continued to regularly compile and submit aggregate data and financial indicators for the Cyprus banking sector to the ECB and IMF, which are published on the respective websites of the aforementioned organisations. Specifically, the Consolidated Banking Data (CBD) for banks operating in Cyprus, which are used for macro-prudential analysis conducted at the ECB/ESCB level, were submitted to the ECB on a bi-annual basis. The CBD contain information on the profitability, balance sheets, asset quality and capital adequacy of EU banks. These data are reported by the competent national banking supervisory authorities (central banks or other authorities) of each EU member state on a cross-border and cross-sector consolidated basis, in order to facilitate the comprehensive assessment of all risks to the stability of the EU banking sector. In addition, the aggregate Financial Soundness Indicators (FSIs) data for deposit institutions operating in Cyprus were submitted to the IMF on a quarterly basis. These indicators have been developed by the IMF, together with the international community, with the aim of supporting macro-prudential analysis. The FSI data reported by member states are compiled using different methodologies, which are likely to vary for each reporting period and for the same country. As a result, FSI users are advised to consult the accompanying metadata so as to be able to perform meaningful cross-country comparisons or properly assess the evolution of a given FSI for each country.


Participation in the committees and substructures of the European Systemic Risk Board, the European System of Central Banks and the EUIn the year under review members of the Financial Stability Department (FSD) participated in the meetings and workings of the Advisory Technical Committee (ATC) of the European Systemic Risk Board (ESRB) and its working groups. The ATC provides advice and assistance on matters relevant to the work of the ESRB. The Committee contributes, inter alia, to the:• Regular reviewof financial stability conditions in

the EU, including the identification of systemic risks.• Analyticalandpolicypreparationsfordiscussionsin

the ESRB Steering Committee and General Board on warnings and recommendations.

• Review and possible development of macro-prudential policy instruments for use by the competent authorities of member states.

• Regular monitoring of macro-prudential policydecisions of the competent authorities of member states as well as those from outside the EU and the discussion of their possible implications for the EU as a whole.

Members of the FSD also participated in the meetings and workings of the Financial Stability Committee (FSC) of the ESCB and its working groups. The FSC assists the decision making bodies of the ECB in the fulfilment of its tasks in the field of prudential supervision of credit institutions and the stability of the financial system. It contributes, inter alia, to the:• Analysisoffinancialstabilityissuesrelatingtothe

euro area. • Reviewofanalyticaltoolstosupportsystemicrisk

analysis at the euro area level. • Analysis of policy issues in the field of financial

regulation. • SupervisionandcrisismanagementintheEUand

internationally.• Assessment of the impact of regulatory and

supervisory requirements on the stability of the euro area financial system.

• Promotionoffinancialstabilityarrangementsintheeuro area and EU levels.

Furthermore, a member of the FSD participated in the meetings of the Financial Stability Table (FST) of the EU Economic and Financial Committee (EFC). The EFC-FST is responsible for preparing the ECOFIN Council’s discussions on financial stability matters.

Participation in meetings with representatives of international organisationsIn 2012 members of the FSD participated in meetings with representatives of the Troika on financial sector issues with a view to concluding a Memorandum of Understanding for Cyprus’s participation in an economic adjustment programme and support from the European Stability Mechanism.

Regulatory framework for crisis management and resolutionIn the year under review members of the FSD contributed to the drafting a series of bills concerning the development of a comprehensive crisis management and resolution framework at the national level, which are expected to be sent to the House of Representatives for approval. The said framework includes, inter alia, regulatory provisions for the application of early intervention measures at credit institutions, the special liquidation of a credit institution, the implementation of resolution measures at credit and other institutions as well as the establishment and operation of a Scheme for the Deposit Protection and Resolution of Credit and Other Institutions. During the Cyprus Presidency of the Council of the

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EU in the second half of 2012 members of the FSD participated in the meetings of the relevant Working Group of the Council of the EU on the proposal for a Directive of the European Parliament and of the Council establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directives 77/91/EEC and 82/891/EC, Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC and 2011/35/EC and Regulation (EU) No 1093/2010.

Administration of the Deposit Protection Fund and the Investor Compensation Fund for Clients of Banks

Deposit Protection Scheme (DPS)During 2012, 29 banks participated in the DPS. In the same year, the fifth instalment of the initial contribution of the banks to the Deposit Protection Fund (DPF) was paid in accordance with the regulations governing the DPS. As a result, the total funds of the DPF at the end of the year amounted to approximately €130 million. The DPS provides coverage of up to €100.000 for the aggregate amount of deposits held with a particular bank by natural or, under certain circumstances, legal person. Participation in the DPS is obligatory for all banks incorporated in Cyprus and for banks incorporated in third countries which operate in Cyprus through branches. Coverage is also provided for deposits held with the overseas branches of banks incorporated in Cyprus. During 2012, as in previous years, no conditions or circumstances arose which necessitated the activation of the DPS. During the year under review the examination of the European Commission’s proposal for issuing a directive on the resolution of banking institutions continued at the EU level. As part of this review, the

Working Group of the EU Council, in which a CBC representative participates, had the opportunity to further examine the regulations governing the deposit guarantee schemes in order to adopt effective arrangements for the systems operating in EU territory. Among other things, the new regulations are expected to take into account the additional needs that a banking institution may have in terms of recovery and resolution issues. Furthermore, it is anticipated that the role of deposit guarantee schemes as a means of maintaining the trust of depositors will be further strengthened via the new regulations-directives. More specifically, they aim to achieve faster compensation payout, better distribution of information to depositors as well as further strengthening of the cooperation between the different deposit guarantee schemes operating in the EU. In 2012 the implementation of the programme relating to the operation of a comprehensive Depositor’s Register for the Banking System commenced. The DPF is expected to have at its disposal a full register for the whole banking system, which will enable the DPF to be in a position to know the level of its contingent liabilities against each separate depositor. As in previous years, during 2012 the CBC participated via a representative in conventions organised by the European Forum of Deposit Insurers (EFDI). During the aforementioned conventions various positions and recommendations were submitted, aiming to adopt proposals which could enhance stability in financial systems.


Investor Compensation Fund for Clients of Banks (ICFCB)Τhe ICFCB which has been operating since 2004 under the auspices of the CBC, continued its operation in 2012, aiming to ensure the stability of the financial sector. Through the Fund’s operation further security is provided to clients of banks regarding claims they might have in connection with the provision of investment services. In accordance with the regulations governing the operation of the ICFCB, participation is obligatory for all banks which provide investment services and which have been incorporated in the Republic of Cyprus or have been established in other countries and operate in Cyprus through branches. Investment services provided by overseas branches of banks incorporated in the Republic of Cyprus are also covered. The maximum amount of compensation payable to each covered client-investor cannot exceed €20.000, irrespective of the number of accounts maintained, the currency or the country from which the investment services are provided. During 2012 the number of banks participating as members of the ICFCB increased to 16. The Management Committee of the ICFCB determined the additional contributions that members of the ICFCB would be required to make after evaluating each bank’s investment obligations and the level of risk using official estimates. The total amount payable for 2012 was paid within the set timeframes. During the same year, the CBC participated with one representative in consultations held with representatives of supervisory authorities from other EU member states, in order to attempt shaping the new institutional framework which will govern the investor compensation schemes. The new regulatory framework aims, among other things,

to adopt a practical and effective compensation system. Specifically, it aims to provide enhanced protection, faster compensation payout and the best possible information to investors. In addition, further cooperation between different compensation schemes operating across the EU is anticipated.

4.3 LicensingThe CBC is the competent authority for granting licenses to legal persons, concerning the following operations: (a) commencement of banking business under the Banking Business Law, 1997-2012, (b) provision of payment services by payment institutions, under the Payment Services Law, 2009-2010, (c) issue of electronic money under the Electronic Money Law, 2012, and (d) establishment of international collective investment schemes under the International Collective Investment Schemes Law, 1999-2000. The CBC, acting within the remit of its licensing role, assesses, inter alia, the fitness and properness of persons applying: (i) for a direct or an indirect acquisition of a controlling shareholding interest, (ii) to increase their controlling interest in the share capital, (iii) to act as directors, chief executive officers or managers, in the above financial entities. The CBC, acting in accordance with the above laws, notifies the competent supervisory authorities of EU member states, regarding the intention of banks, payment institutions or electronic money institutions licensed by it to exercise their right of freedom of establishment (through branches) or to offer services on a cross-border basis without establishing a presence. Furthermore, the CBC receives notifications concerning financial institutions which have been licensed by the competent authorities of other EU member states regarding the exercise of their right to provide their services in the Republic of Cyprus.

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Needless to say that the CBC, acting within the powers vested in it by the provisions of the above laws, may amend and/or revoke wholly or partly the above licences, or require the resignation of any director, chief executive officer or manager or to prohibit any financial institution licensed by it, to carry out activities in another EU member state. The CBC maintains duly updated public registries within which the following entities are recorded: (i) banks licensed or authorised to offer banking services in the Republic, (ii) payment institutions and electronic money institutions licensed or authorised to offer payment services or issue electronic money, respectively, in the Republic, and their authorised agents, and (iii) international collective investment schemes (ICIS) which have been recognised by the CBC. The said registries are publicly available on the CBC’s website (http://www.centralbank.gov.cy/nqcontent.cfm?a_id=1&lang=en).

Banks During 2012 the CBC, acting within the scope of its responsibilities, approved the following:(i) application by Bank of Cyprus Public Co Ltd for

the sale of its wholly owned subsidiary bank in Australia, Bank of Cyprus Australia Ltd.,

(ii) application by Cyprus Popular Bank Public Co Ltd (ex-Marfin Popular Bank Public Co Ltd) for the sale of the total of its shareholding (70,5427%) in Marfin Bank Eesti AS, incorporated in Estonia,

(iii) application by Bank of Cyprus Public Co Ltd to transfer the operations of its UK branch to its wholly owned subsidiary, Bank of Cyprus UK Ltd. The latter has been licensed and is under the supervision of the UK’s Financial Services Authority.

(iv) application by USB Bank PLC for the establishment

of a Representative Office in Russia.

Moreover, the CBC received a notification from the competent supervisory authority of Denmark concerning the intention of Saxo Bank A/S, a bank incorporated in Denmark, to establish a branch in the Republic, exercising the right of the freedom of establishment. Following its assessment of the above notification, the CBC indicated to Saxo Bank the conditions under which, in the interest of the general good, its branch should carry out its activities in the Republic. At the same time, the representative office established by Saxo Bank A/S in Cyprus terminated its operations and the CBC revoked the relevant license. During 2012 the CBC received 19 notifications from supervisory authorities of EU member states concerning the intention of banks under their supervision, to offer services in the Republic on a cross-border basis. As a result, the total number of banks from EU member states which had notified their intention to offer services in the Republic was increased to 257. In view of the above developments, as at the end of 2012, 41 banks operated in the Republic, out of which 14 were locally incorporated and the remaining 27 were branches of foreign credit institutions. Eight of the locally incorporated banks were subsidiaries of foreign credit institutions. As regards the 27 branches of foreign credit institutions which are operating in the Republic, it should be noted that 11 originate from other EU member states while the remaining 16 originate from third countries. Finally, one representative office of a foreign credit institution is operating in the Republic.

Payment institutionsDuring 2012 the CBC issued a licence to a company to operate as a payment institution (PI) and, as a result,


the total number of PIs which held a valid licence issued by the CBC increased to nine. Six provided money remittance services without maintaining payment accounts, two were authorised to issue and/or acquire payment instruments and one provided money remittance services, maintaining payment accounts. The PIs operated through 38 own branches as well as through 246 branches of authorised agents, including 69 branches which were authorised during 2012. As regards the provision of payment services in the Republic by PIs licensed by other member states, it should be noted that during 2012 the CBC received the following notifications from supervisory authorities of other member states: (a) 36 PIs notifying their intention to provide cross-border payment services in the Republic. Thus, the total number of such institutions rose to 128 as at the year end; and (b) 4 PIs exercised their right of establishment and, subsequently, appointed 27 new agents.

Electronic money institutionsThe Electronic Money Institutions Law, 2012 was enacted on 27 June 2012, so as to harmonise with the “Directive 2009/110/EC of the European Parliament and of the Council of 16 September 2009 for the taking up, pursuit, and prudential supervision of the business of electronic money institutions”, substituting the previous relevant law of 2004. During the year under review, one electronic money institution licensed by the CBC was operating in the Republic. Moreover, ten electronic money institutions established in other member states notified their intention to offer cross-border services in Cyprus, raising the total number of such institutions to 24.

International collective investment schemesDuring 2012 a large number of applications for

recognition as an International Collective Investment

Scheme (ICIS) had been received. Specifically, during

the year under review, 24 new ICISs were recognised

by the CBC, raising the total number of ICISs operating

in the Republic at the end of 2012 to 93.

4.4 Payment and Settlement SystemsPayment, clearing and settlement systems play

an important role in the economy, as economic

activity and its smooth and orderly development

rely on the existence of safe and efficient means of

payment. Furthermore, they contribute significantly

to maintaining financial stability because they are

the means through which economic disturbances

are transmitted from one financial sector to another.

In addition, substantial increases in financial market

activity, coupled with rapid advances in technology,

have brought to the fore the importance of the safety

and efficiency aspects of payment, clearing and

settlement systems.

For these reasons, the existence of the necessary

legal framework and of the infrastructure that ensures

the smooth, secure and productive operation of

payment and securities settlement systems, both at

the European and local level, is of vital importance.

The close cooperation between the CBC and the

banking community in the field of payment systems

is also important to ensure timely and effective

responses to developments, whether these are

connected to EU/Eurosystem membership or more

general issues. Various committees, such as the

Consultative Payments Committee, the Committee

of the Cyprus Clearing House and the National

Coordinating Committee for the Migration to the

Single Euro Payments Area (SEPA), facilitate the

effective exchange of information and coordination

among all parties involved.

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Legal frameworkThe role of the CBC concerning payment, clearing and settlement systems, as envisaged by the acquis communautaire, is based on the Central Bank of Cyprus Law, 2002-2007. In particular, section 6(2)(g) specifies as one of the main responsibilities of the CBC the promotion, regulation and oversight of the smooth operation of payment, clearing and settlement systems. Furthermore, in accordance with Section 48 of the Law, the CBC may administer, participate in or become a member of any payment, clearing and settlement system and may place under its oversight any payment, clearing and settlement system that operates in the Republic. The CBC is also empowered to issue directives regulating the functions and operating procedures of the systems under its oversight. The CBC is the competent authority for designating the payment and settlement systems that fall within the scope of the provisions of the Settlement Finality in Payment Systems and in Securities Settlement Systems Law, 2003-2011. In addition, this Law gives the CBC the right of access to any information that it may deem necessary in the exercise of its responsibilities and the power to impose administrative fines on any participant for non-compliance. The CBC has designated as systems falling under the provisions of the Settlement Finality Law, the TARGET2-CY system and the Central Depository and Central Registry of the Cyprus Stock Exchange. The Payment Services Law, 2009-2010 and the CBC’s Payment Institutions and Access to Payment Systems Directive, 2009, transpose into Cyprus law the provisions of EU Directive 2007/64/EC. Similarly, the Electronic Money Law, 2012 and the Electronic Money Directive, 2012, which were adopted on 27 June 2012 and 29 June 2012 respectively, transpose

the provisions of the European Community Directive 2009/110/EC into national law. The CBC is the competent authority for ensuring the application of the provisions of these laws, including the supervision of payment institutions and e-money institutions. In this capacity, it has set up a committee as an out-of-court complaint and redress procedure for the settlement of disputes between users and payment service providers both within the context of the above-mentioned directives and of Regulation (EC) 924/2009 as regards cross-border payments.

Payment and securities settlement systems operating in CyprusThere are currently six payment, clearing and settlement systems operating in Cyprus. These are the TARGET2-CY system, the Cyprus Clearing House for cheques, the payment cards clearing and settlement system, the retail credit transfers system (JCCTransfer), the government credit transfers system and the Cyprus Stock Exchange clearing and settlement system (CDCR). These systems, with the exception of the government credit transfers system and the Eurosystem’s TARGET2, are described in the ECB publication Payment and Securities Settlement Systems in the European Union issued in August 2007 (http://www.ecb.int/paym/market/blue/html/index.en.html). The CBC is the operator of TARGET2-CY and the government credit transfers system whereas it provides settlement services to the Cyprus Clearing House and the CDCR.

Single Euro Payments Area (SEPA)The CBC supports the efforts of the European banking sector for the formation of the legal and regulatory framework as well as an integrated infrastructure that will allow the adoption of an advanced and reliable


network for retail payments leading to the realisation of SEPA. For the completion of this project in Cyprus, a National Coordination Committee was established under the chair of the CBC. The Committee’s task is to coordinate the efforts for the replacement of the existing national payment schemes with SEPA compliant products relating to credit transfers, payment cards and direct debits. The CBC, as the banker to the government, supports its efforts to achieve the widespread use of SEPA compliant products. Therefore it sends and receives SEPA compliant credit transfers for the government through the RPS payments mechanism of the Deutsche Bundesbank; it is expected that during 2013 most electronic government payments will be effected in this way. For local government transfers, the use of IBAN is already mandatory and it is expected that during 2013 IBAN will be used for all domestic transfers. For this target to be achieved the use of domestic non-SEPA compliant payment systems, such as JCCTransfer, will have to be terminated. The review of the migration progress is being coordinated on a pan-European level by the European Commission and the ECB within the context of the SEPA Council in which representatives of both providers and users are participating. In order to speed up the migration, the European Parliament and the Council adopted Regulation 260/2012, which specifies 1 February 2014 as the final date for the completion of the migration to SEPA compliant products and the phasing out of non-SEPA compliant national payment schemes for credit transfers and direct debits.

Oversight of payment and settlement systemsThe CBC, in accordance with the powers vested in it

by law, has placed under its oversight the payment, clearing and settlement systems operating in Cyprus. In exercising these duties it applies, as far as possible, the policies and methodologies adopted by the Eurosystem. The Oversight Policy Document of the CBC is currently under review and is expected to be approved and published in the first quarter of 2013. In the course of 2012 four authorised payment institutions which offer money remittances services were assessed.

T2S (TARGET2 Securities)The CBC is participating in T2S, an important Eurosystem infrastructure project relating to payment and securities settlement systems. This system aims at delivering a single integrated securities market for financial services by providing a single, borderless pool of pan-European securities as well as a core, neutral and state of the art settlement process. The project is at the development stage and it is expected to go live in 2015.

TARGET2In November 2012, the cash settlement of the Cyprus Stock Exchange migrated to TARGET2 via the Ancillary System Interface and is therefore effected in central bank money. The migration of the settlement of the Cyprus Clearing House to TARGET2 via the Ancillary System Interface is expected to be completed early in 2013.

Cheque truncationThe Cyprus Clearing House has 20 active and two non-active members. Fifteen out of the 20 active members are also participants in the electronic cheque truncation system. More banks are expected to join the electronic cheque truncation system in 2013. In 2012 the subcommittee for the revision of

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the reasons for cheque returns concluded its work, while the subcommittee for the monitoring of the electronic cheque truncation procedures continued with its mandate. Also, at the last plenary committee meeting of 2012, the Cyprus Clearing House announced its decision to proceed with the ab initio revision of the regulations governing the operations of cheque clearing in Cyprus.

Efforts to reduce the use of cheques as a payment instrumentIn the context of the continued efforts to reduce the use of cheques as a payment instrument, the dedicated Cyprus Clearing House subcommittee that was established in 2011 continued its work.

Central Information Register for Issuers of Dishonoured Cheques (CIR)As part of the efforts to reduce the problems caused by dishonoured cheques, the directive governing the operation of the CIR was amended in November 2012 so as to be aligned with the revised procedures adopted by the Cyprus Clearing House regarding the decrease of the validation period of cheques from six to three months from the date of issue.

4.5 Euro Banknotes and CoinsThe issuing of currency (banknotes and coins) into circulation falls within the competence of the CBC. In this context the CBC is tasked with the establishment of the necessary legal framework, participation in the ECB pooled banknote production arrangements, the minting of coins, the processing and distribution of banknotes and coins, and the withdrawal and destruction of banknotes and coins that are unfit for recirculation. At the end of 2012, the total amount of euro banknotes in circulation issued by the Eurosystem

reached €912.593 million, representing an increase of 2,7% compared with the end of 2011. The free movement of people and goods implies inflows and outflows of cash in a continuous migration flow that cannot be measured accurately for the purpose of determining the actual value of euro banknotes in circulation in each country.

Legal frameworkAmendment of the Currency (Counterfeiting and Other Related Matters) Laws, 2004-2008 The Currency (Counterfeiting and Other Related Matters) Law, 2004-2008 was amended in 2012 in order to implement Regulations (EC) No 1338/2001 and (EU) No 1210/2010 and Decision ECB/2010/14. The amending law lays down obligations to credit institutions and cash handlers on the authenticity and fitness checking of banknotes and coins before recirculation, the withdrawal of counterfeit banknotes and coins and their hand over to the competent national authorities and the return of unfit banknotes and coins to the CBC. Under the provisions of the amending law the CBC is empowered to issue directives, to carry out on site inspections at the premises of credit institutions and other cash handlers, to monitor their banknote and coin handling machines and to impose administrative fines in case of non-compliance.

Cash cycleDuring 2012 116,8 million pieces of euro banknotes were processed by the third party that ten out of 11 banks participating in the “Notes Held to the Order of the Central Bank - NHTO scheme” have subcontracted to store and process their banknotes and by the bank that stores and processes banknotes on its own. Out of these processed banknotes 27,3% (31,9 million pieces) were considered as unfit


for recirculation and were returned to the CBC for further processing. During the same period, the CBC carried out appropriate inspections of the banknote processing machines used by the third party and the bank processing banknotes on its own. The CBC also performed a number of on site inspections at the premises of banks to ensure that the provisions of the relative directive issued by the CBC in June 2011 are observed. The CBC has in 2012 entered into an arrangement with a third party for the storage and processing of coins. During 2012 22 million euro coins were processed, out of which 0,06% (12.115 coins) were considered as unfit for recirculation. Furthermore, the CBC carried out on site inspections at a number of credit institutions in order to establish that the provisions of Regulation (EU) No 1210/2010 were observed.

Counterfeit euro banknotes and coins detected in Cyprus during 2012During the year under review, 1.203 counterfeit euro banknotes of various denominations were detected in circulation, compared with 768 pieces in 2011. As in 2011, the €50 banknote remained the most frequently counterfeited denomination representing 62,8% of the total. Most counterfeits withdrawn from circulation were detected by bank cashiers. The number of counterfeit euro banknotes detected in circulation in Cyprus during the year under review was very small – 14 counterfeit euro banknotes per 10.000 residents – and was one of the lowest in the euro area. During the processing of euro coins a very small number of counterfeit coins (259 coins) were detected. These were of values of €2, €1, and €0,50.

Numismatic matters • Commemorative coin

In February 2012, the CBC issued the second Cyprus commemorative euro coin, in line with the decision of the euro area member states for a common issue with an identical design to commemorate ten years of euro banknotes and coins. The mintage of the Cyprus commemorative coin was 1.000.000 pieces,

out of which 8.000 of proof condition were placed in cases and 5.000 of brilliant uncirculated condition were placed in capsules for collectors. • Collector coinOn the occasion of the Cyprus Presidency of the Council of the European Union a silver collector coin was issued with a nominal value of €5. The coin is in proof condition and is available in a case. The design of the coin depicts a daisy, a motif from Lefkaritiko

embroidery, a characteristic example of Cyprus’s cultural tradition. The issue was limited to 8.000 coins.

• Collector setIn October 2012, the CBC issued 12.000 collector sets

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of the Cyprus euro coins minted in 2012, in brilliant uncirculated condition. This is the third set issued in the series of the Cyprus euro coin sets dedicated to the mosaics of Paphos. The sets also include the commemorative coin, issued in 2012 on the occasion

of ten years of euro banknotes and coins.

Withdrawal of the Cyprus poundThe withdrawal of Cyprus pound banknotes continued during 2012. Banknotes with a total value of £0,7 million were exchanged for €1,1 million. The CBC will continue to exchange Cyprus pound banknotes until 31 December 2017.

4.6 Activities in the Financial Markets

4.6.1 Management of reserves and other activities

On 31 December 2012, the CBC’s reserves, including gold bullion holdings valued at €563,4 million, amounted to €2.059,2 million compared with €3.161,5, million at the end of 2011.The level of the CBC’s reserves declined during the course of the year as a result of the reduced utilisation of the available approved investment options in the face of the very low interest rate environment and the

policy of the CBC for further credit risk reduction in 2012. The reinvestment of interest rate income, the marking to market of investments, the fluctuation of foreign currencies against the euro and other net flows in foreign currencies also contributed to the change in the level of the reserves.

According to the CBC’s Investment Policy (IP) framework, the management of reserves in euro, foreign currencies and gold focuses on the long-term maximisation of their return, without sacrificing other long-standing objectives of critical importance, such as the safety of the reserves and overall capital preservation. The income derived from reserves’ management comprises the major source of financing of the CBC’s operations, thus safeguarding its financial autonomy and independence.

The IP provides for the investment of the currency and gold reserves in approved asset classes, using approved financial instruments. Transactions are executed and processed through approved counterparties, such as banking institutions or investment banks. The cornerstone of the IP is the use of selected Strategic Benchmark Portfolios (SBP).

During 2012 the general investment policy framework which defines, among other things, the nature of both the approved asset classes and the SBP, proved to be appropriate under the prevailing market conditions, as it protected the value of the reserves during the continued global financial turmoil and investment uncertainty. In this regard, during the year under review the CBC held currency reserves primarily in euro, and to a much lesser degree, in dollars and sterling. In the midst of the uncertain and volatile financial market conditions, the CBC’s time deposit placements with credit institutions were kept at significantly low levels.


Participation in the management of the foreign exchange reserves of the ECBThe management of ECB reserves is decentralized and is conducted by the euro area national central banks which act as agents of the ECB. The CBC participates in the management of ECB foreign reserve assets with the management of its share carried out under a pooling arrangement with the Bank of Greece.

Participation in IMF programmesThe Republic of Cyprus has been participating since March 2011 in the ‘New Arrangements to Borrow’ programme which is conducted and overseen by the International Monetary Fund.

4.6.2 Implementation of monetary policy

On behalf of the ECB, which is responsible for formulating monetary policy in the euro area, the CBC participates in a uniform and equal way with the other euro area national central banks in the implementation of the single monetary policy which is set out by the decisions and guidelines of the ECB’s Governing Council. Consequently, the credit institutions that reside in and operate from Cyprus participate in and have access through the CBC to the open market operations and standing facilities of the Eurosystem. In light of the volatile and adverse financial market conditions that prevailed in 2012, both the regular and the supplementary open market operations of the Eurosystem continued to be carried out through fixed rate tenders with full allotment. This tender procedure will continue to be applied until at least 9 July 2013. In line with the other measures for the provision of adequate liquidity, the second longer-term refinancing operation of 36 months duration was executed in February 2012 through a fixed (weighted) rate tender with full allotment, following

the first such operation which was conducted in December 2011. The US dollar liquidity-providing operations also continued to be effected as fixed rate full allotment tenders. To this effect, the ECB extended until 1 February 2014 the temporary bilateral liquidity swap arrangements with the Federal Reserve System, the Bank of England, the Bank of Canada, the Bank of Japan and the Swiss National Bank. On 9 February 2012, and following up its own decision of December 2011 to expand the list of available collateral, the Governing Council of the ECB approved the proposals put forward by interested national central banks, including the CBC. These proposals referred to specific national eligibility criteria and risk control measures for the temporary acceptance of additional credit claims as collateral in the Eurosystem liquidity providing operations. In June 2012, the Governing Council of the ECB, aiming to further support the provision of credit to households and non-financial corporations, decided on further measures to improve bank access to Eurosystem liquidity providing operations. To this end, it reduced the minimum rating threshold and amended the eligibility requirements for certain asset-backed securities (ABS). In addition, to increase transparency and to facilitate the risk assessment of ABS, the ECB published in July 2012 regulations on loan-level data reporting requirements for underlying ABS assets. In September 2012, the Governing Council announced the introduction of the Outright Monetary Transactions (OMT) programme with a view to addressing severe distortions in government bond markets. Member states would only be eligible for the OMT programme if they complied with the strict and effective conditionality attached to predetermined and approved macroeconomic adjustment and stability programmes that would be implemented.

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At the same time, the Securities Markets Programme (SMP) which remained ineffective since February 2012 was terminated. Furthermore, the Governing Council determined to suspend the minimum credit rating threshold in the collateral eligibility requirements for the purposes of credit operations. The suspension applies to marketable debt instruments issued or guaranteed by the central government as well as to credit claims granted to or guaranteed by the central government of countries that are eligible for OMT or are under an EU-IMF programme and comply with the attached conditionality as assessed by the Governing Council. Moreover, the Council adopted, until further notice, the decision that marketable debt instruments denominated in currencies other than the euro, namely the dollar, sterling and yen, and issued and held in the euro area, would be eligible with appropriate valuation markdowns to be used as collateral in Eurosystem credit operations. On 31 October 2012, the second Covered Bonds Purchase Programme (CBPP2) was ended with the total nominal amount purchased reaching only €16,4 billion, as compared to the initially intended amount of €40 billion, mainly due to increased private demand as well as to significantly reduced issuance of new covered bonds.

4.7 Financial Risks ManagementThe CBC is exposed to financial risks stemming from its investment activities (in domestic and foreign currency as well as gold), from the implementation of monetary policy and from other credit providing operations. Since 2011 the management of financial risks has been performed independently from the operations in the financial markets as far as the organisational setup is concerned. In addition, as of the beginning of 2013, an independent Risk Management Office will

be assigned with responsibility for the management of both financial and operational risks, including the CBC business continuity management issues.

CBC investment activitiesThe monitoring, quantification and reporting and in essence the management of financial risks stemming from the CBC’s investment activities are performed according to the approved risk management framework as set out in Bank’s Investment Policy Framework. The CBC’s Investment Policy Framework provides for the investment of the currency and gold reserves in approved asset classes, using approved financial instruments. Transactions are executed and processed through approved counterparties, such as banking institutions or investment banks. The cornerstone of the Investment Policy Framework is the use of selected benchmark portfolios. This practice facilitates not only the comparative measurement of returns but also the assessment of the inherent risks of the real portfolios against parameters that reflect the risk-return profile of the CBC. The framework for monitoring and controlling the inherent risks related to the CBC’s reserves management operations is periodically monitored and updated according to prevailing conditions. The main risks involved are the following:

• Interest rate riskInterest rate risk is the risk of loss in the market value of investments due to fluctuations in market interest rates. In view of the excessive volatility observed in the financial markets during the year and in order to alleviate the exposure to interest rate risk, the weighted average duration of the investment portfolios during 2012 was adjusted to levels lower than those of the respective benchmark portfolios.


The exposure to interest rate risk was further eased by the continuation of the practice of maintaining a substantial part of euro denominated bonds in the held-to-maturity portfolio. Moreover, as in previous years, an additional constraint was applied limiting the remaining life to maturity of all bond investments to five years.

• Credit riskCredit risk refers to the risk that a counterparty or an issuer of securities fails to meet his contractual or legal obligations for the entire or part of the agreed amount during the period of the contract (default risk). Credit risk also includes the risk of loss in the market value of the investments, due to a downgrading of the credit rating of an issuer of securities (downgrade risk). Due to the continuing uncertainty in the markets in 2012, the CBC maintained its strict criteria for eligible counterparties/issuers, a fact which restricted credit risk but which at the same time also limited available eligible investment opportunities.

• Foreign exchange riskForeign exchange risk refers to the risk of incurring losses in the market value of investments due to fluctuations in the exchange rate of the euro against other currencies in which the CBC maintains reserves. During 2012 the CBC held reserves primarily in euro and, to a much lesser degree, in dollars and sterling. This strategy is aimed at preventing potential foreign exchange losses due to fluctuations in the exchange rate of the euro against both the dollar and sterling. During 2012, a period of continued financial turmoil and elevated global investment uncertainty continued from previous years, bank term deposits were kept at low levels, while the major part of the reserves remained invested in government bonds of countries with adequately high credit ratings and

characterised by political and financial stability.

Implementation of monetary policy and other credit providing operationsAs regards the implementation of the monetary policy of the Eurosystem at the national level, the CBC participates in the relevant bodies of the Eurosystem and contributes to the monitoring, measurement and reporting of the financial risks as well as to the enhancement of the risk management framework and the monitoring of the financial soundness of the local counterparties participating in open market operations. Emergency liquidity assistance is provided to credit institutions in accordance with the CBC’s established policy and after approval by the ECB’s Governing Council. Financial risks stemming from such emergency liquidity assistance are managed by the CBC on the basis of principles adopted by the Eurosystem. Overall, financial risks stemming from the CBC’s activities have increased in 2012 due to the continued financial crisis. As a consequence, the CBC has proceeded to further enhance its financial buffers by increasing the level of the provision it maintains against risks.

4.8 Economic Research and Related Activities

The Economic Research Department (ERD) is responsible for analysing and monitoring the domestic and euro area economies as well as the general international economic environment. Its staff systematically brief the Governor on recent economic developments as well as on the projections for Cyprus and the euro area economy, in preparation for his participation in the ECB Governing Council and also participate in various ESCB and EU committees.

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Other activities include the conduct of large research projects, such as the construction of the real estate price index and the Household Finance and Consumption Survey. Furthermore, meetings are held with international organisations visiting Cyprus and also presentations are given to various bodies, such as educational institutions and employers’ organisations. Τhe ERD took on an important role in the meetings with the Troika representatives during the consultation process for the preparation of the Memorandum of Understanding (MoU) in 2012. Specifically, there was active involvement in the discussions on fiscal restructuring and macroeconomic projections, while providing support on macroeconomic aspects of the discussions about the financial sector.

Economic BulletinDuring 2012 the June and December issues of the Economic Bulletin were published. The Bulletin presents the main international and domestic macroeconomic and financial developments, as well as the projections for the Cyprus economy. The Bulletin is prepared in both Greek and English and can be found on the CBC website (www.centralbank.gov.cy). During the year under review, the Bulletin included short specialised analyses covering: (a) the economic governance in the EU with an overview of recent reforms, (b) the unemployment in Cyprus and particularly the problem of long-term unemployed, (c) the harmonised CPI with constant taxes and (d) the Household Finance and Consumption Survey (HFCS).

Book on the Cyprus economyDuring the year under review, the work on a book on the Cyprus economy, entitled “The Cyprus Economy: Historical Review, Prospects, Challenges”

was completed. Specifically, the book contains a historical analysis of issues such as the current account, monetary policy, public finances, inflation, labour market and the real estate market. The English translation of the book was completed and is available free on the website of the CBC: http://www.centralbank.gov.cy/nqcontent.cfm?a_id=12482 <http://www.centralbank.gov.cy/nqcontent.cfm?a_id=12482>.

Governor’s support and participation in the committees and working groups of the ESCBIn the context of the Governor’s preparation for participation in the meetings of the ECB’s Governing Council, support was provided on matters relating to the formulation and conduct of the ECB monetary policy in the euro area. Monthly presentations to the Governor were prepared, analysing macroeconomic and monetary developments in the euro area and the world economy, with an emphasis on expectations for the future path of the economy. CBC officials also participated in the ESCB’s Monetary Policy Committee and its working groups, dealing mainly with (a) economic forecasts, (b) econometric modelling and (c) the analysis of public finances. The Committee and its working groups keep track of economic and monetary developments in the euro area and the EU in general, and prepare reports supporting the decision-making process of the Governing Council. Through its representatives on the Working Group on Forecasting, the CBC participates in the winter and summer projection rounds of the Eurosystem, publishing the national results in the Economic Bulletin. These projections, which relate, inter alia, to the main national macroeconomic aggregates, are prepared by adopting assumptions common to all euro area countries, making the euro


area aggregate analysis feasible. In addition, inflation projections are carried out four times a year, two in the framework of the aforementioned Eurosystem macroeconomic projections and two during the spring and autumn staff exercises1. In the framework of the CBC’s participation in the Working Group on Econometric Modelling, the specialised econometric model CYMCM was used for estimating forecasts for the main national macroeconomic aggregates. The analysis conducted by the Working Group on Forecasting was also supported by, among other things, analysis of various scenarios, updating of model elasticities and responses to questionnaires on technical matters. As a result of the CBC’s participation in the Working Group on Public Finances, the monitoring of fiscal developments has intensified. This contributed to the formation of an independent opinion, as reflected in the autonomous projections of the CBC, as well as in various relevant studies. Moreover, during the year under review, CBC officials continued to participate in the Economic and Financial Committee (EFC) of the EU and its subcommittees. The EFC’s main task is the preparation of the work of the Council of EU Finance Ministers (ECOFIN).

Other research activitiesIn 2012 the quarterly Bank Lending Survey (BLS) continued within the Eurosystem framework. The aim of this qualitative survey is the deeper understanding of the role of credit in the monetary policy transmission mechanism and the enrichment of the analysis for monetary policy purposes. The questionnaire is completed by a representative sample of MFIs and the

national results are, together with the aggregate euro area results, analysed by the CBC. Τhe CBC publishes on its website the aggregated BLS results for Cyprus on a quarterly basis. During 2012 the ERD’s Real Estate Unit (REU) continued the compilation and publication of the general index and sub-indices of residential property prices, by district and by type of residence (houses and flats). In total, 18 indices of residential property prices are published, which include the general index of residential property prices in Cyprus, as well as the sub-indices of flats and houses by district. The aforementioned price indices are available, together with a brief analysis of the developments in the property market, in the quarterly Residential Property Price Index, which is available on the CBC website2. Moreover, the REU examines the preliminary results of the econometric model for the production of forecasts regarding the future direction of residential property prices. The model is based on macroeconomic data which have a high statistical correlation with real estate prices and are found to significantly affect the property market in Cyprus. In addition, this model will be incorporated in the CBC’s general model to produce forecasts for the Cyprus economy. With the availability of more sample data for 2012, the REU proceeded with a more detailed analysis and a review of its cleaning and filtering of data. The larger sample also allowed for a better statistical analysis of each attribute’s significance and, therefore, for the revision of the functional forms of various hedonic models used for the construction of the aforementioned 18 residential property price indices. During the year under review, the ERD continued

1. Inflation projections are published in Cyprus twice a year.2. http://www.centralbank.gov.cy/nqcontent.cfm?a_id=11836&lang=en

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the conduct of the Household Finance and Consumption Survey (HFCS)3, which is carried out in every country of the euro area. The HFCS, which is expected to be repeated every three years, is conducted under the auspices of the ECB. After the data collection, data cleaning, processing and analysis were undertaken in 2012, based on ECB guidelines, while maintaining the confidentiality of the data at all stages of the statistical analysis. The weights of each participating household were also calculated. At the same time, the process of imputation was carried out, which involved the completion of answers not recorded during the interview, either because of the participant’s unwillingness to respond or because of the interviewer’s error. Thereafter, strict tests were exercised by the ECB regarding the technical validation, coherence validation, comparison with other surveys and external benchmarks. After successful completion of these thorough checks, the database for all the 15 participating countries became ready for publication. With the publication of the comprehensive database, which contains 1.237 households from Cyprus and about 62.500 from across the euro area, in Spring 2013 various researchers will be able to use the data for high-quality research, statistics, and further analysis that will be a valuable source of information for exercising effective monetary policy and ensuring financial stability for the benefit of both Cyprus and the rest of the euro area. After analysing the data, the Department is ready to proceed with the compilation of statistics by using the collected survey data. The first results and tables have been prepared using the final (multiply imputed) and weighted sample of the population. With the publication of results in Spring 2013 two

additional articles, which include the detailed analysis of the research for all countries at all stages of the survey (analytical and methodological report), are also expected to be published. At the same time, several research articles from both the CBC and other researchers using the survey data are envisaged to be completed in 2013. In addition, the CBC participates in ad-hoc working groups of the ECB, whose aim is to analyse issues of special interest, such as the working group for the preparation of the ECB’s ‘Structural Issues Report’ that deals with issues of structural policy. The most recent issue taken up by this working group was the labour market in the euro area during the economic crisis. The main objectives of the aforementioned research were to understand the different response of the labour market in the euro area as well as to analyse the likely medium-term effects of these developments. The above work was presented to the European Parliament and was published by the ECB in October 2012.

Visits of foreign experts and public communicationIn 2012 Fitch, Moody’s and Standard & Poor’s visited Cyprus. These rating agencies assess the Cyprus economy at regular intervals and publish independent ratings. Fitch visited Cyprus in April 2012, Moody’s in August and Standard & Poor’s in September 2012. Also, for the first time, the relatively small rating agency DBRS visited Cyprus in March 2012. In June, July and October 2012 a Troika delegation, i.e., a team consisting of officials from the European Commission, the ECB and the IMF visited Cyprus as part of the consultation process on the conclusion for the economic adjustment programme of the Cyprus

3. As from 2 January 2013, the REU and the HFCS work will be transferred to the CBC’s Statistics Department.


economy. The ERD was actively involved in presentations made to all the aforementioned foreign delegations.

4.9 Statistics The collection, compilation and publication of money and banking statistics, financial accounts and external statistics continued uninterrupted in 2012. In addition, the dissemination of the aforementioned statistics to the ECB, Eurostat and international organisations (IMF, BIS), was carried out smoothly, while further progress was accomplished as regards their quality and availability. The financial crisis has heightened the urgency for timely, reliable and granular statistical data, regarding mainly the financial sector and the area of securities issues and holdings. Furthermore, there was a need to implement new monitoring mechanisms such as the Macroeconomic Imbalances Procedure launched by the European Commission. The Procedure aims at the identification and timely correction of imbalances that EU member states might experience. The tool for identifying these imbalances is the Alert Mechanism Report which is published annually by the European Commission with key economic indicators. The ECB has issued new regulations and procedures and revised the existing ones, aiming at ensuring the availability of high quality data to meet the increased user needs. In this regard, the Statistics Department (SD) took all the necessary actions to carry out the required tasks for their implementation. Τhe CBC’s statistical obligations are met, where possible, in a way that minimises the burden on reporting entities. This is achieved by exploiting synergies and adopting automation procedures in order to create a more efficient and effective framework. In addition to the collection and compilation systems of MFI balance sheet, flows and

interest rates statistics as well as investment funds balance sheet and flows statistics, which operate on an automated basis, the redesign of other systems has also been initiated with emphasis on the external statistics data collection system and the compilation system of financial accounts.Statistical obligations The upcoming implementation in 2014, of the “European System of Accounts (ESA 2010)”, concerning the classification of institutional units into sectors according to their main activity and the IMF “Balance of payments and international investment position Manual, sixth edition (BPM6)” triggered wide ranging revisions to all relevant regulations and other related legislation regarding the collection of statistics by the ECB, Eurostat and the IMF. This development provided the opportunity to add new statistical requirements arising from the increased needs of users due to the financial crisis. The SD participates actively in the discussions regarding the revision of these regulations and other legal acts. It also contributes to the compilation of a significant part of the economic indicators which are included in the annual report of the Alert Mechanism published by the European Commission.

Monetary and financial statisticsIn the context of formulating the requirements of the new or revised regulations, with a view to issuing them within 2013, the SD participated in a merits/costs exercise for the ECB regulations concerning the collection of data from banks and other financial institutions, such as investment funds and financial vehicle corporations. Additionally, it contributed to the preparation of the new ECB manual on MFI balance sheet statistics and to the discussion and evaluation of the requirements which will govern the above mentioned regulations. It was also involved

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in the discussions regarding the issue of a new regulation concerning the collection of statistics from insurance companies, as well as the revision of the ECB guideline for the financial accounts, which is expected to be finalised in early 2013. In the course of 2012, the first phase of the revised BIS guideline on international banking statistics was implemented. The said guideline concerns the submission of additional and more detailed balance sheet information on the geographical allocation of banks’ counterparties and their exposure in foreign currency. The implementation of the second phase, which is scheduled for 2013, provides for the decomposition of the reporting population into local banks, subsidiaries and branches of foreign banks as well as more detailed counterparty sector analysis. The structural statistical indicators of the financial sector which are transmitted to Eurostat through Cystat, were produced for the first time on the basis of the income statement submitted by the MFIs to the CBC through the Financial Reporting system (FINREP). Moreover, in the context of improving the quality of investment funds’ balance sheet data, the reporting population was enhanced. During 2012, as was the practice followed in previous years, the internal or external auditors of MFIs were requested to conduct the annual quality exercise regarding balance sheet, interest rates and flows statistics. Following the SD’s evaluation of the audit results, relevant recommendations were issued to the banks.

External statistics In view of the upcoming implementation of the BPM6, the gradual implementation of the latest international statistical standards defined therein began. The first stage of the implementation process, mainly involves reclassifications and enhancements to the

quality and analysis of existing data, as well as several improvements to the procedure currently used for the collection and compilation of balance of payments data. The second stage concerns the ongoing process of reviewing further methodological issues in relation to the production and dissemination of external statistics and working on other BPM6-related projects. A specific example is the development of a common reporting structure (between international organizations) of external statistics (Statistical Data and Metadata Exchange “SDMX”) which leads to a new coding structure and a different data exchange regime. During the first stage of the BPM6 implementation, two new surveys were launched for the enhancement of the current account data. The first one concerns the collection of data in the field of education and is addressed to all higher education institutions and universities in Cyprus with foreign students. The second survey, which is addressed to all monetary financial institutions operating in Cyprus, collects profit and loss account data on a quarterly basis. Furthermore, during 2012, a review of all directives issued to the reporting units was initiated, which entails the redesign, reloading and checking of all relevant reports produced from the electronic statistical systems at submission, processing and production stages. In the context of improving the quality of external statistics, the SD has participated in a voluntary exercise launched by Eurostat for the reduction of asymmetries between member states in the area of direct investment.

Government finance and general economic statisticsAs regards government finance and general economic statistics, changes with respect to the


presentation and submission deadlines for existing statistics as well as the collection and coordination of additional statistics are currently being discussed and implemented by Eurostat and the ECB in close cooperation with member states. The purpose of the aforementioned changes is to promote harmonisation of requirements and avoid duplication of collection, production and dissemination of the said data so as to avoid confusion among users and reduce the reporting burden on data providers. The proposed changes were studied thoroughly in order to be able to comply with them when they will come into force in the next two years. At the same time, views / opinions on the handling of various statistical issues that directly or indirectly affect the public finances, which arose as a result of the crisis were expressed. Examples include the handling of the recapitalisation of banks, government guarantees and pension liabilities. For the purpose of implementing the changes proposed by the ECB in terms of governance and quality of government finance statistics, which are expected to be completed by the end of 2013, the gradual automation of procedures, the creation of a relevant database, the implementation of additional controls and the segregation of staff roles will be among the necessary steps that need to be taken . Due to the impact of the crisis and the need of the government to support the financial sector in Cyprus and take measures for the rationalisation of public finances, the provision of additional information and clarifications was deemed necessary, particularly in relation to public finances.

Securities statistics In the context of fulfilling the CBC’s obligations with regard to the Centralised Securities Database (CSDB), the SD transmits monthly data and participates in the

monthly data quality exercises of the ESCB. Moreover, it has an active participation in the CSDB-SEC Expert Group, which was created by the ESCB with the aim to enhance the quality and the convergence between the securities issues statistics and the CSDB. The Guideline of the ECB on the data quality management framework for the CSDB, which shall enter into force in July 2013, was also approved in 2012. In addition, the ECB has issued a new regulation on securities holdings statistics, aiming at the collection of detailed data and the provision of analytical and statistical support to the ECB and to the European Systemic Risk Board. More specifically, the purpose of the data to be collected is to provide comprehensive statistical information on the exposure of the euro area member states to specific classes of securities, on the links between the economic sectors of holders and issuers of securities (e.g. in the context of financial accounts), as well as on the market for securities issued by euro area residents. With the aim of satisfying the users’ needs until the implementation of the new regulation by the end of 2013, an ESCB ad-hoc group on securities holdings experimental statistics was formed, in which the CBC participates with quarterly data submissions and by providing access to the overall data compiled by the ESCB.

Statistical publicationsIn order to further improve/upgrade the statistics produced by the CBC and meet the growing expectations of internal and external users, existing publications were enhanced and new ones on specialised subjects were introduced. In particular, during 2012, the first edition of Cyprus’s balance of payments (BOP) and international investment position (IIP) annual review was published. The said publication reflects the main developments in the sub accounts of BOP and IIP with relevant

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explanations. In addition to the aforementioned publication, a more detailed report on foreign direct investment (“FDI”) was released, which provides data and information on inflows and outflows of FDI by country and sector of economic activity. With a view to improving the availability of monetary and financial statistics, the work for upgrading the publication titled “Monetary and Financial Statistics”, which is published on the CBC website on a monthly basis, continued in 2012. The efforts mainly concentrated on the revision of the published data for loans and deposits, so that annual growth rates are also adjusted for exchange rate fluctuations. This amendment is expected to provide the users with further important information regarding the actual annual percentage change of the monetary aggregates.

Cooperation with CystatConsidering the need for harmonisation of national and financial accounts data with the BOP, IIP, monetary and financial sector and government sector data, and in order to ensure maximum consistency between the aforementioned statistics, the SD has further enhanced its cooperation with Cystat. In particular, specific actions were initiated towards the development of a common, harmonised business registry, which will be based on uniform concepts, definitions and classifications, as specified in the relevant standards and guidelines issued by the ECB, Eurostat and the IMF. In addition, actions have commenced for further simplification of procedures regarding data reporting and monitoring, better utilisation of already available data from administrative sources and merging of reporting requirements into common questionnaires. In the context of exploiting synergies, a joint effort started with Cystat to determine the population of

ship owning companies registered in Cyprus and for the creation of common questionnaires for the transportation and energy sector surveys. These actions are expected to significantly reduce the burden imposed on enterprises and organisations. The cooperation with Cystat and the MOF, which aims at ensuring the compliance of Cyprus towards its obligations in the field of statistics, is still on an unofficial basis. With a view to further strengthening and expanding the said cooperation and taking into consideration the relevant recommendations of the ECB and Eurostat, the three cooperating authorities have completed a draft memorandum of understanding, which is expected to be signed in 2013.

4.10 Information TechnologyThe main tasks of the Information Technology Department (ITD) during 2012 were:a) The development of new systems, mainly for the

monitoring of financial institutions, the execution of monetary policy, and the provision of timely and accurate information for decision making.

b) The upgrading and extension of the IT infrastructure and systems for the provision of new and improved applications and services.

c) The upgrading of existing systems, mainly due to reviews emanating from the ESCB and the EBA (European Banking Authority).

d) The enhancement of data and systems’ security.

At the same time, the ITD participated in the ESCB’s Information Technology Committee and its working groups and proceeded, locally, with the timely implementation of ESCB projects and decisions.

Infrastructure projectsThe main projects for 2012 were the following:


• Thelaunchingofthebigprojectforupgradingthedatabases, the application servers and all the Bank’s systems to the latest versions. The management and support capability of systems and databases were also enhanced.

• Implementation of ESCB projects such as theIdentity and Access Management (IAM), the Public Key Infrastructure (PKI) and the secure exchange of email messages among ESCB members (SEE) and inauguration of the new project for the replacement of the ESCB teleconference system (NETS).

• The upgrading and enhancement of themanagement and support systems of the infrastructure as well as the incident monitoring. Moreover, the availability, expandability and disaster recovery capability of the CBC’s IT systems continued to be enhanced.

• Theupgradingofthesystemsandprocessesfortheexchange of electronic files with external parties.

• Replacement of a significant part of usertechnology, including computer equipment and printers.

• The upgrading of the SWIFT and emailinfrastructure.

IT systems implementation/maintenance projectsDuring 2012 the following projects were completed:• Development and implementation of the first

phase of the ESCB’s Central European Pricing Hub (“CEPH”) for marketable assets.

• Automation and implementation of the EBA’sFinancial Institutions Register.

• Adoption of the collection and valuation ofAdditional Credit Claims for the provision of additional liquidity to banks.

• Extension of the usage of Business Intelligence

(“BI”) by the addition of new data and analysis for the Economic Research and the Financial Markets departments.

• Replacement of the current file exchangemechanism with the ECB for the purpose of enhancing security.

• Gradual migration of remittances from theGovernment Payments system to the “SEPA” (Single Euro Payment Area) system.

• Redesigning of the balance of payments (BOP)system, in order to meet current requirements.

• Automation of data processing of the QuarterlyFinancial Accounts (“MUFA”), which are submitted to the ECB.

• Redesigning of the reports of the New MonthlyBalance Sheet, which are submitted to the Bank for International Settlements, in order to provide more detailed analysis.

Within the context of maintaining IT systems in operation, modifications were made to a number of systems, the most significant of which were:• UrgentupdatesandrevisionstotheEligibleAssets

Database (“EADB”), Use of Collateral Reporting (“UCDB”) and Tender Operations (“TOP”) due to the ongoing financial crisis and changes imposed by the ESCB.

• AlterationoftheSpecialGovernmentTitlessystemto allow the management of the liquidity provision to banks using government guarantees (based on ad-hoc legislation).

• Alterationoftheemployees’payrollsystemduetosalary deductions based on new ad-hoc legislation.

• Extension of the “BI” tool with new analysis andreports for the monitoring of the banking sector, such as for transmission to the ECB and IMF.

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IT systems securityThe systematic risk assessment of the CBC’s IT infrastructure and information systems continued and security was enhanced, wherever deemed necessary. New policies, procedures and security guidelines were created. Security testing of information systems as well as evaluations of information system confidentiality, integrity and availability were also performed. Security assessments of the CBC’s information were carried out and the corresponding measures are being gradually implemented. Personnel training was also organised for enhancing information security awareness. The following are the most important projects that started in 2012 and are expected to be completed in 2013:• Automationofthedatacollectionandprocessing

regarding the Banks’ Emergency Liquidity Assistance (ELA) mechanism.

• Implementationof anew “BI”model thatwillbeused to process collected data for the Property Price Indices system.

• AutomationoftheCBC’spensioners’payroll.• Replacement of the process for the exchange of

files through SWIFT, for systems such as SEPA, by using “Straight Through Processing”.

• Extension of the service for remote access to ITapplications to smart phones and tablets and the implementation of systems for the secure exchange of email over the Internet.

4.11 Human Resources, Organisation and Methods

During 2012 the Human Resources, Organisation and Methods (HR, O&M) Department continued to provide active support towards fulfilling the CBC’s objectives, taking into account the challenging

economic environment. Focus was mainly directed on implementing HRM best practices while at the same time remaining committed to providing training and development opportunities to staff.

Human resource management By the end of 2012, approximately 10% of the workforce left the CBC, in most cases having exercised their right for early retirement. As a result, in some departments, staff shortages were observed and internal transfer procedures had to be carried out in order to ensure their smooth operation. The Cyprus economic environment in combination with the CBC’s priorities imposed the need for recruiting qualified staff with expertise in communications as well as the employment of persons in other specialised areas through short-term contracts. Employee mobility was promoted both internally and externally, and a number of employees were seconded to various organisations including the IMF and the ECB, in the latter case within the framework of exchange of personnel between national central banks and the ECB.

Human resources development With regards to training, the CBC focused on the development and improvement of staff competencies, skills and expertise through in-house training programmes addressed to staff at all levels. In 2012 particular focus was directed to the management team, implementing programmes on subjects such as strategic thinking, staff management and development. In addition, a number of targeted presentations were delivered to all staff covering topics such as the management of work-related stress and the performance appraisal process, focusing on goal setting and the appraisal interview.


At the same time, employees continued to attend various technical and soft skills seminars organised either by external training providers or by the ESCB. In the context of European activities, the ESCB seminar “Introduction to the functioning of the ESCB” was organised in Cyprus and was attended by 48 participants from 19 national central banks including the ECB.

Labour relations The process of renewing the collective agreement was initiated in late 2012 between the Union of Bank Employees (ETYK) and the CBC. The new agreement will cover the period 2011-2013.

Administration issues The Department continued to provide administrative support to the rest of the CBC and also cooperated with other national central banks to exploit synergies and find more cost-efficient solutions to administrative issues.

Organisational mattersIn line with the CBC’s objective for effectively managing disaster events and ensuring the continuity of its operations, a second cycle of the design and testing of business continuity plans was successfully completed, under the direction of the CBC’s Business Continuity Management team. The departments’ business continuity plans will be further enhanced in 2013. In line with the Department’s role, support was provided to other CBC departments on organisational issues, by conducting a number of projects and submitting suggestions to the CBC’s management. In addition the Department coordinated the implementation of the Operational Risk Management framework across the CBC and

provided methodological support to the responsible staff.

4.12 Health and SafetyThe CBC focused on implementing its established Health and Safety (H&S) policy, by utilising the H&S system and the related risk assessment. Specifically, during 2012:• Instructions were issued to all members of staff

with respect to higher risk operations. These instructions, which form a fundamental part of the H&S system, were also published on the CBC’s intranet.

• TheH&SOfficercontinuedtheperiodicinspectionsat all workplace areas.

• Various construction works were completed, inorder to minimise occupational risks and maintain a healthy and safe working environment. In addition, specialised equipment was purchased to deal with emergencies.

• Additional members of staff received first aidtraining and a drill exercise was carried out to ensure the CBC’s readiness to deal with emergencies.

• Various H&S training programmes andpresentations were organised to increase awareness among staff.

4.13 Security and PremisesThe main responsibilities of the Security and Technical Support Department include: (i) the implementation of strict security measures for the protection of the building, installations, personnel, visitors and the assets of the CBC;

(ii) the maintenance of the smooth operation of the building in order to ensure that the office environment is safe, pleasant and conducive to

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productive work; and

(iii) the maintenance of the building’s installations.Within the above framework, the training of the security staff during the year under review continued in cooperation with the police. Also, during 2012 CBC staff participated in the ESCB’s Security Inspectors Group, which deals with security issues related to the euro, as well as in the Heads of Security of EU and G10 Central Bank Group, which deals with central bank security issues. The CBC’s technical staff were trained in the implementation of the regulations for electrical installations as well as in issues related to health and safety. The building’s environmental conditions as well as the operation of the equipment were continuously monitored and controlled. Various mechanical equipment were upgraded with new technology equipment in order to reduce energy consumption and one of the building’s elevators was upgraded. Αs part of the CBC’s commitment to renewable energy, the installation of a photovoltaic system has been completed. Looking ahead, the CBC is planning the: replacement of part of the mechanical equipment in order to reduce energy consumption; upgrading of the security system; and continuation of general maintenance work on the building.

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5. FINANCIAL STATEMENTS2012

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A N N U A L R E P O R T 2 0 1 2

ASSETS €’000 €’000 €’000

1 Gold and gold receivables 563.423 543.546

2 Claims on non-euro area residents denominated in foreign currency 343.332 391.282

2.1 Receivables from the IMF 230.763 261.580

2.2 Balances with banks and security investments, external loans and other external assets 112.569 129.702

3 Claims on euro area residents denominated in foreign currency 171.544 399.237

4 Claims on euro area residents denominated in euro 0 0

4.1 Balances with banks, security investments and loans 0 0

4.2 Claims arising from the credit facility under ERM ΙΙ 0 0

5 Lending to euro area credit institutions denominated in euro

related to monetary policy operations 411.000 5.521.400

5.1 Mainrefinancingoperations 0 2.655.000

5.2 Longer-termrefinancingoperations 411.000 2.807.400

5.3 Fine-tuningreverseoperations 0 0

5.4 Structuralreverseoperations 0 0

5.5 Marginal lending facility 0 59.000

5.6 Credits related to margin calls 0 0

6 Other claims on euro area credit institutions denominated in euro 9.400.110 3.500.161

7 Securities of euro area residents denominated in euro 1.634.041 2.484.732

7.1 Securities of euro area residents denominated in euro heldformonetarypolicypurposes 427.295 462.404

7.2 Other securities of euro area residents denominated in euro 1.206.746 2.022.328

8 General government debt denominated in euro 1.402.974 1.453.666

9 Intra-Eurosystem claims 976.402 662.047

9.1 ParticipatinginterestinECB 33.519 31.238

9.2 Claims equivalent to the transfer of foreign reserves 78.863 78.863

9.3 Claimsrelatedtopromissorynotesbacking

theissuanceofECBdebtcertificates 0 0

9.4 Net claims related to the allocation of euro

banknotes within the Eurosystem 864.020 551.946

9.5 Other claims within the Eurosystem (net) 0 0

10 Items in course of settlement 31.864 57.287

11 Other assets 119.790 144.207

11.1 Coins of euro area 0 0

11.2Tangibleandintangiblefixedassets 10.085 11.282

11.3Otherfinancialassets 0 0

11.4 Off-balance sheet instruments revaluation differences 0 0

11.5Accrualsandprepaidexpenses 72.853 76.156

11.6 Sundry 36.852 56.769

Total Assets 15.054.480 15.157.565

BALANCE SHEET AS AT 31 DECEMBER 2012

Central Bank of CyprusEurosystem

31 Dec. 2012 31 Dec. 2011

Thenotesonpages61-76formpartoftheseaccounts.


BALANCE SHEET AS AT 31 DECEMBER 2012


31 Dec. 2012 31 Dec. 2011


LIABILITIES €’000 €’000 €’000

1 Banknotes in circulation 1.642.665 1.599.530

2 Liabilities to euro area credit institutions

related to monetary policy operations 3.984.451 3.172.985

2.1 Current accounts (covering the minimum reserve system) 1.903.451 1.571.584

2.2 Depositfacility 1.840.000 1.226.401

2.3 Fixed-termdeposits 241.000 375.000

2.4 Fine-tuningreverseoperations 0 0

2.5 Depositsrelatedtomargincalls 0 0

3 Other liabilities to euro area credit institutions denominated in euro 0 0

4 Debt certificates issued 0 0

5 Liabilities to other euro area residents denominated in euro 260.120 929.592

5.1 General government 256.973 924.449

5.2 Other liabilities 3.147 5.143

6 Liabilities to other non-euro area residents denominated in euro 29.132 87.372

7 Liabilities to euro area residents denominated in foreign currency 100 23

8 Liabilities to non-euro area residents denominated in foreign currency 0 0

8.1 Deposits,balancesandotherliabilities 0 0

8.2 Liabilities arising from the credit facility under ERM ΙΙ 0 0

9 Counterpart of special drawing rights allocated by the IMF 154.808 157.597

10 Intra Eurosystem liabilities 7.473.041 7.909.333

10.1 Liabilities equivalent to the transfer of foreign reserves 0 0

10.2Liabilitiesrelatedtopromissorynotes

backingtheissuanceofECBdebtcertificates 0 0

10.3 Net liabilities related to the allocation

of euro banknotes within the Eurosystem 0 0

10.4 Other liabilities within the Eurosystem (net) 7.473.041 7.909.333

11 Items in course of settlement 32.388 57.592

12 Other liabilities 235.878 301.506

12.1 Off-balance sheet instruments revaluation differences 10.342 44.546

12.2 Accruals and income collected in advance 7.563 10.594

12.3 Sundry 217.973 246.366

13 Provisions 415.082 231.231

14 Revaluation accounts 567.137 549.461

15 Capital and Reserves 148.102 144.792

15.1Capital 90.000 90.000

15.2 General Reserve Fund 58.102 54.792

16 Surplus for the year 111.576 16.551

Total Liabilities 15.054.480 15.157.565

A N N U A L R E P O R T 2 0 1 2

€’000 €’000 €’000 €’000

1.1 Interest income 371.457 246.535

1.2 Interest expense (99.662) (120.554)

1 Net interest income 271.795 125.981

2.1Realisedgainsarisingfromfinancialoperations 3.899 4.868

2.2Writedownsonfinancialassetsandpositions (1.236) (27.852)

2.3 Transfer to provisions for foreign exchange and price risks (185.000) (25.000)

2 Net result of financial operations,

writedowns and risk provisions (182.337) (47.984)

3.1 Fees and commissions income 3.963 2.162

3.2 Fees and commissions expense - -

3 Net income from fees and commissions 3.963 2.162

4 Income from equity shares and participating interests 1.952 1.425

5 Net result of pooling and redistribution

of monetary income (5.593) (759)

6 Other income 620 287

Total Net Income 90.400 81.112

7 Staff costs (33.259) (31.994)

8 Administrative expenses (6.921) (4.857)

9 Depreciationoftangiblefixedassets (1.605) (1.873)

10 Banknote acquisition cost (681) -

11 Other expenses (762) (837)

Total Expenses (43.228) (39.561)

Release of the provision for the minting

of coins and the supply of banknotes in euro 4.404 -

Release of part of the liability of banknotes denominated

in Cyprus Pound that ceased to be legal tender 60.000 -

Surplus for the year 111.576 41.551

Transfer to General Reserve Fund - (25.000)


Appropriation Account

General Reserve Fund 22.315 3.310

Consolidated Fund of the Republic 89.261 13.241


INCOME AND EXPENDITURE ACCOUNT for the period 1 Jan. 2012 - 31 Dec. 2012


2012 2011

11 March 2013 Panicos Demetriades Governor


60


ACCOUNTING POLICIES General principles for the preparation of the financial statementsThe financial statements of the CBC are prepared in accordance with article 57(2) of the Central Bank of Cyprus Law, 2002-2007 on the basis of approved accounting principles applicable in the ESCB, as determined by Accounting Guideline ECB/2010/20 and amended by Guideline ECB/2011/27and ECB/2012/29. These principles, even though based on generally accepted accounting principles, have been designed to take account of the specialised operational framework of the national central banks (NCBs) of the Eurosystem.

Main accounting principlesThe main accounting principles applicable in the Eurosystem and applied by the CBC are:• The principle of economic reality and transparency

in the presentation of the financial assets and liabilities of the CBC so as to present its true financial position.

• The principle of prudence. In accordance with this principle, unrealised gains from the revaluation of gold, financial instruments in foreign currency and securities are not recognised as income in the profit and loss account but are transferred directly to revaluation accounts. On the other hand, unrealised losses resulting from revaluations at the end of the accounting period and exceeding unrealised profits previously transferred to the revaluation accounts are recognised as expenses and transferred to the profit and loss account.

• The principle of the recognition of post-balance sheet events, i.e. events that have occurred between the balance sheet date and the date of the approval of the accounts. If such events have a material

influence on the financial position of the CBC the assets and liabilities are adjusted accordingly.

• The principle of materiality.• The principle of going concern. The financial

statements have been prepared on a going concern basis.

• The principle of accruals. Income and expenses are recognised in the year in which they occur irrespective of when they are collected or paid.

• The principle of consistency and comparability. The criteria for the valuation of the balance sheet items and the construction of the income and expenditure are applied with consistency so as to ensure the comparability of items in the financial statements.

Recognition of assets and liabilitiesAn asset or liability is recognised in the balance sheet only when it is probable that any associated future economic benefit will flow to or from the CBC, substantially all of the associated risks and rewards have been transferred to the CBC, and the cost or value of the asset or the amount of the obligation can be measured reliably.

Accounting treatment of transactionsForeign currency transactions, financial instruments denominated in foreign currency and related accruals are recorded at spot settlement date (economic ‘alternative’ approach). Interest accrued on foreign fixed deposits and financial instruments, including premiums or discounts, is recorded on a daily basis from the spot settlement date. At year-end, both financial assets and liabilities are revalued at current market prices/rates. This applies both to on-balance sheet and off-balance sheet transactions. The average acquisition cost and the value of

NOTES TO THE FINANCIAL STATEMENTS

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each currency position are calculated on the basis of the sum total of the holdings in any one currency, including both asset and liability positions and both on-balance sheet and off-balance sheet items.

Balance sheet valuation rulesThe assets and liabilities of the CBC in foreign currency and gold are valued on the basis of the ruling exchange rates on the date of the balance sheet as these appear on the currency exchange rates report of the ECB. Income and expenses are translated into euro using the exchange rates ruling at the time of the transaction. As regards gold there is no distinction between the differences resulting from price adjustments and exchange revaluations. A single gold valuation is accounted for based on the price of gold in euro per fine ounce, as this is determined from the exchange rate of the euro against the US dollar at the date of the balance sheet. The readjustment of the value of assets and liabilities in foreign currency is carried out on a currency by currency basis, including both on-and off-balance sheet items.

Income recognitionGains and losses realised in the course of transactions in foreign currency and securities are taken to the profit and loss account. The average cost method is used on a daily basis for gold, foreign currency instruments and securities to compute the acquisition cost of items sold, having regard to the effect of exchange rate and/or price movements. Unrealised revaluation gains arising from the revaluation of a security or currency or holdings in gold, are not taken to the profit and loss account, but transferred directly to revaluation accounts on

the balance sheet. Unrealised losses are recognised in the income and expenditure account when they exceed previous revaluation gains registered in the corresponding revaluation account; they may not be reversed against new unrealised gains in subsequent years. Premiums or discounts arising on securities are calculated and presented as part of interest income and are amortized over the remaining life of the securities.

Fixed assetsFixed assets are valued at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis from the year of acquisition and for the expected economic life of the assets:

Asset category Depreciation Period

Computers, related hardwareand software, motor vehicles 4 years

Equipment, furnitureand plant in building 10 years Buildings 25 years

Fixed assets purchasedfor less than €10.000 No capitalisation

Retirement planThe CBC operates a defined benefit scheme for staff members holding a permanent, pensionable post before 1 October 2011. The liability recognised in the balance sheet in respect of the defined benefit plan is the present value of the defined benefit obligation at the balance sheet date. The defined benefit obligation is calculated annually using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting the estimated future cash flows, using interest rates of high quality corporate bonds that are denominated in


euro and have similar terms of maturity to the term of the related pension liability. Actuarial gains and losses can arise from adjustments (where actual outcomes are different from the actuarial assumptions) and changes in actuarial assumptions. The net amount recognised in the income and expenditure account comprises the current service cost of the benefits accruing for the year, the interest at the discount rate on the defined benefit obligation.

ESCB capital keyThe capital key is essentially a measure of the relative size of each EU member state and is calculated, in equal shares, on the basis of GDP and population size. The key is used as the basis for allocating each NCB’s share in the ECB capital and is adjusted every five years and every time a new member joins the EU. The Eurosystem key is the adjusted capital key for Eurosystem NCBs only and is used as the basis for the allocation of monetary income, banknotes in circulation and the ECB’s profit/loss.

Securities Marketable securities other than those held-to-maturity and similar assets are valued at the mid-market prices prevailing at the balance sheet date, on a security-by-security basis (by ISIN). Marketable securities classified as held-to-maturity and non-marketable securities are valued at amortised cost and are subject to impairment tests.

Banknotes in circulation Euro banknotes are issued by the ECB and the NCBs, which together comprise the Eurosystem. The total value of banknotes in circulation is allocated among the ECB and the Eurosystem NCBs on the last working day of each month. The ECB is allocated a share of 8% of the total value of euro banknotes in

circulation, whereas the remaining 92% is allocated to the Eurosystem NCBs according to their banknote allocation key. The share of banknotes allocated to the CBC is disclosed under the balance sheet liability item “banknotes in circulation”. The difference between the value of the euro banknotes allocated to each NCB in accordance with the banknote allocation key and the value of the euro banknotes that it actually puts in circulation, gives rise to remunerated intra-Eurosystem balances. These claims or liabilities are disclosed under the sub-items “intra-Eurosystem claims/intra-Eurosystem liabilities: Net claims/liabilities related to the allocation of euro banknotes within the Eurosystem”. In the first five years following the year of the cash changeover and the introduction of the euro in any member state, the intra-Eurosystem balances arising from the allocation of euro banknotes are adjusted in order to avoid significant changes in the respective NCB’s relative income positions as compared with previous years. The adjustments are effected by taking into account the differences between the average value of banknotes in circulation for each NCB in the reference period and the average value of banknotes that would have been allocated to each NCB during the same period applying the banknote allocation key. This adjustment is phased out annually until the first day of the sixth year following the year of the cash changeover when income on banknotes is allocated fully in proportion to the paid-up share of each NCB in the capital of the ECB. For the CBC the adjustment period ends on 31 December 2013. The interest income or expense on these balances is cleared through the accounts of the ECB and is disclosed under item 1 (“net interest income”) of the income and expenditure account.

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ECB profit distribution The Governing Council of the ECB has decided that the seigniorage income of the ECB arising from its allocated share (8%) of euro banknotes, and its net income arising from the Securities Markets Programme (SMP) shall be due to the NCBs in the same financial year they accrue, and shall be distributed on the second working day of the following year in the form of an interim distribution of profit. These shall be distributed in full unless the ECB’s net profit for the year is less than its income earned on euro banknotes in circulation and securities purchased under SMP, and subject to any decision by the Governing Council to reduce this income in respect of costs incurred by the ECB in connection with the issue and handling of euro banknotes. The Governing Council may also decide to transfer part or all of the ECB’s seigniorage income and all or part of the ECB’s income arising from SMP securities to the provision for foreign exchange rate, interest rate, credit and gold price risks. At its meeting on 10 January 2013, the Governing Council of the ECB decided that for 2012 the ECB would retain part of the income arising from SMP securities and part of the ECB’s seigniorage income on euro banknotes in circulation and transfer it to the provision for foreign exchange rate, interest rate, credit and gold price risks. The remaining balance of that income was distributed by ECB on 31 January 2013. The CBC’s share amounts to €1,1 million and is shown under item “income from participating interest” in the income and expenditure account.

Intra-Eurosystem balancesIntra-Eurosystem balances arising from the allocation of euro banknotes within the Eurosystem are included in the balance sheet under “claims related to the allocation of euro banknotes within the Eurosystem”.

Post-balance sheet eventsAssets and liabilities are adjusted so as to take account of events occurring between the balance sheet date and the date the financial statements are approved by the Board of Directors, provided such events have a significant impact on the state of these assets and liabilities as at the balance sheet date. Significant events occurring after the balance sheet date that do not affect the state of assets and liabilities as at the balance sheet date appear in the notes.

BALANCE SHEETASSETS1. Gold and gold receivables This item comprises the CBC’s holdings of international specifications gold, which on 31 December 2012 remained unchanged at 446.794,82 fine ounces as at 31/12/2011. At a market value of €1.261,18 per fine ounce (31 December 2011: €1.216,86) the CBC’s gold holdings were valued at €563,4 million at the balance sheet date (31 December 2011: €543,5 million). These gold holdings are kept with foreign central banks. The valuation of gold is carried out on the basis of the price in euro per fine ounce in force at the end of the year as reported in the ECB special report on exchange rates. The price in euro per fine ounce is derived on the basis of the price of gold in USA dollars combined with the euro / dollar exchange rate as at the same date. The revaluation on 31 December 2012 resulted in an unrealised valuation gain of €19,9 million (31 December 2011: €71,7 million). The total gold revaluation balance (representing unrealised gains arising by comparing the market price to the average cost) as at 31 December 2012 amounted to €549,6 million (31 December 2011: €529,7 million) and is included in the balance sheet under liability item 14.


2. Claims on non - euro area residents denominated in foreign currency These claims consist of receivables in special drawing rights (SDRs) from the IMF and claims denominated in foreign currency against non-euro area countries.

2.1 Receivables in SDR from the IMF (Table 1, p. 66)The claims on the IMF presented in Table 1 (p. 66) were valued at the SDR rate prevailing on 31 December 2012 as reported by the ECB in its exchange rates circular, i.e. SDR1= €1,1657 (31 December 2011: SDR1=€1,1867).

2.2 Claims denominated in foreign currency (Table 2, p. 66)Table 2 (p. 66) Claims denominated in foreign currency.

3. Claims on euro area residents denominated in foreign currency (Table 3, p. 67)

5. Lending to euro area credit institutions related to monetary policy operations denominated in euroThis item reflects the volume and composition of amounts related to the participation of credit institutions located and operating in Cyprus, in the liquidity providing Eurosystem monetary policy operations executed in a decentralised manner by the NCBs of the euro area member states (Table 4, p. 67).

5.1 Main refinancing operationsThese are regular liquidity providing open market operations executed by the Eurosystem in the form of a reverse transaction. They are conducted through weekly standard tenders and normally have a maturity of one week.

5.2 Long-term refinancing operationsThese are regular liquidity providing open market operations executed by the Eurosystem in the form of a reverse transaction. They are conducted through monthly standard tenders. They normally have a maturity of three months and aim to provide the credit system with additional longer-term refinancing. The balance also includes the supplementary longer-term refinancing operations (LTRO) of 1, 3, 6 and 12 months maturity which were carried out in the context of the measures to combat the financial crisis.

5.5 Marginal lending facilityThis refers to the standing marginal lending facility provided by the Eurosystem to credit institutions, and particular the provision of overnight credit from the NCB at a pre-specified interest rate, in the context of the implementation of the single monetary policy in the euro area.

6. Other claims on euro area credit institutions denominated in euroThis includes an amount of €9.400 million in relation to Emergency Liquidity Assistance advanced outside of the Eurosystem’s monetary policy operations to domestic credit institutions against collateral. The respective amount for 31 December 2011 was €3.500 million and in the financial statements of 2011 it was shown under balance sheet asset item “Other items - Sundries”. The presentation under item “Other claims on euro area credit institutions denominated in euro” was done for the purpose of harmonised disclosure with the annual financial statements of the eurosystem central banks. 7. Euro area securities denominated in euro

7.1 Securities held for monetary policy purposes (Table 5, p. 68)

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This item comprises securities acquired by the CBC

in the context of the programme for the purchase of

covered bonds and public debt securities acquired in

the context of the SMP. These securities are classified

as held – to – maturity. The total holding of SMP

securities by Eurosystem NCBs as at 31 December

2012 at amortised cost amounted to €209.033 million

(31 December 2011: €211.990 million). SMP securities

in the CBC’s books amounted to €302,2 million as at

31 December 2012 (31 December 2011: €353,4 million).

Pursuant to article 32.4 of the Statute of the ESCB, any

income or possible losses arising from holdings of

SMP securities are eventually to be shared in full by

all Eurosystem NCBs in proportion to their prevailing

ECB capital key shares.

7.2 Other securities of euro area residents denominated in euro (Table 6, p. 68)Marketable securities held to maturity are securities with fixed or determinable payments and a fixed maturity which the CBC has the positive intent to hold until maturity. 8. General government debt denominated in euroThis balance sheet item exclusively represents the claim that the CBC has on the Cyprus government for a long-term loan issued prior to Cyprus’s accession to the EU. According to the official agreement between the CBC and the Ministry of Finance, the loan is for an initial term of 30 years, starting from 4 July 2002, with a grace period of five years as regards capital repayment and bears interest at 3% per annum.

31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000

Quota in IMF (equivalent to SDR 158,2 million

as at 31 December 2012 and 2011 respectively) 184.414 187.736 (3.322)

IMF deposits (127.914) (118.321) (9.593)

Reserve position with the IMF 56.500 69.415 (12.915)

SDR holdings 174.263 192.165 (17.902)

Total claims on the IMF 230.763 261.580 (30.817)

31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000

Balances with overseas credit institutions 1.260 2.351 (1.091)

Marketable securities other than held to maturity 111.121 127.232 (16.111)

Other claims 188 119 69

Total 112.569 129.702 (17.133)

Table 1 Receivables in SDR from the IMF

Table 2 Claims denominated in foreign currency


In 2012 capital repayments amounted to €50,7 million (2011: €49,2 million) while interest payments amounted to €43,7 million (2011: €45,1 million).

9. Intra-Eurosystem claims

9.1 Participating interest in the capital of the ECBThis item shows the CBC’s participating interest in the ECB. Under article 28 of the ESCB Statute, the NCBs of the ESCB are the sole subscribers to the capital of the ECB. Subscriptions depend on the capital key of each NCB which is calculated on an equal basis on the proportion of each member state in the GDP of the EU, and on its share in the EU’s total population (article 29.1 of the ESCB Statute). Following the decision of the Governing Council on 16 December 2010 the subscribed capital of the ECB was increased by €5 billion from €5,76 billion to

€10,76 billion with effect from 29 December 2010. The NCBs of the Eurosystem paid up their share in the increase of the capital in three equal annual instalments. On 27 December 2012, the NCBs of the Eurosystem paid the last and final instalment which for the CBC amounted to €2,3 million. 9.2 Claims equivalent to the transfer of foreign reservesThis item represents the CBC’s claims arising from the transfer of foreign reserve assets to the ECB in accordance with the provisions of the Treaty establishing the European Community (article 30 of ESCB Statute). The value of foreign reserves transferred was in proportion to the CBC’s participation in the paid up capital of the ECB and was made up of 85% in US dollars and 15% in gold. These claims are denominated in euro at the original conversion

31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000

Balances with overseas credit institutions 18 28 (10)


Total 171.544 399.237 (227.693)

31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000

5.1 Mainrefinancingoperations 0 2.655.000 (2.655.000)

5.2 Longer-termrefinancingoperations 411.000 2.807.400 (2.396.400)

5.5 Marginal lending facility 0 59.000 (59.000)

Total 411.000 5.521.400 (5.110.400)

Table 3 Claims on euro area residents denominated in foreign currency

Table 4 Lending to euro area credit institutions related to monetary policy operations denominated in euro

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31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000

Covered Bonds 125.111 108.991 16.120

Securities Market Programme 302.184 353.413 (51.229)

Total 427.295 462.404 (35.109)

Table 5 Securities held for monetary policy purposes

31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000


Marketablesecuritiesclassifiedasheldtomaturity 713.560 1.155.957 (442.397)

Total 1.206.746 2.022.328 (815.582)

Table 6 Other securities of euro area residents denominated in euro

rate. They are remunerated at the latest available marginal rate for the Eurosystem’s main refinancing operations, adjusted to reflect a zero return on the gold component.

9.4 Net claims related to the allocation of euro banknotes within the EurosystemThis item comprises of the claims and liabilities of the CBC vis-à-vis the Eurosystem relating to the allocation of euro banknotes within the Eurosystem (see notes for the “Banknotes in circulation” and “Intra-ESCB balances). 10. Items in the course of settlementThis claim mainly results from the process of the Cyprus Clearing House for cheques.

11. Other assets

11.2 Fixed assets Table 7, p. 69.

LIABILITIES1. Banknotes in circulationThis item comprises of the CBC’s share of the total euro banknotes in circulation as calculated on the basis of its banknotes distribution key (see “Banknotes in circulation”, in the note for the accounting principles.

2. Liabilities to euro area credit institutions related to monetary policy operations denominated in euro (Table 8, p. 70).


Computer Land Furniture Software & Building & Equipment & Hardware Motor Vehicles Total €’000 €’000 €’000 €’000 €’000

Cost

As at 01/01/2012 22.278 12.211 6.948 846 42.283

Additions 173 140 95 0 408

Disposals 0 0 (174) (20) (194)

As at 31/12/2012 22.451 12.351 6.869 826 42.497

Accumulated Depreciation

As at 01/01/2012 13.928 9.660 6.572 841 31.001

Charge 815 514 273 3 1.605

Disposals 0 0 (174) (20) (194)

As at 31/12/2012 14.743 10.174 6.671 824 31.412

Net Book Value

As at 31/12/2012 7.708 2.177 198 2 10.085

As at 01/01/2012 8.350 2.551 376 5 11.282

Table 7 Fixed assets

2.1 Current accounts (covering the minimum reserve system)This item contains the credit institutions’ current accounts which are required to be held with the CBC within the framework of the Eurosystem’s minimum reserve system.

2.2 Deposit facilityThis is a standing facility of the Eurosystem which counterparties may use to make overnight deposits in a NCB, which are remunerated at a pre-specified interest rate. 2.3 Fixed-term depositThis item refers to credit institutions’ deposits with the CBC, remunerated at a fixed rate of interest for a fixed term period, envisaged only for fine-tuning purposes in order to absorb liquidity in the market,

under the implementation of a single monetary policy in the euro area.

5. Liabilities to euro area residents denominated in euroThis item refers mainly to the deposits held by the government and other public sector counterparties. 6. Liabilities to non-euro area residents denominated in euroThis item comprises mainly of euro-denominated liabilities to the European Commission for refinancing projects in Cyprus. 7. Liabilities to euro area residents denominated in foreign currencyThese are deposits in foreign currency by public sector organisations other than government.

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9. Counterpart of special drawing rights allocated by the IMFThis item represents the counterpart in euro of the SDR 132,8 million allocated to the CBC as a result of Cyprus’s membership of the IMF (31 December 2011: SDR 132,8 million).

10. Intra-Eurosystem liabilitiesThis item is primarily made up of the net TARGET2 balance, arising from cross-border transfers via TARGET2 with other NCBs in the euro area, the ECB and other NCBs of the ESCB that participate in TARGET2. These obligations arise, on the one hand, from the transfer of the excess liquidity of the local credit institutions to other EU member states following the adoption of the euro on 1 January 2008, and on the other hand, from the funding of credit institutions operating in Cyprus within the context of the exercise of a unified monetary policy.

11. Items in the course of settlementThis is mainly a liability to the government and results from the operations of the Cyprus Clearing House for cheques.

12. Other liabilities

12.1 Off-balance sheet instruments revaluation differencesThis item reflects the valuation of contracts for the exchange of currencies on the basis of the exchange rates ruling at the end of the year. 12.3 SundriesThis mainly consists of the value of euro coins in circulation amounting to €96,1 million (2011 - €96,3 million). Part of the liability for the banknotes denominated in Cyprus pound, value of €60,0 million, which with the introduction of the euro ceased to be legal tender that had not until 31 December 2012 been returned to be exchanged with euro, was released and transfer to the income and expenditure account. The remaining liability after that released amounted to €9,2 million and the respective figure as at 31 December 2011 was €70,3 million. The banknotes denominated in Cyprus pounds can be exchanged until 31 December 2017.

13. Provisions (Table 9, p. 71).

Pension benefits The CBC operates for its employees holding a

31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000

2.1 Current accounts (covering

the minimum reserve system) 1.903.451 1.571.584 331.867

2.2 Deposit facility 1.840.000 1.226.401 613.599

2.3 Fixed - term deposits 241.000 375.000 (134.000)

Total 3.984.451 3.172.985 811.466

Table 8 Liabilities to euro area credit institutions related to monetary policy operations denominated in euro


permanent and pensionable post before 1 October 2011, a pension scheme which provides benefits to retired employees based on their final pensionable salary. Up to 30 September 2011, employees contributed only for the transfer of their pensions to their widows and orphans. Under the provisions of the Pension Benefits of State Officers and Employees of the Wider Public Sector including Local Government Authorities (General Application Provisions) Law, 2011, as it was replaced as from 1 January 2013 by the provisions of the Pension Benefits of State Officers and Employees of the Wider Public Sector including Local Government Authorities (General Application Provisions) Law, 2012 as from the date of its adoption 1 October 2011, an amount equal to 3% of employees earnings is withheld and applied to secure the sustainability of the pension scheme in the long term, without converting it into a funded scheme for the purpose of the Social Insurance Law, 2010. The amounts withheld for the period 1 October 2011 to 30 September 2012 are transferred monthly to the Consolidated Fund of the Republic, while as from October 2012 these were held by the CBC and accounted against the cost of the scheme. The pensionable service liability of the CBC

is reviewed at regular intervals by independent qualified actuaries. The latest actuaries valuation was carried out as at 31 December 2012 and revealed a past service deficiency of €1,3 million. On the basis of recommendations from the actuaries, the unrecognised past service deficiency was charged in full to the accounts for 2012. In addition, on the basis of the actuaries recommendations, the normal contribution has been reduced from 23,4% to 9,3% of the salaries. The next actuarial valuation is planned to be carried out with reference date 31 December 2015.

Provision against risks arising from the main activities of the CBC The CBC maintains a general provision against all risks emanating from the main activities of the Bank and which relate to credit and operating risks, market risks (interest rate and foreign exchange rate risks), monetary policy operations risks and emergency liquidity risks. The Board of Directors taking into consideration the continuing financial instability, decided to increase the provision by €185 million by transfer from the income and expenditure account (2011: increase of provision by €25 million).

31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000

Pensionbenefits 129.526 125.126 4.400

Provision against risks

arising from the main activities of the CBC 285.000 100.000 185.000

Special provision in respect of monetary

policy operations 556 1.701 (1.145)

Provision for the minting of coins

and the supply of banknotes in euro 0 4.404 (4.404)

Total 415.082 231.231 183.851

Table 9 Provisions

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Special provision in respect of monetary policy operations

In accordance with the general accounting principle

of prudence, the Governing Council of the ECB

deemed appropriate establishment in the books of

the NCBs for 2008 of a provision amounting in total to

€5.736 million against counterparty risks in monetary

policy operations. In accordance with article 32.4 of

the ESCB Statute, this provision was funded by all the

NCBs of participating member states in proportion

to their subscribed capital key in the ECB, as this was

prevailing in 2008.

As a result, and based on the CBC subscribed

capital key which was 0,17921% in 2008, the share of

the CBC in this provision amounted to €10,3 million.

At the end of each financial year the Governing

Council of the ECB assesses and reviews the size and

this provision.

At its meeting on 6 February 2013, the Governing

Council of the ECB reviewed the adequacy of the

size of this provision and decided to reduce the

overall provision by €310 million with effect from 31

December 2012. Consequently, the share of the CBC

in the provision as at 31 December 2012 was reduced

by €1,1 million and amounted to €0,6 million.

Provision for the minting of coins and the supply of banknotes in euroThe provision was established during the years 2005-2007 to cover the cost of the minting of coins and the supply of banknotes in euro as a result of the accession of Cyprus in the Eurosystem on 1 January 2008. As the provision was established for a specific reason, the unused outstanding balance was released to the income and expenditure account.

14. Revaluation accountsIn accordance with the rules and accounting principles established by the ECB for the NCBs in the ESCB, and particularly the principle of prudence, unrealised gains from the revaluation of gold, financial instruments in foreign currency and securities are not recognised as income in the profit and loss account but are transferred directly to revaluation accounts (which operate as reserves solely for the specific assets). On the other hand, unrealised losses resulting from revaluations at the end of the accounting period and which exceed unrealised profits previously transferred to the revaluation accounts are recognised as expenses and transferred to the profit and loss account.

31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000

Net obligation as at 1 January 125.126 119.012 6.114

Provision for the year 4.968 3.865 1.103

Capitalisation of interest 6.002 5.723 279

Employees’ contribution 118 - 118

Employee contributions to the widows and orphans fund 319 212 107

Benefitspaid (7.007) (3.686) (3.321)

Net obligation as at 31 December 129.526 125.126 4.400

Table 10 Movement in net obligation


The revaluation at the end of 2012 resulted in an increase in the overall unrealised gains by €17,7 million (31 December 2011: €71,4 million), as shown in more detail in Table 11. These amounts represent a safety reserve against future possible adverse moves in the prices of gold and securities and in the exchange rates of currencies in which foreign currency reserves are maintained. The General Reserve Fund increased by the transfer of 20% of the net surplus for 2011 in accordance with the provisions of Article 59(b) of the Central Bank of Cyprus Law. The remaining 80% of the net surplus for each year is transferred to the government general account for the credit of the Consolidated Fund of the Republic, unless the Board of Directors deem necessary due to exceptional circumstances, to withhold additional net profits.

Off-balance sheet instrumentsHedging against exchange risksIn 2012 the CBC conducted currency swap and forward transactions in line with the currency risk hedging strategy. The forward leg of the outstanding currency swap and forward transactions as at 31 December 2012, amounting to $144,5 million (31 December 2011: $449 million), ST£85 million (31 December 2011: ST£116 million) and SDR zero (31 December 2011: SDR66 million) form part of the off-balance sheet accounts.

31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000

Pre-stage III revaluations 241.007 241.007 -

Currency revaluations 312.370 295.869 16.501

Price revaluations 13.760 12.585 1.175

Total 567.137 549.461 17.676

Table 11 Revaluation accounts

31 Dec. 31 Dec. 2012 2011 Change €’000 €’000 €’000

Capital 90.000 90.000 -

General Reserve Fund 58.102 54.792 3.310

Total 148.102 144.792 3.310

Table 12 Capital and reserves

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INCOME AND EXPENDITURE ACCOUNT FOR 2012

2. Net result from financial operations, writedowns and risk provisions Write downs of financial assets and positions largely reflect the reduction, below net average cost, of the market value of securities of Eurosystem member states which were affected by the deterioration in the financial uncertainty and are unable to raise finance from international money markets. 4. Income from equity shares and participating interestsThis item comprises mainly the CBC’s share of €1,1 million (2011: €1,3 million) in the ECB’s partial distribution of seigniorage income of €574,6 million (2011: €652,0 million), as referred to in the section on

“Interim profit distribution by the ECB”. At its meeting on 20 February 2013, the Governing Council of the ECB decided to distribute the net profit for 2012 amounting to €423,4 million. The CBC’s share amounts to €828 thousand. The distributed net profit for 2011 amounted to €76,1 million and the CBC’s share was €149 thousand. 5. Net result of pooling and redistribution of monetary income Monetary income is the income pooled by the NCBs in carrying out their obligations in the performance of the Eurosystem monetary policy operations. The monetary income of each NCB is determined by measuring the actual annual income derived from

2012 2011 Change €’000 €’000 €’000

Interest income on

Foreign exchange assets 18.094 16.739 1.355

Euro denominated assets 72.319 84.257 (11.938)

Claims arising from transfer

of reserve assets to ECB 601 849 (248)

Net claim on euro

banknote position 5.869 4.655 1.214

Lending on credit institutions 231.610 95.491 136.119

Credit facility to government 42.799 44.354 (1.555)

Staff loans 165 190 (25)

Total interest income 371.457 246.535 124.922

Interest expense on

Liabilities in foreign currency 242 617 (375)

TARGET2 liability 85.948 94.492 (8.544)

Minimum reserves 7.308 18.975 (11.667)

Other deposit facilities to credit institutions 3.259 2.915 344

Other euro denominated liabilities 2.905 3.555 (650)

Total interest expense 99.662 120.554 (20.892)

Net interest income 271.795 125.981 145.814

Table 13 Net interest income


the earmarked assets held against its liability base. The liability base consists of the following items: • banknotes in circulation,• liabilities to credit institutions related to monetary

policy operations denominated in euro,• net intra-Eurosystem liabilities resulting from

TARGET2 transactions,• net intra-Eurosystem liabilities related to

the allocation of euro banknotes within the Eurosystem.

Any interest paid on liabilities included within the liability base is to be deducted from the monetary income to be pooled. The earmarked assets consist of the following items: • lending to euro area credit institutions related

to monetary policy operations denominated in euroς,

• intra-Eurosystem claims equivalent to the transfer of foreign reserves to the ECB,

• net intra-Eurosystem claims resulting from TARGET2 transactions,

• net intra-Eurosystem claims related to the allocation of euro banknotes within the

Eurosystem,• a limited amount of each NCB’s gold holdings in

proportion to each NCB’s capital key share. Where the value of an NCB’s earmarked assets exceeds or falls short of the value of its liability base, the difference shall be offset by applying to the value of the difference the latest available marginal rate for the Eurosystem’s main refinancing operations. The monetary income pooled by the Eurosystem is allocated among NCBs according to the subscribed ECB capital key. The difference between the monetary income of €6,9 million (31 December 2011:€3,1 million) pooled by the CBC and the €52,7 million (31 December 2011: €33,8 million) reallocated to the CBC is the net result of €45,8 million (2011 - €30,7 million) arising from the pooling and redistribution of monetary income. The income due to the reduction of provision for counterparty risks on monetary policy of the Eurosystem amounted to €1,1 million (2011 - €2,3 million).

7. Staff costsStaff costs are analysed in Table 14.

2012 2011 Change €’000 €’000 €’000

Basic salaries 14.110 14.398 (288)

Cost of living allowance 3.950 3.914 36

Social insurance

and other contributions 2.692 2.686 6

Overtime and other allowances 1.447 1.269 178

Staff training 90 139 (49)

Provision for pension fund 10.970 9.588 1.382

Total 33.259 31.994 1.265

Table 14 Staff costs

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Provision for pension fundThe charge to the provision for the employees’ retirement benefits is included in the provisions and is analysed in Table 15.

Main actuarial assumptionsThe main actuarial assumptions used for the actuarial valuation performed with reference date 31 December 2012 are presented in Table 16.

8. Administrative expensesAdministrative expenses include telecommunications, insurance and maintenance of building and equipment, utility expenses, travelling and other miscellaneous expenses.

2012 2011 Change €’000 €’000 €’000

Current service cost 3.703 3.865 (162)

Past service cost 1.265 - 1.265

Interest on pension fund obligation 6.002 5.723 279

Total 10.970 9.588 1.382

Table 15 Provision for pension fund

Discount rate 3,15%

Average rate of total salary increases 1,75%

Inflationrate 1,50%

Rate of increase in the basic insurable earnings 2,00%

Rate of increase in pensions 1,50%

Rate of increase in social insurance payments 1,50%

Table 16 Main actuarial assumptions


Report on the Financial StatementsWe have audited the accompanying financial statements of the Central Bank of Cyprus (the “Bank”) on pages 58 to 76, which comprise the balance sheet as at 31 December 2012, and the income and expenditure account for the year then ended, and a summary of significant accounting policies and other explanatory information.

Governor’s and Board of Directors’ Responsibility for the financial statements The Governor and the Bank’s Board of Directors are responsible for the preparation of financial statements that give a true and fair view in accordance with Article 57(2) of the Central Bank of Cyprus Law, 2002-2007, in conformity with the accounting principles applicable in the European System of Central Banks (ESCB) as these are determined by the European Central Bank (ECB) in the Accounting Guideline ECB/2010/20, as amended by Guidelines ECB/2011/27 and ECB/2012/29, and for such internal control as the Governor and the Board of Directors determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s responsibilityOur responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those Standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected

depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation of financial statements that give a true and fair view in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the Governor and the Board of Directors, as well as evaluating the overall presentation of the financial statements.

Opinion In our opinion, the financial statements give a true and fair view of the financial position of the Central Bank of Cyprus as of 31 December 2012, and of its financial performance for the year then ended in accordance with Article 57(2) of the Central Bank of Cyprus Law, 2002-2007, in conformity with the accounting principles applicable in the European System of Central Banks (ESCB) as these are determined by the European Central Bank (ECB) in the Accounting Guideline ECB/2010/20, as amended by Guidelines ECB/2011/27 and ECB/2012/29.

Report on other legal requirements Pursuant to the requirements of the Auditors and Statutory Audits of Annual and Consolidated Accounts Law, 2009, we report the following:• We have obtained all the information and

explanations we considered necessary for the purposes of our audit.

• In our opinion, proper books of account have been kept by the Bank.

Independent Auditor’s Reportto the Board of Directors of the Central Bank of Cyprus

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• The Bank’s financial statements are in agreement with the books of account.

• In our opinion and to the best of our information and according to the explanations given to us, the financial statements give the information required by Article 57(2) of the Central Bank of Cyprus Law, 2002-2007, in conformity with the accounting principles applicable in the European System of Central Banks (ESCB) as these are determined by the European Central Bank (ECB) in the Accounting Guideline ECB/2010/20, as amended by Guidelines ECB/2011/27 and ECB/2012/29, in the manner so required.

Other matter This report, including the opinion, has been prepared for and only for the Bank’s Board of Directors as a body and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whose knowledge this report may come to.

George C. KazamiasCertified Public Accountant and Registered Auditor

for and on behalf of PricewaterhouseCoopers LimitedCertified Public Accountants and Registered Auditors Nicosia, 11 March 2013

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