INSIGHT

At the time of writing this issue of Banking Insight, Europe finds itself once

more at crossroads over the eurozone sovereign credit crisis. Meanwhile,

Cyprus’ economy is returning to growth, albeit at low levels, and local banks

remain committed to preserve a safe and stable banking system. Towards

this direction, Cypriot banks have recently managed in these difficult

economic conditions to successfully complete significant capital increases.

In addition to strengthening their capital base, banks are undertaking

necessary steps to safeguard their liquidity and improve their competitiveness.

In the current issue of the “Insight”, we attempt to address the connection of

the financial crisis to public and private sector imbalances. In addition, we

outline the factors that keep interest rates in Cyprus at levels higher than the

eurozone average and that includes, among others, the effects of the continuing

instability in the eurozone area. Through an article contributed from a collaborator,

we present the opportunities made possible through use of Public Private

Partnership Financing. In addition, we present future trends in mobile payments,

cheques and alternative payment methods that are currently brought forward

by our member banks. Other articles in this publication include updates on the

new Trust Law that was recently voted in Cyprus, as well as issues on credit

relating to residential property.

We hope that you find this issue informative and, as always, we welcome your

comments and suggestions.

DDrr.. MMiicchhaaeell KKaammmmaassDDiirreeccttoorr GGeenneerraall

AAssssoocciiaattiioonn ooff CCyypprruuss BBaannkkss

1

ASSOCIATION OFCYPRUS BANKS

BULLETINCONTENTS

Interest rate levels in Cyprus 2

The Cyprus International

Trusts Law : Revamped 4

UCITS IV 6

Mobile Payments -

The future of Payments? 7

Future of Cheques and Alternative

Payment Methods –

Actions Ahead 9

Public Private Partnership (PPP)

Financing Under Current

Economic Conditions 11

Credit relating to residential

property: A case for action 12

The financial crisis and eurozone’s

private and public sector

imbalances 14

AAddddrreessss1E Menandrou Str., 1st Floor,P.O.Box 233631682 Nicosia, Cyprus+357 22664293, +357 22665135info@acb.com.cyPPrriinnttiinnggR.P.M LITHOGRAPHICA LTDDDeessiiggnnCHROMASYN - Alexia Nissiforou chromasn@cytanet.com.cy

ACB Copyright 2008The contents of the Articles representonly the personal views of the authors

ISSUE No 7June 2011

Michael Kammas

Cyprus Banking

INSIGHT

Interest rate levels in CyprusPrior to 2001, interest rates charged by financialintermediaries in Cyprus were fixed through a legallydetermined maximum rate level. Interest rate liberalizationtook place in January 2001, and was accompanied by alifting on capital movement restrictions. At present, eachfinancial intermediary may freely determine its own interestrate levels, subject to prevailing market forces.

A brief overview of the trend in interest rates showsthat following deregulation, deposit and lending rates(both for housing and corporate loans) have declined (seediagram 1). However, interest rate convergence toeurozone averages has remained elusive (see diagram 2).

In order to understand the level of interest rates, oneneeds to examine the competitive situation in thefinancial market in Cyprus together with the exogenousand endogenous factors that affect financial institutions.

A main driver of financial institutions’ profitability is theirnet interest margin, which effectively averages thedifference between interest rate received by the bank andinterest rate paid by the bank. According to statisticsprovided by the European Central Bank1, the average netinterest margin in Cyprus is 1.6 which is at the same levelsas the average net interest margin of mid-range banksin the eurozone (with assets between €2 – €200 bln).In the eurozone, the group of small-range banks (withassets below €2 bln) has a higher net interest margin of2.3. Since Cypriot financial institutions have assets thatplace them in the mid- and small-range categories, it canbe seen that Cypriot banks have net interest margins atthe same or lower levels of equivalent size banks withinthe eurozone. This demonstrates that the finance marketin Cyprus is competitive. One musttherefore turn to other factors whichinfluence how financial institutionsset their interest rates to understandwhy interest rates in Cyprus remainhigher than eurozone averages.

Deposit rates: Each individual financialinstitution will take into account itscost of raising deposits, the competitiveconditions in the market, Euribor, thebase rates set by the European CentralBank, its macroeconomic expectationsand its risk-taking strategy in orderto determine its interest rates. The costof raising deposits in Cyprus remainspersistently high, as seen by depositrates which are presently around 4%.The outflow of deposits from Greece hasincreased the liquidity needs of the

Greek banking system, which has inevitably affectedcompetition for deposits both in Greece and Cyprus.Another factor for driving up the competition for depositshas been the uneven competition between banks andcooperative credit institutions, since the latter are subjectto more favourable reporting rules, are practically exemptfrom income tax and do not fall under the supervisionof the Central Bank of Cyprus.

Cost of debt: The credit rating and size of each financialinstitution influences the cost of raising debt capitalfrom the capital markets. The small size of Cyprus bankscompared to global financial institutions has been aconstant factor that kept high the required return ofinvestors, whereas the recent downgrades of Cyprus’ssovereign debt and financial institutions have increasedfurther the cost of capital.

Cost of capital: The economic slowdown has increasedcredit risk for banking loans and has caused banks toprudently raise their provision levels, with a subsequentimpact on their equity levels. Consequently, for a givenlevel of operations, banks need to raise more fundsto replenish their equity levels, and this drives up theircost of capital.

Lengthy procedures for foreclosures: According to astudy by the Bank of Greece2, in countries where theprocedures for foreclosing collateral take two or moreyears, the average interest lending rate is higher thanthe average rate in the eurozone. In Cyprus, theseprocedures are especially lengthy and drive up costsfor banks, effectively driving up interest rates.

Christina PieridesSenior OfficerFinancial Markets

21. EU Banking Sector Stability, European Central Bank, September 20102. Bank of Greece, Report on Monetary Policy 2006-7, Feb 2007, p.64

Diagram 1

3

Structure of financial institutions in Cyprus: Dueto cultural factors, banks in Cyprus have in the pastexpanded through establishing a large number ofbranches. Today the Cypriot banking sector remainsover-branched, with 861 inhabitants per branchcompared to 1,802 on average for the eurozone3. Thisdrives up operating costs.

Regulatory framework: Banks in Cyprus adhere tostricter liquidity requirements compared to banks inother member states, since they maintain minimumliquidity of 70% in respect to foreign currency deposits.This is prudent given that around one third of depositsin the Cypriot banking system are from foreignresidents. However, it means that for a given levelof lending, Cypriot banks need to have more depositsthan banks in other jurisdictions, which in turn drivesup their costs and interest rates.

Sovereign cost of borrowing: Following the recentdowngrades of sovereign debt, investors require ahigher interest rate when buying government bondsand so government debt is traded in the secondarymarket with a yield higher than 6%. This affectsliquidity in the market as well as interest rate levels.

Specific factors that affect corporate lending rates:The loan portfolio of Cyprus banks have a higher portionof loans to small and medium enterprises compared tobanks in other member states of the eurozone. Thesetypes of loans are characterized by greater credit risksand higher interest rates and they drive up the averagecorporate lending rates in Cyprus, compared to theaverage of the eurozone. Additionally, until recently,Cyprus did not have a credit bureau. This implied agreater credit risk for loans provided to clients of Cyprusbanks compared to loans given by financial institutionsto clients based in other eurozone countries whichhave established credit bureaus that have been inoperation for years.

Inflation: Inflation in Cyprus is higher than averageinflation in the eurozone. In 2010, the harmonizedindex of consumer prices in Cyprus grew by 2.6%whereas in the eurozone it grew by 1.6%. Sinceinflation and inflation expectations affect the nominalinterest rates, inflation can be seen to account forapproximately 1 percentage point of the interestrate differential of the Cyprus and eurozone averages.

It can be seen that in addition to the above factors,there are a number of developments under way whichare expected to exert upward pressure on interest rates.As the focus of the European Central Bank shiftsaway from recessionary risks and towards the risinginflation, the main refinancing operations rate was

increased by 25 basis points, and there are indicationsthat further rate hikes will follow. This directly affectsborrowers whose interest rates are linked to the ECBrates, as well as banks borrowing from the ECB. Inaddition, the new regulatory framework forstrengthening the financial system that is currentlybeing implemented in the EU, provides for the creationof bank stability funds as well as for a stricter regulatoryframework under Basel III, improved quantity andquality of bank capital and increased liquidity levels.All of these increased regulatory requirements areexpected to drive up the compliance costs of bankswhich will then impact profitability and interest rates.

Certain measures have already been taken to alleviatethe upward pressure on interest rates such as theintroduction of special government bonds as well asthe introduction of a legal framework for covered bonds.However, for a sustainable reduction in domesticinterest rates, the Cypriot economy needs to strive forfiscal consolidation. This will convince markets thatthe risk of investing in Cyprus is low, and will translateinto lower borrowing costs for the government and,consequently, for the banks and the private sector.

3. European Banking Statistics 2009, European Banking Federation

Diagram 2

4

In recent years, demand for investment and tax planningin the commercial Trust sector has grown, while theadvent of an increasingly aged society has led to a globalincrease in the possible use of Trusts, for the purposesof asset management and estate planning. Due to thesechanges, the dynamics of Trusts for both internationalprivate family and commercial purposes have changeddramatically. Trusts are now undoubtedly the planningvehicle of choice worldwide that have an increasinglyinternational reach of investments and family members. In Cyprus Trusts are governed by the Cyprus InternationalTrusts Law (‘Law’), which was enacted in 1992 andremains unaltered ever since. It is against thisbackground that an effort has been enacted for thereview and modernisation of the Cyprus InternationalTrust Law. Furthermore the evolution of trustslegislations in other countries and the need ofcommensurability of legal infrastructure is intensifyingthis initiation.

A draft amendment of the Cyprus International TrustsLaw (‘Proposed Law’) has been submitted in Parliamentand is due to be examined following the May 2011 MPelections. The Proposed Law takes into account the

realities of the Cyprus economy today and is incompliance with EU Law and Directives.

This Proposed Law makes a substantial number ofamendments to the current Law with the objective ofenhancing the attractiveness of Trusts governed. Themost important amendments may be summarised asfollows:

1.Expansion of the definition of the term‘International Trust’

The expansion of the definition of the “InternationalTrust” is going to be achieved by the deletion of therestriction included in the current Law that thebeneficiaries of the Trust must be persons having theirresidence oversees and hence cannot have apermanent residence in Cyprus. In addition thedefinition of International Trust shall be enhancedby the inclusion in the allowed assets of the Trust,property situated in Cyprus. The current Law does notallow this inclusion and instead provides for the assetsof the Trust to be situated only outside Cyprus.

The Cyprus International Trusts Law: Revamped

Elena FrixouSenior OfficerLegal Affairs

5

2.Powers of the Settlor

The Proposed Law provides for the expansion of thepowers of the Settlor without jeopardising the validityof the Trust. Unlike the current Law these powersare clearly stated in a new proviso and includeinter alia: powers to amend the terms of the Trust, togive instructions for the dissipation of any of theassets of the Trust, to appoint or remove anytrustee/protector/beneficiary/investment consultantand/or restrict their power, and to change thejurisdiction of the Trust.

3. Investments of the Trust.

One of the most noticeable insertions in the ProposedLaw is the withdrawal of the restriction found in thecurrent Law that “the investments in relation to theTrust cannot be made in relation to property situatedin Cyprus”. Hence the passing of the Proposed Lawwill allow the Trustee to invest in movable andimmovable property (including shares in companiesregistered in Cyprus) situated in Cyprus and abroad.

4.Modern asset and jurisdictionalprotection clauses

The Proposed Law promotes the introduction ofefficient “firewall” provisions and modernjurisdictional protection clauses that address thesecurity concerns expressed by existing and newforeign investors.

Notably the law in force in Cyprus or in any othercountry relating to inheritance or succession shallnot affect in any way such transfer or disposition orotherwise affect the validity of such internationalTrust. In addition, the validity of the Trust shall notbe affected in situations where legal provisions inother jurisdictions do not recognise the concept ofa Trust, or in the case where foreign legal ordersaim to dissolve the Trust.

In addition, the assets of the Trust are going be furtherprotected as no claim maybe placed against the latterin the case of settlor’s bankruptcy or liquidation orin any action or proceedings against the settlor atthe suit of his creditors notwithstanding any provisionsof the law of Cyprus or of the law of any country.Notwithstanding further that the trust is voluntary

and without consideration having been given for thesame, or is made on or for the benefit of the settlor,the spouse or children of the settlor or any of them.This is unless and to the extent that it is proven tothe satisfaction of the Court that the Trust wasmade with the intent to defraud the creditors of thesettlor at the time when the payment transfer ofassets was made to the Trust.

5.Duration of the Trust, Confidentialityissues and Charitable Trusts

The Proposed Law removes the 100 year maximumduration clause and proposes the insertion of anunlimited duration clause. It also provides for aprohibition of the acceptance of any rule againstperpetuities. In addition the definitions ofconfidentiality and charitable trusts are widelyexpanded.

6.Choice of Law and jurisdictional issues

A major addition in the Proposed Law is the insertionof provisions which deal with the principles of choiceof law in the Trust. The choice of the governing lawof the Trust may be stated expressly or impliedly inthe Trust. In the case where the governing law isnot chosen then the Trust shall be governed by thelaw which is “most closely related” to the Trust asdefined in the Proposed Law.

The explicit elaboration on the jurisdiction of Cypruscourts and application of foreign jurisdictional lawsis also a novelty introduced by the Proposed Law.Specifically the Proposed Law provides for theinstances where the Cyprus courts have jurisdictionsuch as inter alia: (i) where the law chosen is theCyprus law or (ii) the Trustee is a permanent residentin Cyprus, or (iii) any asset of the Trust is situatedin Cyprus or (iv) the management of the Trust is carriedout in Cyprus.

It is unquestionable that the amendments promotedthrough the Proposed Law shall further enhance thecredible, sound and versatile concept of the CyprusInternational Trust and create real choice forsophisticated and well-advised settlors to considerCyprus as a highly attractive Trust destination.

The UCITS IV Directive, which will be transposed intonational legislation of Member States and come intoeffect by July 2011, is expected to simplify the regulatoryenvironment by reducing administrative barriers forcross-border trading of funds, creating cost savingsby allowing huge economies of scale, broadeninginvestor choice and providing increased investorprotection by making sure the retail investors obtainmore appropriate information on their investments.

The new Directive provides for:- The inclusion of the Management Company Passport

which will allow funds authorised in one Member Stateto be managed remotely by a Management companyestablished in another Member State and be authorisedby that Member State’s regulatory body;

- The removal of administrative barriers to cross-borderdistribution of UCITS funds by improved cooperationmechanisms between national regulators;

- The creation of a framework for mergers between UCITSfunds and allows the use of "masterfeeder" structuresto accommodate the cultural preference towardsdomestic funds;

- The replacement of the "Simplified Prospectus" witha short two-page "Key Investor Information" document.

Asset Pooling

The New Directive makes entity pooling possible throughso-called master feeder structures. Master feederstructures exist at national level and have beensuccessfully used in a number of countries for sometime. There are a large number of benefits of the masterfeeder structures, including the realisation of economiesof scale and a reduction of charges or better performancefor the investor as a result.

The UCITS Notification Procedure

The previous UCITS Directive set out common rules whichallow a UCITS authorised and supervised in one MemberState to market its units in any other Member State. Underthis procedure, before a UCITS starts marketing its units,it had to complete a notification procedure. However,this procedure turned out to be very burdensome andtime consuming for fund promoters. The delays betweenthe moment of the notification and the actual marketingof the UCITS were very disadvantageous when comparedwith other financial products for retail investors, whichare often subject to less strict information or investorprotection requirements.

Accordingly, UCITS IV covers the creation of astreamlined notification process for cross borderfunds sales. Under the new procedure: ñ A UCITS seeking to market its units in another Member

State informs its home authority of its intentionand sends them the notification documents;

ñ The home authority checks the completeness of thefile and, if complete, transmits it electronically to thehost authority, together with an attestation confirmingthat the UCITS fulfils its obligations under theDirective;

ñ The competent authorities of the host Member Statewill not be entitled to review, challenge or discussthe merits of the UCITS authorisation granted in thehome Member State;

ñ The home authority informs the UCITS about thetransmission date and the latter can start marketingits units in the host country three days after thetransmission date;

ñ The host authority checks ex post that marketing isconducted in accordance with national rules. This willallow for a fast regulator to regulator procedure dueto the suppression of the current two month deadlinebetween notification and access to the market.

Key Investor Information

Under UCITS III there was an obligation to offer asimplified prospectus, free of charge to subscribersbefore the conclusion of the contract. UCITS IV replacesthis with the concept of “key investor information”.

Article 73 requires the investment company or themanagement company (where applicable) to draw upa short document containing key investor informationthat will be valid in all Member States.

It is noted that UCITS IV acknowledges the importance

6

UCITS IV

Dr. Demetra ValiantiSenior OfficerLegal Affairs

of having a fully harmonised “document” includingthe information on the basis of which funds can bemarketed across borders without the possibility fornational authorities to ask for additional information.

The Management Company Passport

The Management Company Passport will allow assetmanagers to sell funds across the EU without havingto establish a full suite of administrative functionsfor every jurisdiction. Moreover, it will allow a UCITSestablished in one Member State to be managed by aManaged Company established in another Member State.

Cross Border Fund Mergers

The Directive seeks to reduce barriers to cross boardermergers by providing a framework in order torationalise the process while at the same time ensurea high level of investor protection.

Supervisory Cooperation

The Directive provisions in this area will allow forenhanced supervisory powers and supervisorycooperation to ensure for example equivalence ofpowers for competent authorities and the developmentof existing mechanisms relating to exchange ofinformation.

Cyprus Developments

The public consultation has already been finalised andthe relevant Bill is expected to be voted into Law uponthe reopening of the Parliament in June after theParliamentary elections.

The competent supervisory authority will, as previously,be the Cyprus Securities and Exchange Commission.

7

Many consumers are already using mobile phones forservices beyond the traditional means of voice callsand text messages. This is due to the introductionof new packaged offers such as internet access, whichare provided by the mobile network operators. As aresult, consumer expectations with regard to mobilephone functionality have increased dramatically, withmany users eager to use new mobile banking services,such as payments. The availability of practical mobilepayments could provide a realistic alternative to cashand cheques, which are considered as costly methodsof payment.

A recent study conducted by the “Yankee Group”research company, shows that a major increase in thevolume of mobile payment transactions is expectedin the next four years. In particular, it is predictedthat the worldwide transaction volume of mobilepayments will total $984 billion by 2014, as opposedto $162 billion in 2010, showing an increase of 507%.

Despite the above figures, there are increased concernsby consumers about the safety of mobile payments,with the loss of privacy, theft of identity and otherfraudulent activities being amongst their main worries.At the same time, merchants demand that the newmobile banking technology should be reflected into

cost savings, increased business volume and reducedexposure to security threats.

For the time being, there are four primary models ofmobile payments:

1. SSMMSS--bbaasseedd ttrraannssaaccttiioonnaall ppaayymmeennttss.. According tothis method, the consumer sends a payment requestthrough an SMS text message and the charge isapplied to his/her phone bill or online wallet. Themerchant is then informed about the payment’ssuccess and releases the paid goods or services.Banks are usually not involved in this process. Thismethod is usually used for the purchase of digitalgoods (such as music, games, ringtones, etc) andis not considered as a popular method due to itspoor reliability, slow speed and high costs.

2. DDiirreecctt MMoobbiillee BBiilllliinngg.. The consumer uses the mobilebilling option during checkout at a website, in orderto complete the payment. After a two-factorauthentication procedure involving a PIN and aone-time-password, the consumer’s mobile accountis charged for the purchase. Although Banks areusually not involved in this type of payment, it isconsidered as a much safer and easier-to-usemethod.

Mobile Payments - The future of Payments?

Marios NicolaouSenior Officer

Payment Systems

8

3. MMoobbiillee wweebb ppaayymmeennttss.. The consumer uses web pagesdisplayed on his/ her mobile phone, in order to makea payment. This method uses WAP (WirelessApplication Protocol) as supporting technologyand thus inherits all the advantages of WAP, whichare: customer satisfaction due to quick and easier-to-use payments, more security (due to betterprotection of payment details and customer identity)and ability to provide accurate responses in cases ofno-money availability. This payment model alsoinvolves Banks, mainly through the use of CreditCards. Another advantage comes from the factthat, once the merchant is able to automatically andsecurely identify his customers, then the same carddetails will be able to be recalled for future purchases,turning credit card payments into simple one-clicktransactions.

4. CCoonnttaaccttlleessss ppaayymmeennttss.. This method is mostly usedfor the purchase of goods in physical stores, or fortransportation services. The consumer, using a mobilephone equipped with a smartcard, waves his/herphone near a reader module. Most transactions donot require authentication, but some require the useof a PIN before a transaction is completed. Thepayment is then deducted from a pre-paid account,

or charged to a mobile or a bankaccount directly. The contactlesspayment method is becomingincreasingly popular amongstphone manufacturers and banksdue to it’s lack for need ofcomplicated infrastructure orstandards. For the time,contactless payments are mainlyused in Europe for parkingplaces. Hence, customers benefitfrom the convenience of beingable to pay for parking from thecomfort of their own car, andparking operators for not havingto pay large investments in newparking infrastructures.

Banks in Cyprus have also startedto increase the range of theirmobile banking services. For thetime, the most popular types ofservices include, account balanceand statement inquiries,payments of utility bills,interbank money transfers(including repayments of cards)and exchange rate enquiries.

Some banks also offer stock market facilities such asplacements of buy or sell orders, portfolio viewingand trading account information.

Having the above developments in mind, the EuropeanPayments Council (EPC)* decided to implement themobile channel as an initiation channel for SEPApayments. As a result, in July 2010 the EPC publisheda “White paper on Mobile Payments”. The white paperfocuses on mobile contactless payments, where themobile devise needs to be in close proximity to a point-of-sale terminal (method 4 described above). The whitepaper also addresses some aspects of mobile remotemoney transfers, where two parties will be able to sendand receive funds to each other, irrespective of wherethey are located. The EPC through it’s white papertries to respond to the changing customer requirementsin the payments market and to demonstrate how mobilepayments can increase efficiency, effectiveness andconvenience. It also tries to create awareness on howto best combine the benefits of state-of-the-art SEPApayment instruments (i.e. credit transfers, direct debitsand card payments), handled through one of the mostpopular and versatile devices introduced in the past twodecades. The mobile phone.

9

Cheque usage in Cyprus still remainsone of the highest in the eurozonewith transactions covering 27% of thetotal payments for 2009 (ECB PaymentStatistics). Statistics for 2009 showa small decrease of 3% compared to2008 figures with cheque usage stillremaining at light levels compared toother payment instruments. In recent years the EuropeanPayments Council (EPC) has beencalling for the banking industry toreconsider the use of cheques andmove to alternative payment methods. In Europe astrong tendency is already under way to phase out theuse of cheques and replace it with other paymentmethods. In Nordic countries cheques have beencompletely abolished and in Germany, Austria and theNetherlands they have almost disappeared over DirectBank Payments, Credit Cards and other ElectronicPayments. In the UK, the Payments Council has madea decision to close the Clearing House setting a targetdate for 2018 with a final decision to be reached in2016. In Cyprus a strong movement towards thatdirection is now being made by the government andlocal banks with the collaboration of the Central Bankof Cyprus.

Disadvantages

The main disadvantages in the use of cheques includerisks involved from dishonoured cheques, theft,counterfeit cheques, risk of returns due to human error,of post dated cheques and the costs associated withthe follow up and handling of the aforementionedproblems.

The introduction of the Central Information Registry(CIR) for issuers of dishonoured cheques has had littlecontribution to the decline in the number ofdishonoured cheques entering the economy anddisrupting the inflows and outflows of businesses.In fact, over the past two years the Central Bank ofCyprus (CBC) has reported an increase in the numberspartly due to the global financial crisis which is alsoaffecting the island’s economy. Efforts to have thedata on issuers of dishonoured cheques also availablevia Artemis Bank Information Systems Ltd, has notcontributed to that effect.

Time to migrate to payment alternatives

Users across the board will migrate to other instrumentsonly if they are convinced of the benefits offered. Itis vital the plethora of alternative payment methodsshould match the needs of the different users. Thequestion nevertheless remains whether current optionsand efforts are adequate to move things forward:

ñ SEPA – The introduction of SEPA will contributesignificantly to the reduction in the use of cheques.It involves a unified and standardised system ofpayments which aims to slowly diminish the use ofcheques offering a fast, secure and cheap unifiedelectronic payment system and at the same timereducing reconciliation time and effort.

- SEPA Direct Debits - SEPA – Credit Transfers- SEPA – Credit Cards

ñ E-Banking

ñ Credit cards

ñ Debit cards

ñ Electronic File Transfers – via FTP for mass payments

ñ Mobile banking

The UK case

In 2009 a decision was taken by the UK PaymentsCouncil to close Cheque Clearing. A national ChequeReplacement Program is already underway with a targetdate set for 2018. Its progress will be officially reviewedin 2016 for a final decision. The following key criteriamust be met prior to a final decision being made:

Future of Cheques and Alternative Payment MethodsActions Ahead

Yiota YiangouLoizidou

Sub-Manager Alpha BankCyprus Ltd

1. Adequate alternatives are available for each usergroup.

2. People are aware of the alternatives and considerthem acceptable.

3. If they have been adequately adopted by the users.The cheque replacement program in the UK aims athaving a managed program of decline over an extendedperiod. The vision with the UK case is that innovationin the payments market has delivered acceptablealternatives to cheques so that personal customers andbusiness users have migrated away from cheques bychoice, thereby enabling the benefits to be realized.

The Case for Cyprus - Major Constraints

A number of issues have been identified as majorconstraints to the overall effort:ñ Use of Post-Dated cheques by companies to raise credit.Current legislation permits the extensive use of post-dated cheques by companies and tradesmen to raisecredit to the extent that cheques are being misused. ñ Need to modernize current legislation regarding PostDated Cheques. The last attempt by the Cyprus ClearingHouse made in 2003 to abolish the use of Post DatedCheques stumbled following a ruling from the High Courtand a change in legislation. A post dated cheque is notconsidered as a cheque but regarded as a bill of exchangepayable on maturity.ñ Extended use by certain user groups:

- Small and medium sized businesses that lacktechnical infrastructure. Use of cheques as proofof payment.

- Organizations that send and receive large volumesof cheques e.g. dividends, insurance settlements,refunds, etc.

- Use by the elderly, the disabled and the lesstechnologically knowledgeable.

- Use of Bank Drafts to Land Registry, large valuepayments by individuals.

- Payments to Schools, Technicians, Charities andClubs.

- Gifts or one-off payments

The need for Long Term Planning

Cyprus can benefit from the UK experience and take stepstailored to the local needs and economy. This may entaila similar Cheque Replacement Program over a pre-specifiedperiod of time. The program may have to include:

ñ Updating the current legislation governing the use ofpost-dated cheques. This should include changes in theLaw regarding the definition of a cheque (Bills ofExchange Act Cap262 S73) and Criminal Code Amending

Law of 2003 S305A (1) governing the handling ofDishonoured Cheques. Based on the current legislationPost Dated Cheques are not considered as Cheques butBills of Exchange payable on maturity.

ñ Consulting with organized representatives such as theCCCI (KEBE), the CEIF (OEB) and the Consumers’Association and listening to their needs.

ñ Development by the Banks of adequate alternativesbased on the needs identified for each user group.

ñ Readjustment of the current cost of cheque issuanceto reflect the true cost of the transaction.

ñ Existing payment alternatives such as electronic domesticpayments should reflect the true cost of the transaction.

ñ Payment alternatives should reflect the user groupneeds in order to remain viable.

ñ Sufficient time should be given to users to migrateto alternatives.

ñ Transparency in alternative payment systems used.

ñ Communicating to and educating the users of thebenefits and features of the alternatives.

Challenges ahead for the Banking Industry

ñ To identify and chart areas of cheque usage wherethere is currently no alternative payment method inorder to meet arising needs and devise new ways ofelectronic payments.

ñ To enhance existing alternative payment methodsto tailor for the changing needs of existing users.

ñ To identify opportunities for the development of newpayment methods.

ñ To focus on future trends and needs. A new generationof clients is emerging who are more technologicallyknowledgeable and will opt for E-banking and MobileBanking rather than cheques. These new users requirenew applications and they will ultimately become acompletely new type of financial services consumer.

In conclusion, the main question would be whether thebanking industry and the economy wish to see chequesbeing totally replaced by electronic payment methodsand whether this is the right time amidst the currenteconomic climate to take things further.

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11

A Private Public Partnership is a partnership, a contractand engagement between a Public Sector Authorityand a Private Investor (usually a consortium of PrivateInvestors) in which the Public Sector Authority assignsto the Private Sector Investor the development of aparticular project and the provision of a public service.The Public Sector either undertakes to pay the PrivateSector Investor a fee for when the project is developedand the service is provided by the Private Investor andused by the public (e.g. construction of non-toll roads),or receives by the Private Investor a pre-agreed feefor the exploitation of the service or project (e.g.airport construction and operation). Typically, thefinancial, technical and operational risks in the projectare assumed by the Private Investor.

The Public Private Partnership is an approach andmethod for the development and exploitation of largePublic Works Projects and Investments that wasrelatively recently and originally applied by WesternEuropean countries, Australia and USA. Although manyexamples of PPP’s are found in economies in earlytimes, this method of co-operation between the publicand the private sector only made a breakthrough inthe 80’s and 90’s; also serving as a method ofprivatisation of existing and new public services. Itconstitutes a modern and alternative scheme to developlarge infrastructure works and projects for which thecountries themselves are either unable, or unwillingto allocate huge amounts of capital from their budgetsfor their development. PPP examples are identified inalmost all sectors of both developed and developingeconomies.

Many types and forms of PPP’s appeared and exist; themost common ones are the following: Build OwnOperate (BOO), Build Operate Transfer (BOT), DesignBuild Operate (DBO) and Build Develop Operate (BDO);each method having its own characteristics (financial,legal, operational etc) and approaches to thepartnership created between the Public and the PrivateSectors. Typical examples of Project Developmentthrough PPP’s include infrastructure Projects(Highways, Ports, Rail Roads, Water Dams etc) andnon-infrastructure Projects (Hospitals, Schools etc).

The need for this type of partnerships between thePublic and the Private Sector Investor has arisen partlydue to the continuously mounting public debt thatmade additional lending for the Governments eithertoo costly or non-beneficial and also due to the

inability of the Public Sector to adopt and followefficient procurement procedures that would enablethe construction and maintenance of large projectswhile at the same time offering quality levels of serviceto the end users (the public). Financing and developingof such projects by the Public Sector could not bejustified and the funds available to the Governmentswere placed in other uses, such as investment inprimary education and provision of and defence andsocial welfare. Despite the real benefits that PPP’shave provided to the countries, societies and investors,Governments are usually accused that by contractingPrivate Investors through PPP’s they are offering tothem higher returns compared to the ones that couldotherwise be enjoyed by the investors had theyinvested their available funds in Government Bonds.These accusations of course ignored that the formerassumes higher and multiple levels of risk than thelatter. It was the scarcity of funds and the lack ofalternatives that pushed those countries to engagePrivate Sector Investors in Public Works, Projectsand Investments previously and exclusively procuredby the Governments and their agencies.

The recent dislocation in the Financial Markets andthe adverse and deteriorating Market Conditions hadserious impacts on the procurement of large ProjectDevelopment by both the Public and the Private SectorInvestors. Uncertainty in the economic and politicalenvironment, difficulties in securing debt financing,government resistance to bear new financialcommitments and the high cost of capital have a majorrole in the decision to procure new investments,especially those that the returns are visible mostlyin the long-run. The financial crisis has affected everyparticipant involved in PPP’s:ñ Governmentsñ Banksñ Investors ñ End users

The financial crisis created a huge burden for all toaccess Capital Markets and also had a negative effectto the demand for certain types of Public Works andProjects. Governments have been affected by theunavailability and costly funding and by fallingrevenues, Banks have been affected by the absence oflow-risk projects and Investors by the limited accessto funding and by the reduced sources of income; allthese having a negative impact on the End users ofPublic Works and Projects.

Public Private Partnership (PPP) Financing Under CurrentEconomic Conditions

Petros AgathocleousSpecialized Lending

OfficerProject Finance &Loan Syndication

UnitBank of Cyprus

Public CompanyLtd

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Credit relating to residential property: A case for action

The size and funding difficulties of certain types ofPublic Works and Projects forced the Governments tore-think and re-engineer the methodology of designing,financing, developing and exploiting them. Once theeconomic meltdown has become every Government’sprimary concern and people were focused on keepingtheir jobs and meeting their daily needs, priorities ofGovernments shifted towards procuring new sizeableprojects that would maintain the growth of the economy.In this adverse current negative macroeconomicenvironment PPP’s have become more relevant by meansof securing new Projects and Investments for the Publicand the Private Sectors, creating new jobs and sustaininga positive level of development for the economies.Political support and changes in the regulatoryframeworks were also necessary to provide an advantageand attract the international investor in infrastructureand public services.

The question raised under these adverse conditions washow to procure new projects (with all the benefits to thepublic and the economy) without charging theGovernments and their agencies with additional and costlydebt. The financial crisis has affected the confidence ofthe Private Investor to engage in new private projectsand also the confidence of the Government to undertakenew public works. PPP’s proved to be an answer to thereluctance of the Private Investor and the Government

to engage into new projects, to the question of how newprojects can be procured and also to the increasingdemand and rising costs on public infrastructure services.All these, combined with the Private Investors’ access toinnovation and application of best management practicesmade it attractive for the Governments to add valueand pursue growth through PPP’s.

To sum up, it is worth noting again that PPP as amethodology for Public Works and Projects procurementis found in almost every economy, developed ordeveloping, thus making it a preferred way thatGovernments and the Private Sector Investors createpartnerships for the mutual benefit of the public andthe Private Sector Investors while a number of largeprojects may not have been able to be procured in itsabsence. Once market conditions have deterioratedin the past few years and Financial Markets and newinvestments have been badly hit, PPP’s have offered asafer way out for Governments in their efforts to maintainpositive levels of development and to procure newprojects without sacrificing valuable funds required tofinance their short and medium term obligations. Atthe same time this has also benefited the Private SectorInvestor which gained access to new projects andBanking Institutions through financing of large projectswith controllable and manageable risk profiles andcharacteristics.

The effort to create an internal market for residentialmortgages is not new. The initiative goes back in2007 with the White Paper on the integration of EUMortgage Markets. Following the international financialcrisis, the European Commission has launched a seriesof studies so as to identify potential problems withinthe EU mortgage market. A number of problems werethen brought to light and was found that irresponsiblelending and borrowing activities were presentthroughout the European Union. The figures and datacollected confirmed that there was a case for EUintervention in the field of mortgage credit. TheEuropean Commission’s aim was to create a competitivesingle market in the area of residential property whileat the same time promote financial stability, fosterconsumer confidence and cross-border mobility.

Household credit plays an important role in the EUeconomy. In 2008, mortgage lending represented about50% of EU GDP or almost EUR 6 trillion. Taking amortgage credit is one of the most essential decisions

in a person’s life, entailing a financial commitmentfor probably decades. Statistical data shows that risinghousehold debt exists throughout EU. Mortgage debtaccounted around 70% of households’ total financialliabilities as at the end of 2008. Going further, figuresshow that 16% of people cannot repay bills and 10% ofall households reported arrears. Arrears, defaults andforeclosure of properties are further increased inenvironments of general economic downturn, asindividuals cannot repay their debts due to pooreconomic conditions, such as, higher levels ofunemployment.

Some of the problems that can be highlighted are thosewhich arise from gaps in national regulations andincomplete and unclear practices on the part of financialinstitutions. Problems can be outlined as follows: (a)Unbalanced, incomplete and unclear advertising andmarketing materials. Although misleading advertisingand unfair terms are already regulated by EU Directives,unbalanced advertising practices still exist and mislead

Maria IoannouSenior OfficerConsumers Affairs

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consumers, and even more preventobjective comparison of differentoffers by consumers. (b)Insufficient and complex pre-contractual information which doesnot allow consumers to takeinformed decisions or compareoffers. Statistics show that 38% ofEU citizens find it difficult tocompare offers due toinsufficiencies in pre-contractualinformation provided cy creditinstitutions. Moreover, 59% ofconsumers find the informationdifficult to understand while therisks involved are not clear to them.(c) Inadequate creditworthinessassessments from the creditproviders that lead customers toborrow money for residentialproperties they cannot reallyafford. All of the above problemslead to irresponsible activities both on behalf offinancial institutions and consumers. And as shownby the financial turmoil, irresponsible lending andborrowing can affect other markets beyond the onewhere it was originated. The presence of multinationalbanks, branches, subsidiaries all over the world, aswell as the global securities and bond markets,contribute in transmitting the impact of irresponsiblebehavior originated in one location to other markets.

Another driver of irresponsible behavior is theinconsistency in the regulatory framework for non-credit institutions (NCIs). Due to the fact that manyNCIs are not adequately regulated or supervised insome Member States, an unlevel paying field betweencredit institutions and NCIs in the area of mortgagecredit is formed within the EU. This lack of regulationand supervision leads to market failure and can bethe source of financial crisis. Similarly, there is lackof registration, authorization and supervision for creditintermediaries in Member States, which creates anuncompetitive and unprofessional environment in theindustry.

Furthermore, low levels of financial literacy withinthe EU lead to irresponsible borrowing. People whoare financially illiterate cannot evaluate correctlywhether a credit product is suitable for them and takefinancial risks that they cannot meet. One way totackle this problem would be through the promotionof educational and financial programs all over Europe,

in order to educate citizens and help them understandthe information and the products offered to them.Financial education will help them choose the mostsuitable product for their needs and reduce additionaleconomic risks.

As a consequence, the European Commission soughtways to prevent irresponsible lending in all MemberStates and promote overall financial stability. At thesame time, focus is given on cross-border activityand the need to boost consumer protection andconfidence. Given the fact that the above objectivescould not be achieved by Member States alone, EUintervention was justified and the preferred policyinstrument to ensure responsible lending throughoutEurope was the introduction of a European Directive.A Proposal for a Directive on credit agreementsrelating to residential property is therefore currentlybeing prepared by the European Commission. ThisProposal applies to credit agreements which aresecured by real estate for residential purposes andincludes provisions similar to those of the ConsumerCredit Directive, 2008/48/EC (CCD).

Some of the preliminary provisions that may beincluded in the Proposal are the following:

- Standard information to be included in advertisingmaterials for mortgage credit, in order to ensure clear,complete and balanced information and enableobjective comparison of various offers.

In the first issue of the Cyprus Banking Insight (March2008) I wrote an article entitled «Credit expansion andthe real estate prices prior to Euro adoption». I discussedthe rapid credit expansion in some eurozone countriesthe years prior and immediately following the adoptionof the euro. In some of the so called peripheral countriescredit expansion reached 30% yearly, leading toexceptional growth in economic activity. A few years later,the financial crisis has shown that those countries thatenjoyed strong and exceptional economic growth prior tothe crisis are now experiencing severe structuralweaknesses. In this article I will discuss the repercussionsof excessive credit expansion in the private sector, therepercussions of fiscal indiscipline and growing debt inthe public sector and the policies and measuresimplemented by the European Authorities in order toprevent such events from occurring in the future.

In the private sector, the introduction of the euro led toimproved growth prospects, ample credit supply andsignificant declines in lending interest rates. As aresult, demand for credit increased rapidly. A large partof this lending was directed to the housing market. Theglobal crisis affected severely the financial sector andbrought to surface all the previous imbalances. In orderto avoid further deterioration of the financial markets andeliminate the risk of a banking sector collapse, European

Authorities intervened and managed to prevent a bankingcrisis. In the short-run, they supported the financialsystems of the affected eurozone countries in two ways.The European Union (EU) implemented a program forrestructuring and recapitalizing crisis-hit banks and theEuropean Central Bank (ECB) took exceptional andunconventional measures (credit support) to ensure anuninterrupted flow of adequate liquidity to the financialsystem. In the long-run, European Authorities are puttingin place permanent measures to address the underlyingweaknesses revealed during the financial crisis and avertpossible future banking crises. The Basel Committeeon Banking Supervision (BCBS) acknowledged that thecrisis was caused by insufficient regulation of the financialsector and completed a new supervisory framework knownas Basel III Capital Framework. Basel III, which will beimplemented through the new Capital RequirementsDirective (CRD IV), is applicable to all financialinstitutions in the European Union. Amongst others, itimposes significant changes to the definition of capital,liquidity management and leverage. Banks will be forcedto increase the quantity and quality of their capital,especially equity capital, so to ensure their ability toabsorb losses and withstand future periods of stress.They will be required to build-up a minimum liquiditystandard for emergency situations (30-day LiquidityCoverage Ratio) and a stable, long-term funding of assets

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- Pre-contractual information to be available tocustomers in sufficient time, so as to make informeddecisions and be able to shop around both locally andcross-border. In order to facilitate this, personalizedinformation will be provided to consumers in a EuropeanStandard Information Sheet (similar to the ESIS providedwithin the CCD).

ñ In order to ensure higher protection for consumers,it is necessary to ensure that the Annual PercentageRate of Charge (APRC) is comparable throughoutthe European Union. The total cost of the credit tothe consumer comprises all costs that the consumerhas to pay in connection with the credit agreement.The APRC includes the interest, commission, taxes,fees as well as the cost of insurance or other ancillaryproducts (where these are obligatory in order to obtainthe credit). At the pre-contractual stage the APRC willbe indicated only through a representative example.This is also along the lines of the CCD.

ñ Creditworthiness assessment to be conducted bythe lender before the granting of the credit agreement.These assessments will be carried out on the basisof general information provided by the borrower aswell as through information accessed by databases.The aim is to ensure that both creditors and borrowerswill take the most appropriate decisions.

ñ Credit intermediaries and non-credit institutions willbe registered, authorized and supervised to eliminategaps and ensure a level playing field between all marketplayers.

Once the Proposal is finalized and voted by theEuropean Parliament, EU Member States will have totranspose their national regulations. In light ofthis, the Cyprus national law covering housing creditwhich was passed in November 2010 by the Parliamentwill be replaced by the regulations of the EuropeanDirective as well.

The financial crisis and eurozone’s private and public sector imbalances

Michael KronidesFirst Senior OfficerBanking Supervision

and business activities (1-year Net Stable FundingRatio). Lastly, they will need to apply a leverageratio that will limit credit growth based on their Tier1 capital so as to contain the build-up of excessiveleverage and debt in the banking system. Additionally,European Authorities have established the EuropeanBanking Authority (EBA) in order to improve the qualityand coordination of supervision of financial institutionswithin the European Union and to safeguard thestability of the financial system.

In the public sector, the introduction of the eurodiminished country risk premia and decreased sovereignbond spreads in peripheral countries, leading to anincrease in public (government) borrowing. This,together with over-optimistic expectations regardinglong-term prospects of economic growth, led to fiscalindiscipline and deterioration of public finances.Initially, fiscal deficits were financed by governmentborrowing and by the increasing tax revenues from thegrowing real estate sector, as explained earlier.Unfortunately, this proved to be unsustainable. Largecurrent account deficits and fiscal indiscipline couldnot continue indefinitely as the global financialcrisis slowed down economic activity and eventuallyeconomic growth. This caused sovereign bond spreadsto rise and tax revenue from the real estate sector todecline considerably. Growth proved to be cyclical rather

than structural in nature. Large current account deficitson the balance of payments caused a serious sovereigndebt crisis, forcing some eurozone countries toimplement hard and painful measures in order to reformtheir economies. European Authorities are takingcorrective measures to address the issue of MemberStates fiscal discipline. They are in the process ofreforming the Stability and Growth Pact in order tostrengthen economic governance and improve fiscaland broader economic policy coordination. Also,European Authorities are setting up mechanisms forthe provision of financial support in case of futuresovereign crises (European Stability Mechanism) andfor the prudential surveillance of macro economic risksthat pose a threat to the eurozone financial stability(European Systemic Risk Board).

The financial crisis clearly unveiled the unsustainablefinancial and fiscal imbalances that existed in someeurozone countries. Excessive credit growth in the privatesector and growing debt in the public sector causedmajor financial and fiscal problems. European Authoritieshave identified the weaknesses revealed during the crisisand are taking decisive and corrective measures tostrengthen the supervision and resilience of the financialsystem, to improve economic governance, to preventthe build-up of excessive deficits and to incorporatemacro economic surveillance.

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The Cyprus Banking Insight is a publication of the Association of Cyprus Banks (ACB). No part of this publication may bereproduced without the permeission of the ACB. The views and opinions expressed by the authors in the publication areprovided in the authors’ personal capacities and are their sole responsibility.

Furthermore the views and opinions expressed are not necessarily those of the ACB and its Board of Directors and must neitherbe regarded as constituting advice on any matter whatsover, nor are interpeted as such.