In business there is a saying which originates from the laws of nature; “whatever doesn’t grow, dies.” Therefore, an organization that does not evolve and grows will be outrun by its competitors. This does not happen overnight, there are always signs.

The banking sector existed before the Cyprus Republic was even formed. Its size over the years grew several times larger than the country’s GDP and has funded almost every business on the island. The sector today, however, reminds nothing of its former glory. it’s experiencing a significant decline.

First things first, what exactly is the banking business? What would best describe it is that banking is a business of trust. Banks take the money from deposits and give it to clients in the form of loans or other credit facilities. Therefore, the more deposits they have, the more money they can lend out. To attract more deposits, banks offer attractive deposit interest rates. To make a profit, they charge lenders with interest rates higher than the deposit ones. Pretty simple, and pretty much safe. But wait, it gets even better. Banks are regulated by central banks, which oppose strict rules on operations. One of them is that the banks cannot lend out all their deposits, they must keep at least a specific proportion in-house. This is called the capital ratio. The higher the risk of the bank failing, the higher the capital ratio set by the regulator. So, banks must be very safe, right? They receive deposits, loan them out to the economy, and receive interest payments back and a portion of that goes back to the depositors. Here is where it gets tricky.

The banking business is a business of trust. Depositors trust their money to the bank, and the bank trusts its lenders to pay back the loaned amount. If either of these links breaks, we have a huge problem. If depositors want their money back all at the same time, the bank does not have enough cash to satisfy its obligations. The amount of cash held equals its capital ratio. In 2023, the minimum capital ratio in Europe is 10.7%. In simple terms, if a bank holds €100 million in deposits, it might only keep € 10.7 million in cash (capital). Now if all depositors require their money, the bank is short of all the amount loaned out to lenders. This shortfall will force the bank to fail.

The second link of trust is crucial as well. The bank trusts and relies on lenders to repay their loans on time. If they don’t, the bank will have problems satisfying its obligations toward depositors and paying their deposit interest rate. When a lender does not repay on time, the loan is considered a Non-Performing Loan (NPL). So, what would happen if both links of trust were broken? Look no further than 2013, as this combination was one of the things that happened to Laiki Bank. The bank closed, with a hell of chain reactions breaking loose.

Today, both trust links are severely traumatized. Deposits, for a series of reasons, have significantly decreased. While amounting to €70,2 billion in December 2012, in December 2022 deposits are down to €52,1 billion. It’s interesting to combine these figures with total loans at the same time. In December 2012 total loans amounted to €72,5 billion and in December 2022 to €26,1 billion. Within a decade the scenery has shifted massively. The Loan/Deposits ratio is 103% for 2012 and 50% for 2022. Like every coin, this change has two sides. One side states that the more loans, the more sources, and amount of income a bank has. The other side states that the banking sector is in trouble when loans exceed deposits as it is greatly exposed. Thus in 2012, the income was significantly higher, along with the risk. In 2022 the risk is drastically lower; however, income is quite lower as well. Considering that Cypriot banks rely heavily on interest income from loans, the matter has become a great challenge to overcome.

Current conditions are not favorable. Deposit interest rates are low, thus not attractive for depositors. Acquiring a loan has become almost impossible, due to the huge amount of checks and conditions placed by the banks. But who is to blame them, when almost 50% of loans were reported as Non-Performing back in 2015?

A new competitor rises, FinTech. FinTech refers to Financial Services and Technology. The term describes any business that uses technology, like AI or blockchain, to modify, enhance, or automate financial services, both for businesses and consumers. These new players outrun banks in the speed of service, ease of use, and 24/7 responsiveness. Which is almost exactly all the perks a customer wants today. Estimations indicate that within the Eurozone, FinTech has captured up to 8% of banking revenues. This is a major blow for traditional banks, who look at their profitability shrinking rapidly. Cypriot banks suffer from decreasing profitability, as their Net Profit Margin has decreased from 4,5% (2014) to 2,2% (2021).

The Cypriot banking sector is struggling. Profits are lower, margins are thinner, trust is shaken, technology and competitors evolve faster, and banks are still trying to solve their problems. An economic sector under such conditions faces consolidation. The law of the jungle applies and only the strongest prevail. The biggest examples are the Bank of Cyprus absorbing Laiki, and the Hellenic Bank acquiring the healthy part of the Cyprus Cooperative Bank.

Over the last ten years, the sector has gone through phenomenal challenges. While seeming to bloom in 2012, the deposit haircut applied in 2013 changed everything. All weaknesses were exposed and people, who were praising the banks until then, shifted their hearts. In combination with the financial crisis at the time, banks took a huge blow of exponential NPLs and declining new loans. If there is a point in time where we should give credit to the banks is post-2013. Through drastic measures, painful operations and personnel reductions, huge transformation projects, and human capital efforts they managed to start turning the tables around. Cypriot banks made such progress, that even when the pandemic hit in 2020, they were able to support their customers by suspending their loan obligations for a period. Today the banking sector is at its healthier phase since 2013, however, it has a long way to go to ensure viability and sustainability.

Looking forward, banks must properly assess the challenges opposed by FinTech and even blockchain technologies. Upcoming EU legislation, most probably, will recognize specific blockchain technologies as means for financial transactions. In combination with FinTech evolution and expansion, Cypriot banks face heavy competition in an area where they should pay more attention to commission and services income. The banks should consider taking lessons from FinTech and collaborating with them instead of treating them as rivals. Customer satisfaction, automation of procedures, ease of access, speed of delivery, 24/7 support, technology advancements, and regaining customer trust should be on top of their agenda. Areas at which FinTech thrives! And if banks improve, they will build the competitive edge needed to become viable and grow. Elena Kontou CEO of Sepaga, a leading Electronics Money Institution, states: “For Cypriot Banks to not just survive, but thrive in today’s rapidly evolving landscape, they need to rethink their business strategies with an open mind, embrace the power of technology, and eagerly collaborate with Fintech companies.”

Cypriot banks have made huge steps towards a more viable operating model. Unfortunately, they stayed behind on current technological abilities and customer demands. The reason might be that they were an economic empire and a powerhouse in terms of supporting the Cypriot economy. They felt safe. On top of that, they are still pouring resources into exterminating the legacy problems resulting from previous NPLs and overall decreased loans. However, we cannot forget that banks are the major source of funding for any type of business in Cyprus and are one of the most significant contributors to the growth of our economy. Yet again, nothing is too big to fail, even if it is getting healthier. The sector’s share is quite large, and competitors are on the move to acquire more of their customer base and source of income. Just like a herd protecting its weaker members from coming predators, the banking sector faces a big dilemma. Will it stay slow and take hits from rivals, or will it shred the excess weight, and speed up? The matter is now obvious. Are we expecting another acquisition in the banking sector?