Banks making excessive profits from activities that are hurting businesses and society
A meeting of the Finance Committee of the House of Representatives on October 7, 2024 discussed the proposal of the general secretary of Akel, Stefanos Stefanou, for the levying of a temporary fee of 5 per cent on the increased net interest income of Cyprus banks, with proceeds to be used for financing a ‘Social Solidarity and Borrower Support Fund’.
A number of MPs, representatives of the government, the Central Bank, the Fiscal Council, and the Association of Cyprus Banks expressed the following reservations about the tax proposal.
There were unsubstantiated claims that the proposed tax on bank profits would profoundly harm the ability of Cyprus banks to contribute to economic development with the implication being that the ongoing activities of banks were contributing positively to the good performance of the Cyprus economy.
However, this is not the case. Rather than contributing to the economy and society by providing borrowers with loans at reasonable interest rates, banks are making abnormally high profits by imposing exorbitant interest rates and charges on businesses and households. And even greater profits are being made from banks investing large proportions of their huge cash holdings with the ECB to ‘earn’ substantial interest income.
Cyprus banks are not using their resources as productively as other systemically important banks in the euro area, which by the end of June 2024 had deployed 61 per cent of their assets in loans and advances. This compares with only 41 per cent for all Cyprus banks.
In 2023 Cyprus banks boosted their profits by 744 per cent to nearly €1.3 billion by depositing over 30 per cent of their assets with the ECB ‘earning’ up to an interest rate of 4 per cent.
Indeed, estimates based mainly on the financial statements of the Bank of Cyprus and Hellenic Bank indicate that the increase in interest income from the ECB was around €660 million in 2023, that is, equivalent to around 60 per cent of the increase in rise their profits. And in the first half of 2024 Cyprus banks continued to record abnormally high profits totaling €603 million owing to substantial interest income from their very large cash deposits at the ECB.
In addition, the overwhelming practice of banks of extending loans on the basis of the collateral of the borrower rather than on a proper assessment of their ability to repay together with the rise in loan interest rates have resulted in numerous loans becoming non-performing, thus leading to banks calling-in NPLs and selling off these loans and related property collateral at a profit to third parties.
It was argued that if bank profits were decreased there would be less incentive to invest in the Cyprus banks and economy in general. But, profits of Cyprus banks have been extremely high from 2022 onwards, with profits of €1.2 billion and a return on equity of 24.6 per cent in 2023 compared with an average return of 9.7 per cent for systemically important banks in the euro area.
The tax proposal would only decrease profits by an estimated €100 million over the two years 2024 and 2025. Such a small reduction would not distract foreign entities from investing in Cyprus.
With their huge amounts of cash and cash balances at the CBC and the ECB and excess reserves of over €6 billion, Cyprus banks had a liquidity coverage ratio of 328 per cent on September 30, 2024, the highest in Europe. And together with their adequate capital ratios Cyprus banks are financially-sound and are well-placed to withstand small reductions in their ample profits and funds.
The head of the Fiscal Council, Michalis Persianis stated that the permanent taxing of bank profits should be considered in the context of a general tax reform. But, as such a reform could take some years to implement, delays in determining the tax liability of banks would contribute to implicitly encouraging banks to continue to make excessive profits from activities and charges that are not benefitting, indeed hurting, businesses and society. Â Â Â Â
Furthermore, it was agreed by MPs that the finance committee should request ECB advice on this extraordinary tax matter. In the case of Italy advice from the ECB caused delay in enacting their extraordinary tax on bank profits. Thus, it is hoped that such a situation does not arise for Cyprus and that a plenary session on the proposed extraordinary tax can be scheduled at an early date.
Thus, the bottom line is that Cyprus banks have made abnormally large profits from activities such as in investing very large amounts of their loanable funds in the ECB and making gains by calling-in and selling impaired loans, that is, from activities that do not finance economic development and support society.
Accordingly, an extraordinary tax on profits of Cyprus banks is needed to return some of their gains from non-productive activities to help fund Cyprus businesses and citizens. And syphoning off a relatively small amount of profits from net interest income with a tax of 5 per cent would not hamper significantly the ability of banks with their ample funds and abnormally large profits to contribute to economic development and deter potential investors. At the same time financial stability would not be jeopardised.
Leslie G. Manison
Former Senior Economist at the International Monetary Fund, ex-Advisor at Cyprus Ministry of Finance, and a former Senior Advisor at Central Bank of Cyprus
