Via: The Banking System in Cyprus:Time to Rethink the Business Model? †Constantinos Stephanou∗World Bank           

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Cyprus is important

“Cyprus has a large banking system compared to its economy (total assets
of 896% of Gross Domestic Product or GDP in 2010), relative to the average
for the EU and the Eurozone (357% and 334% respectively in 2009). Even if
one excludes the overseas operations of domestically-owned banks, the
size of the banking system is still large and exceeds 7 times GDP.”

“The current size of the Cypriot banking system, and particularly of the two
biggest banks, raises the issue of whether growth has unequivocally been a
good thing that should continue indefinitely. In particular, against the
benefits previously mentioned are risks that need to be taken into account.
The most important of them is systemic risk – namely, the “risk of
disruption to financial services that is caused by an impairment of all or
parts of the financial system and has the potential to have serious negative
consequences for the economy” (IMF, BIS and FSB, October 2009). ”

“In the case of Cyprus, the two big domestically-owned banking groups
appear to satisfy the criteria for being systemically important based on the
aforementioned definition. Their role as intermediaries of foreign financial
flows and as providers of domestic financial services means that the
collapse of either of them would have significant negative repercussions
on the real economy and deleterious reputational effects on Cyprus as an
international business centre.”

“As in other countries, the two big Cypriot banks are operating under the
presumption by the credit rating agencies and many market participants of
government support in case of need. The recent rating downgrades of
Cypriot government debt, which prompted the rating agencies to lower
their assessment of the government’s capacity to support the banking
system and thereby led to the downgrade of the bank ratings as well,
highlights the close links between the sovereign and the banking system.”