Cyprus Banking Crisis Deepens – Uncertainty over Mortgage Rates

 

There have been reports that Cyprus Banks disagreed that a drop in the refinancing rate should also mean a drop in their base rates.

It is a clear signal to Cyprus Banks that they must cut their base rates in line with those of the European Central Bank when the island joins the euro zone in 10 days time.

Cyprus Central Bank Governor, Athanasios Orphanides said “Reading some press reports in recent days, we realised that not everyone was as sure as we were as to the correct interpretation of the law,” Orphanides said. “I was puzzled by this.”

“There were some doubts at how the conversion would work on existing loans so we decided to clarify that,” Governor Athanasios Orphanides said after an unscheduled meeting of the rate-setting monetary policy committee.

The Cyprus Informer concludes that the position is that existing customers will enjoy reduced rates while new loans will become more expensive.

In the Cyprus Mail, Stefanos Evripidou writes about “What the euro means for your loan”.

THE CREDIT market is in line for a shake-up after January 1, with interest rates on borrowing likely to go up for some and down for others, according to market analysts.

Interest rates on existing loans are likely to drop temporarily, while new loans could become more expensive.

On the one hand, the Central Bank wants commercial banks to make borrowing cheaper in line with the new interest rates set by the European Central Bank (ECB).

On the other, banks want to ensure they keep making a profit even when the lending rate is lower than the rate paid on deposits. And if there were a third hand, it would reflect the Central Bank’s deep concern over the spiralling number of new loans in the Cypriot market.

On January 1, 2008, Cyprus will adopt the euro as its official currency. The Central Bank will give up all control on monetary policy, losing its power to play with interest rates, a tool often deployed to tackle inflationary pressures. Monetary policy will become the sole domain of the ECB based in Frankfurt. The most the Central Bank can do is issue directives and circulars giving advice to commercial banks on how to keep the credit market stable and out of danger.

The ECB’s base interest rate for refinancing currently stands at 4 per cent, half a per cent lower than the Central Bank’s rate. From January 1, the ECB’s rate will come into effect in Cyprus and it is this rate which will determine all interest rate transactions, including the cost of commercial loans. As a result, the Central Bank is leaning on the banks to ensure they drop their base rate after January 1 from 4.5 per cent to 4 per cent on existing loans with floating rates. For those who borrowed on a fixed interest rate, there is obviously no change, regardless of shifts in the base rate.
Post-euro adoption, the Central Bank cannot force the banks to drop their rates, even if they are getting money at a cheaper rate. This is something that will be fixed by market forces and the level of competition.

“The Central Bank has made a recommendation to drop our base interest rates. When setting rates, our members must take into account the interests of our clients and shareholders and the advice of the supervising authority [Central Bank],” said Michalis Kammas, General Manager of the Commercial Banks’ Association.

“We can’t say if interest rates will move up or down or stay the same. The new year will show how the situation will develop,” he added.

As one market observer noted: “There isn’t much the Central Bank can do to enforce compliance. It’s all about competition in the banking sector now. Generally, the banks are expected to follow suit. And where they lose on lower interest rates for loans, they make up elsewhere.”

While the Central Bank has one eye on ensuring consumers enjoy the lower base rates set by the ECB, the other is on the worrying trend in credit expansion, which could rise even higher with a cheaper lending rate.

“If we weren’t entering the eurozone and the Central Bank still had control over monetary policy, interest rates would have gone up. The Governor is very worried about credit expansion. New loans have gone up by 22 per cent since last year, the bulk of which is on construction,” said the observer.

“It depends on the banks now to show responsibility,” he added.

A banking official who wished to remain anonymous said banks would probably take on board the Central Bank’s ‘strong recommendation’ to lower the lending rate.

“Nevertheless, there is the simple issue of economics to be taken into account.

Current deposit rates are close to 5 per cent. How will a bank survive if the basic lending rate is 4 per cent? It doesn’t make sense. Banks in Europe are experiencing the same situation. To make ends meet, they may have to increase margins on new loans,” he said.

So, existing customers will enjoy reduced rates while new loans will become more expensive. “The Central Bank doesn’t tell us what to do with new loans,” noted the banking official.

Asked if banks may try to offset the difference by increasing credit card rates, he replied: “No, because they already have a satisfactory yield. Anyway, they make up a small percentage of our lending portfolio.”

Of course, if the lending rate for new loans goes up, this means fewer people will borrow money, which helps the Central Bank affect the credit squeeze which it wants to do anyway.

Either way, the cheaper rate for existing loans may not last long, as the ECB will meet on January 8 to discuss changing the base interest rate. Reports suggest it may go up to 4.5 per cent to tackle the inflationary price rises in energy and food.

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