Risk Management in Banks in Cyprus - Essay Example

Conduct a literature review on risk management in banks in CYPRUS, with particular reference to how far risk management is reconcilable with whole economy and market efficiency. Risk management is extensively used by organizations of all types in order to estimate the risk involved in various strategic plans. Usually, advanced IT systems are employed in order to develop specific risk management strategies; however, risk management is not exclusively depended on technology. It is rather related with the structure and the strategic options of a particular organization. In the banking sector, the use of risk management policies has been proved to be particularly helpful in order to protect the firms operating in the specific sector from severe failures – at least this was the initial target when introducing risk management in the banking industry. On the other hand, because the complexity of projects developed by the firms operating in the banking sector can be high, the application of risk management plans on banks and other financial institutions operating in the banking sector needs to be closely monitored and controlled by the state either directly or indirectly. In most cases, countries around the world tend to follow similar practices regarding the development of risk management plans in the banking industry; however, social and cultural ethics and trends as well as the strength of the national economy are likely to influence the structure and the effectiveness of these plans especially when the global political and financial conditions are not stable. In Cyprus, the use of risk management in the banking sector presents differentiations as a result of the co-existence of two different cultural and political systems in the same geographic region. In a recent study (of 2007) it is noticed that ‘the speculative attack on the Turkish Lira in 1994 and 2001 put stress on banks operating in North Cyprus and led to banking sector distress; bank-specific weaknesses, high interest rates, high credit, low trade and the fixed exchange rate policy significantly increased the bank fragility’ (Gunsel, 2007, 410). The above findings are related with the banks operating in North Cyprus. In the rest of the island the development of a strong financial system has ensured the stability in the performance of the firms operating in the banking sector. In accordance with the view of A. Eliades (CEO of Bank of Cyprus) ‘a year-and-half ago we started taking preemptive measures to reduce risk, lower leverage and boost our liquidity to very high levels so that if and when a crisis would pop up, we would be prepared’ (Financial Mirror, October 3, 2008, online article). In Cyprus, the effects of global recession have been limited mostly because of the measures taken in advance by the government but also the CEOs in the firm’s major financial institutions. The measures mentioned above have helped towards the protection of the country’s economy against the global financial turbulences. An indicative example of the effectiveness of the above measures is the fact that ‘current ratio of loans to deposits of Cyprus banks is 90%, and even if the foreign currency deposits are excluded from the overall calculation, the ratio goes to 110%’ (Financial Mirror, November 27, 2008). This is a significant achievement of CEOs in Cyprus banks; the balance between loans and deposits can be used in order to highlight the effectiveness of the financial policies used by a country’s financial institutions. The effectiveness of risk management techniques used by the Cyprus banks (as indicatively described above) can be also proved by the fact that the profitability of the banks in Cyprus has remained at high levels (at the levels set in advance) reaching the 540 million euros by the end of the year, 2008 ( Reuters, November 6, 2008). One of the main reason for the success of the country’s central bank – the Bank of Cyprus – has been the fact that the latter ‘has no exposure to high-risk derivative products and has minimal reliance on wholesale (11 percent) whereas 80 percent of the group’s assets are funded by customer deposits’ (Reyters, November 6, 2008). Apart from the general risk management techniques adopted by managers in Cyprus banks, additional measures have been also employed in order to help towards the limitation of risk across the country’s banks. In this context, the use of Moody’s Risk Advisor, a System designed in order to offer credible risk assessment and estimation of cost related with the various banking projects has helped the Bank of Cyprus to improve its existing risk management strategy (Moody’s, 2008, online article). More specifically, the specific system has been implemented in the Bank of Cyprus supporting the limitation of risk related with the organization’s projects and strategic initiatives. The difficulties involved in the development of effective risk management strategies in the firm’s of Cyprus banking sector can be related with the fact that within the country two different ‘banking frameworks’ – onshore and offshore – co-exist in order to serve the needs of the foreign investors. Since its entrance in the European Union, Cyprus had to change its existing banking rules and ethics ensuring the increase of clarity in the transactions conducted in the country’s financial institutions (EurActiv, 2003, online article). The performance of the firms operating in the banking sector of the particular country proves that the policies adopted by the state – regarding the specific sector – can be characterized as justified – especially if taking into consideration the strong political and financial turbulences worldwide. Regarding this issue, it is noticed that during the last 15 years the economy of Cyprus has been improved, a fact that is clearer if the country’s financial characteristics are thoroughly examined. More specifically, it has been proved that ‘since 1992, the year in which the Cyprus pound was formally pegged to the ECU, growth has averaged 3.5% and inflation 3.25%’ (European Commission, 2007, online article). It is not clear whether the banks in Cyprus have to change their risk management policies under the influence of the global financial crisis; rather the current strategies should be followed emphasizing on the importance of deposits for the development of banking projects. On the other hand, it should be noticed that risk can have many aspects – even in banking. Credit risk is one of these aspects which should be handled carefully by the firm’s employees trying to protect both interests of the parties involved – i.e. the individual/ investor and the financial professional. The concept of credit risk has been introduced in order to explain the strategic plans of managers in banks and other financial institutions; in this context, it is explained that ‘credit risk is the chance that a counterparty to a financial transaction failing to perform according to the terms and conditions of the contract’ (West, 1998, online article). Under the above terms, the effectiveness of the measures taken by the banks in Cyprus can be explained if taking into consideration the main criteria used by managers in these banks in order to ensure the profitability of their organizations; high level of loans offered and increase of deposits of individuals/ firms are two major policies used by managers in Cyprus banks. In the literature, it has been proved that the specific techniques are effective towards the increase of the profitability of a banking institution. More specifically, it has been proved that ‘the benefits of advances in risk management in banking may be greater credit availability, rather than reduced risk in the banking system’ (Cebenoyan et al., 2004, 19). In other words, the success of banks in Cyprus can be possibly identified to the fact that the country’s financial institutions follow a rather aggressive strategy by increasing their investments (as loans and FDI) instead of reducing the money invested in the private and the public sector. References Cebenoyan, A., Strahan, P. (2004) Risk management, capital structure and lending at banks. Journal of Banking and Finance, 28(1): 19-43 Central Bank of Cyprus (2004) Banking in Cyprus, available from http://www.centralbank.gov.cy/nqcontent.cfm?a_id=28&lang=en EurActiv (2008) What challenges for Cyprus and Malta? available from http://www.euractiv.com/en/enlargement/challenges-cyprus-malta/article-110396 European Commission (2008) Economic and Financial Affairs, Issue 9, available from http://ec.europa.eu/economy_finance/een/009/article_6467_en.htm Financial Mirror (November 27, 2008) No worries about the banks in Cyprus, available from http://www.searchcyprus.eu/index.php?option=com_content&view=article&catid=60:financial&id=116:no-worries-bank-cyprus&Itemid=144 Financial Mirror (October 3, 2008) Bank of Cyprus in Russia is safe, says CEO, available from http://www.xak.com/main/newsshow.asp?id=91314 Gunsel, N. (2007) The North Cyprus banking sector: the effect of a speculative attack on the Turkish Lira. The Journal of Risk Finance Incorporating Balance Sheet, 8(4): 410-421 Moody’s (2008) Client Spotlight: Bank of Cyprus, available from http://www.moodyskmv.com/about/clientspotlight_BC.html Reuters (November 6, 2008) Bank of Cyprus 9-month net profit up 1 pct, available from http://www.reuters.com/article/bankingFinancial/idUSL528185320081106 West, L. (1998) Can Credit Risk Go The Distance? Bank Technology News, available from http://www.highbeam.com/doc/1G1-53004816.html Read More