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Cyprus banks still struggling as deposits ebb away

Thursday, 31 Oct 2013 | 6:00 AM ET
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Cyprus' embattled banking industry will have to undergo "major structural reforms," according to a report into the sector's viability, after it came close to collapsing earlier this year.

In its final report on the country's banking industry, the Independent Commission on the Future of the Cyprus Banking Sector (ICFCBS) also described a lack of depositor confidence as a result of the crisis as a "major issue."

"Steady leakage of deposits continues despite the existence of capital controls," the report, which was published on Thursday, said.

(Read more: ECB's Draghi:New bank stress tests 'just the beginning')

"The Commission believes that the best way to restore confidence within a reasonable time frame is for the government to issue a state guarantee of all deposits in Cyprus banks, and for this to be backed by a commitment from the European authorities to provide the necessary capital and liquidity support."

In March, international lenders including the European Union, the European Central Bank (ECB) and International Monetary Fund stepped in to rescue the flailing sector in an effort to resolve country's financial crisis.

The so-called "bail-in" agreement saw shareholders and bondholders bear some costs of restructuring, and included a controversial levy on uninsured bank deposits over 100,000 euros ($136,000). Authorities also imposed temporary restrictions on bank transactions in an effort to avoid large depositors in the country's banks immediately withdrawing their money.

(Read more: ECB sets tests to strengthen Europe's banks)

The ICFCBS's report added: "The Cyprus banking industry will have to undergo major structural reform to achieve viability under the new realities. Costs will have to be cut, branch networks reduced, and high staffing levels brought down."

The year-long inquiry into the sector, which was commissioned by the Central Bank of Cyprus, resulted in 35 recommendations, including calls for a review of the structure of the country's financial services market.

The Commission said Cypus' international financial services business should continue - but should rely more on the quality of services, rather than on tax breaks. These exacerbated the country's banking crisis as they resulted in foreign investors piling into the country's banks, inflating the size of the sector.

The report also stressed that better corporate governance was needed across the industry, and said poor governance at the Central Bank of Cyprus in particular contributed to the crisis by concentrating too much power in the hands of its governor.

"The solution lies in having a stronger non-executive board membership with clearly defined board responsibilities, and a more formalized executive structure," the report said.

Its other recommendations included calls for a national financial services strategy to provide a framework for the banking industry; the bringing together of the country's co-operative credit institutions into one joint-stock entity; and the strengthening of consumer protection measures.

(Read more: Spain to 'come out on top' in stress tests)

David Lascelles, chairman of the Commission and former banking editor at the Financial Times, insisted that although the recommendations were daunting, "it is in Cyprus' power to address all of them."

He added that Cyprus' banking crisis contains lessons that can "help strengthen international best practice in areas such as the management of large banking systems and crisis recovery."

Europe's banks have been at the heart of the euro zone's financial crisis, after taking on too much debt which turned toxic when borrowers struggled with their repayments. A number of European governments were forced to step in and rescue their struggling institutions – deemed in many cases "too big to fail" – which in turn hit the solvency of these already debt-laden countries.

Last week, the president of the ECB, Mario Draghi, unveiled the tough criteria for its stress tests of the euro zone's banks, designed to analyze lenders' ability to withstand adverse economic conditions.

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