## Preface ## Source details **Canonical URL:** [Preface](https://www.imf.org/-/media/files/publications/ofca/english/073001a.pdf) ## Other formats - [Markdown version](/-/media/files/publications/ofca/english/073001a.pdf.md) - [Structured JSON version](/-/media/files/publications/ofca/english/073001a.pdf.json) --- ### Scope and purpose - The Governor of the Central Bank of Cyprus (CBC) invited the International Monetary Fund to carry out an assessment in March 2001 of the extent to which Cypriot supervisory arrangements for the offshore financial sector complied with internationally accepted standards. - The assessment used the “Module 2” approach described in the paper “Offshore Financial CentersThe Role of the IMF” (July 2000). - The document provides a detailed assessment of compliance with the individual Basel Core Principles for Effective Banking Supervision in respect of the offshore banking sector in Cyprus; principal conclusions are summarized in a separate main report. ### Principle 1 — Clear responsibilities and objectives; independence; legal framework; powers; protections; information sharing - Principle 1 summary: An effective system of banking supervision requires clear responsibilities and objectives for each supervisory agency; operational independence and adequate resources; a suitable legal framework covering authorization and ongoing supervision; powers to address legal compliance and safety-and-soundness concerns; legal protection for supervisors; and arrangements for information sharing and confidentiality. H3: 1(1) Clear responsibilities and objectives - Description and legal basis: - Central Bank of Cyprus Law effective from 1963; Section 6 assigns powers including to supervise banks. - Banking Law Section 26 assigns CBC responsibility for supervision to ensure orderly functioning of the banking system. - Section 34 gives the CBC responsibility, as agent of the Ministry of Finance, for administration of foreign exchange control legislation then in force. - All responsibilities for banking supervision rest solely with the CBC; CBC decides when and how to effect the orderly resolution of a problem bank. - Banking Law Section 30(3) requires CBC to consult with the Minister of Finance before certain enforcement actions. - Banking Law Section 4 (5) requires consultation with the Minister on policy with respect to granting licenses. - The Banking Law was enacted in 1997 and amended on June 25, 1999 and June 30, 2000. - Assessment: Compliant. H3: 1(2) Operational independence and adequate resources - Facts: - CBC is independent and managed by a Board of Directors: the Governor and five Directors. - The President appoints the Governor for a term of office of up to five years; current law does not specify reasons required for removal nor require public disclosure of reasons. - A new law is being prepared to ensure complete independence of the CBC, including preventing removal of the Governor prior to expiry of term. - Supervision is divided between domestic and international sections. Total staff: 35, of whom 12 are responsible for monitoring and examining 31 International Business Units/Administered Banking Units, 116 International Finance Companies and 12 International Trust companies. - There are currently four staff vacancies. - Average experience of staff related to banking supervision is 15 years. - Salary levels have reportedly fallen below industry levels in recent years. - CBC can seek reimbursement of costs for on-site examination but has not made use of this right; this is included as part of conditions imposed on IBU licenses. - Targets for on-site review completion: once a year for locally incorporated banks and once every two years for branches; some banks have not had a full review for more than three years. - Assessment: Materially noncompliant. - Recommendations and operational findings: - Shortcomings in the law regarding reasons for removal of the Governor are being addressed in the new law under preparation. - CBC should publish supervisory commentary in its annual report to inform the public about supervisory activities and how they have been discharged. - Staffing is insufficient: 12 persons currently supervise IBUs/ABUs/IFCs; more staff are required to shorten intervals between on-site visits and meet CBC targets. - Vacant positions (four) should be filled at an early date to enable increased on-site reviews and reduce intervals between reviews. H3: 1(3) Legal framework for authorization and ongoing supervision - Description and powers: - CBC designated as Banking Supervisory authority under Central Bank of Cyprus Law (Section 6) and Banking Law (Section 26) for granting and withdrawing banking licenses. - Banking Law (Section 30) empowers CBC to require banks to take actions it considers necessary, including prohibiting acceptance of deposits or granting credit, assuming control of a bank, or revoking a bank’s licence. - Banking Law (Section 26) requires banks to make available to the CBC all books and records and to provide information in the form and frequency the CBC deems necessary. - Decisions of the CBC are subject to appeal to the High Court of Justice. - CBC publishes an annual report and current and historical statistics; all locally incorporated banks must file audited financial statements with the CBC. - Assessment: Compliant. H3: 1(4) Powers to address compliance and safety-and-soundness concerns - Statutory powers: - Banking Law Section 41 empowers CBC to set prudential rules autonomously and administratively, except with regard to policy of granting banking licenses (Section 4.5). - Section 30(1) permits remedial measures when banks fail to comply or when asset liquidity is impaired, including prohibition on deposits/credit, assuming control, and revocation of license after consultation with the Minister of Finance. - Section 26 gives CBC unfettered access to institutions' records and books. - Assessment: Largely compliant. - Recommendation: - Consultation requirements with the Minister of Finance should be formally limited to policy issues to ensure full operational autonomy over individual institutions. H3: 1(5) Legal protection for supervisors - Legal provision: - Banking Law Section 32: neither the Central Bank nor any Director or officer shall be liable in any action for damages for actions or omissions in discharge or purported discharge of functions under the Law unless it is shown the act or omission was not in good faith or was the result of gross negligence. - Assessment: Compliant. H3: 1(6) Arrangements for information sharing and confidentiality - Practice and instruments: - CBC responsible for domestic and international banking supervision and administration of the Exchange Control Law. - No formal domestic inter-agency arrangements but continuing contacts with the Superintendent of Insurance, Registrar of Companies and Head of the Unit for Combating Money Laundering. - Banking Law Section 27 enables CBC to provide home supervisory authorities information enabling consolidated supervision; information on individual accounts is excluded. - Memoranda of understanding signed with Russia, Belarus, Bulgaria and Ukraine; negotiations started with supervisory authorities of the United Kingdom, Greece, Romania, France, and Austria. - Finding: - Formal written arrangements for routine information sharing are limited, though multiple bilateral MOUs exist or are under negotiation and practical cooperation is active. ### Confidentiality, secrecy, and permitted disclosures (legal provisions) - Statutory confidentiality and permitted disclosures: - CBC Law Section 17(4): every director, officer or employee of the Bank shall be bound to secrecy. - CBC Law Section 18: Governor, Directors, officers and employees must take the oath of fidelity and secrecy before assuming duties. - Banking Law Section 29(1) prohibits bank supervisors from divulging customer account information except in enumerated cases (e.g., written permission, bankruptcy/winding up, civil proceedings, information to police or authorized public officer, garnishee orders, internal duties, creditworthiness assessments of a general nature, public interest or protection of bank interests). - Assessment: Compliant. - Practical point: Both legislation and practice provide for a full range of information to be shared with domestic and foreign regulators within statutory limits. ### Principle 2 — Permissible activities of licensed banks and control of the word “bank” - Legal definitions and limits: - Banking business defined in Section 2: lending of funds acquired from obligations to the public (deposits, securities or other evidence of debt). - Section 13 permits activities integral or closely related to banking, including securities activities under Section 13(3). - Section 13(1): a bank is limited from holding directly or indirectly more than ten percent of the share capital of any other company; aggregate holdings for banks incorporated in Cyprus shall not exceed 25 percent of the bank’s capital base. - Section 15 prohibits acquiring and dealing in its own shares. - Licensed banks may engage in insurance brokerage and may hold up to 100 percent of the share capital in an insurance company provided it is incorporated in the Republic. - Section 5: no person other than a bank shall use the word bank without prior written approval of the Central Bank. - Section 6: prohibits advertising for deposits by persons other than a bank, cooperative society or Housing Finance Corporation. - Section 3: only licensed institutions may accept deposits. - Assessment: Compliant. ### Principle 3 — Licensing authority powers, criteria, and processes - Licensing framework: - CBC is both the licensing and supervisory authority; Banking Law Section 4 permits CBC to grant licenses subject to conditions or refuse (Section 4). - Licensees required to establish a real presence and operate with staffing appropriate to scale. - Exception: Administered Banking Units (ABUs) administer day-to-day operations through an administering bank. - CBC may set minimum and higher capital requirements (Section 20). - Principal licensing criteria: - At least two directors participate in effective direction and management (Section 19). - Minimum capital for a bank incorporated in the Republic: not less than C£3m or higher amount determined by CBC (Section 20). - Directors, Chief Executives and Managers must be fit and proper. - Feasibility study with projected financial statements for the first five years required. - For foreign banking organizations CBC seeks consent and undertaking from home supervisory authority and Letters of Comfort from principal shareholders. - IBUs/ABUs restrictions: - Restricted to deal primarily with non-residents and in currencies other than the Cyprus Pound; since January 1, 2001, IBUs/ABUs allowed to make foreign currency loans to residents. - Recent licensing outcomes: - In the last two years five applications received (one domestic and four for IBUs); one domestic application rejected due to unsuitable major prospective shareholder; two successful; two did not satisfy eligibility criteria. - Assessment: Largely Compliant. - Improvement area: - More emphasis on obtaining information directly from foreign law enforcement and judicial systems rather than relying mainly on private investigations for fitness and reputation checks. ### Principle 4 — Authority over transfers of significant ownership or control - Legal rules and practices: - Banking Law Section 17: no person shall acquire or control a bank without prior written approval of the CBC. - Control defined as beneficial ownership carrying 10 percent or more of voting rights. - Section 16: bank shall not sell or dispose whole or part of its business without prior written approval of the CBC. - CBC considers reputation, depositor protection and competition when granting approvals. - CBC never licenses de novo institutions and conditions locally incorporated IBUs/ABUs against issuing further capital or transferring shares without CBC approval. - Assessment: Compliant. ### Section 13 — Investment limits, real estate restrictions, and capital adequacy (Principle 6) - Investment and expansion limits (Section 13): - A bank shall not acquire or hold directly or indirectly more than 10 percent of the share capital of any other company. - For a bank incorporated in the Republic: value of any share capital held in any other company shall not exceed 10 percent of the bank’s capital base; aggregate for all companies shall not exceed 25 percent of the bank’s capital base. - Exceptions: investments in insurance companies and companies carrying out banking or integral banking functions incorporated in Cyprus. - Prior written approval of the CBC required for investments exceeding limits and for expansion of operations outside Cyprus; approval conditional on availability of information, on-site examination access and ability to exercise consolidated supervision. - CBC reviews business plan and takes into account existence and size of ethnic community in proposed country of operation. - Real estate restrictions (Section 12): - Section 12 prohibits acquisition or purchase of immovable property by banks except in specified cases. - Conditions for IBUs/ABUs incorporated in Cyprus: - Prior written CBC approval required for issuing further capital other than pro-rata to existing beneficial shareholders; registering transfer of shares; creating subsidiaries; participating in share capital of another bank or financial enterprise; opening a branch or Representative Office. - Assessment of Section 13 and related licensing requirements: Compliant. - Capital adequacy (Section 20 and Section 21): - Minimum capital base for banks incorporated in the Republic: not less than £3m. - Capital adequacy ratio required at such minimum level as determined by CBC; at present, the required capital adequacy ratio stands at 10 percent. - It was increased from 9 percent to 10 percent with effect from 1.1. 2001. - Capital adequacy ratio computed in relation to total assets, including off-balance sheet exposures (Section 21). - CBC issued two directives (January 1999) on computation of capital base and computation of capital adequacy ratio; these directives conform to the Basle recommendations and use BIS risk weights and components of capital. - Capital adequacy ratios calculated on both a consolidated and solo basis; branches of foreign incorporated banks are not required to have capital and therefore do not maintain a capital adequacy ratio. - Treatment and limits: - Subordinated debt included in tier two capital and cannot exceed 50 percent of tier one capital. - The total of tier two capital cannot exceed the total of tier one capital. - Revaluation gains credited to revaluation reserve; balance included in tier two capital. - Unrealized losses debited to the revaluation reserve to the extent covered by revaluation gains; any shortfall debited to the Profit and Loss Account, which is included in tier one capital. - Under Section 30.1 CBC has broad remedial powers where capital ratios fall below a certain limit. - Assessment of capital adequacy framework: Compliant. ### On-site examination and asset quality supervision (Principles 7 and 8) - Supervision practice: - All licensed banks subject to regular on-site examination, with prime objective to assess asset quality and adequacy of loan loss reserves. - Examiners review appraisal and authorization of credit exposures, identification of substandard lending, and provisioning policy. - Banks required to review asset quality at least once a year. - Under Section 28 CBC can arrange at least once a year trilateral meetings with each bank and its auditors; auditors may freely report to the CBC any information relevant to supervisory responsibilities. - Asset classification criteria used by CBC: - Pass; Special Mention; Substandard; Doubtful (with examples and provisioning guidance). - The internationally recommended Basle additional criteria (e.g., loans contractually a minimum number of days in arrears such as 30, 60 and 90 days) are recognized. - Findings and assessments: - CBC has developed no generally applicable criteria for classifying losses and provisioning; provisioning determined by bank with external auditors. - CBC examiners review more than 50 percent of Balance Sheet value of bank loans via samples biased to large/problematic loans. - Some banks reported no onsite review for more than three years. - Assessments: Principle 7: Compliant. Principle 8: Largely compliant. - Recommendations: - CBC should develop generally applicable criteria for loan classification and provisioning consistent with best international practice. - CBC should adopt a more conservative stance regarding classification where refinancing and restructuring do not change loan status absent demonstrably realizable collateral. ### Concentration limits and connected lending (Principles 9 and 10) - Statutory limits (Section 11): - Lending to a single person may not exceed 25 percent of the bank’s capital base. - Aggregate of all large facilities as defined in Section 11(4)(b) may not exceed 800 percent of the bank’s capital base. - Aggregate of all credit facilities granted to the bank’s directors may not exceed 40 percent of its capital base. - Total value of any unsecured facilities granted to all the directors of the bank may not exceed 5 percent of the bank’s capital base. - Aggregation and treatment: - Lending to connected persons is grouped for compliance; CBC may treat interrelated interests as one person. - CBC directive requires submission of returns on concentration on a solo and consolidated basis and verification during on-site examinations. - Any infringement of statutory limits is a criminal offence (Sections 11 and 43). - Assessment: Compliant. ### Related-party lending and capital treatment (Section 11) - Legal requirements: - Section 11(1)(c): lending to directors must be approved by Board resolution without the director voting and must be on an arms-length basis. - Section 11(1)(c) and 11(1)(d): aggregate lending to directors limited to 40 percent of capital base; unsecured facilities to directors limited to 5 percent of capital base. - Section 11(3) and the Directive (April 2000): interests of interrelated persons combined for limit calculations. - Lending to affiliates not at arms length is regarded as lending of a capital nature and deducted from the bank’s capital base. - Assessment: Compliant. - Supervisory emphasis: Transactions with related parties receive special attention in on-site examinations. ### Principle 11 — Country risk and transfer risk - Practice: - No formal limits regarding country risk and transfer risk. - CBC obtains monthly reports including data on country exposures and has issued letters directing banks to limit risks to certain countries from time to time. - Assessment: Largely compliant. - Recommendation: CBC should consider requiring banks or head offices to set formal country/transfer risk limits and notify CBC. ### Principle 12 — Market risk measurement and control - Foreign exchange risk rules and capital charge: - Banks required to contain foreign currency exposure for each currency to no more than 10 percent of their capital base. - Overall exposure for all currencies limited to 15 percent of capital base. - Overall open foreign currency position equals the sum of all net short positions or net long positions whichever is greater. - If overall net foreign exchange position exceeds 2 percent of a bank’s capital base, a capital charge of 10 percent as from 1.1.2001 is required to be set-aside on the amount in excess. - Supervisory status: - Current rules under review: proposal to lower foreign currency limits, introduce different limits for intra day and overnight positions, require stop loss limits on a daily and cumulative basis, and require demonstration of monitoring ability. - No regulations or guidelines regarding other market risks (interest rate risk or securities position risk). - CBC views IBU market activity as low (no options or derivatives trading). - Assessment: Materially noncompliant. - Key intent: - CBC intends to implement policies by the end of the year requiring banks to hold capital in relation to market risks and to align with the EU’s Capital Adequacy Directive (CAD); CAD reporting will at least enable CBC to monitor risks. ### Principle 13 — Comprehensive risk management (other material risks) - Liquidity, interest rate and operational risk frameworks: - CBC directive on prudential liquidity uses maturity-banding and mismatch ratios; banks must monitor liquidity daily and submit liquidity return quarterly. - Implemented mid-2000 for domestic banks; similar return exists for IBUs/ABUs but allowable mismatch ratios for IBUs/ABUs not yet determined (expected in the very near future). - Banks set internal limits for interest rate risk; CBC verifies conservatism during onsite inspections. - For operational risk banks have back-up facilities and internal auditors; CBC verifies during onsite exams. - Assessment: Compliant. - Supervisory authority: - CBC empowered under Section 30 to require a bank to hold capital against any risks. ### Principle 14 — Internal controls and governance - Supervisory coverage: - On-site review covers internal audit/controls, credit administration, credit control, credit review, treasury management, management information systems. - IBU/ABU license conditions require external auditors to report directly to CBC on internal control adequacy and information to Head Office. - CBC assesses internal audit resourcing, independence and reporting lines; weaknesses communicated to management. - Licensing requires detailed personal questionnaires and independent verification for directors and senior management. - Legal limits: - Banking Law does not explicitly identify directors’ responsibilities regarding corporate governance or expressly empower CBC to require changes in board composition; CBC may use Section 30 indirectly. - Assessment: Compliant. ### Principle 15 — Anti–money laundering (AML) and know-your-customer (KYC) - Legal and supervisory framework: - Prevention and Suppression of Money Laundering Activities Law (PSMLA), enacted 1996, criminalizes laundering and provides confiscation, freezing, mandatory reporting to the Unit for Combating Money Laundering (UCML), and KYC, record-keeping, internal control and training requirements. - CBC issued Guidance Note under Section 60(3) of PSMLA to banks and guidance to IFCs, ITCs, ICISs and Managers/Trustees. - CBC on-site examinations assess AML compliance and require Money Laundering Compliance Officers. - KYC practice and exemptions: - PSMLA requires identity verification when establishing account relationships except where law allows exemption (e.g., persons reasonably believed to carry on relevant financial business). - CBC Guidance Note permits, in exceptional circumstances and at the bank’s peril, opening trustee/nominee accounts without beneficial owner identification only under strict conditions (trust in trustee/nominee, estimate of likely turnover, undertaking regarding beneficial owner identity, and at least biannual review). - Acceptance of companies with bearer share issuance is permitted only in exceptional circumstances subject to strict conditions (CBC Guidance Note paragraph 2.7 of Section 2). - Reporting statistics and information exchange: - From January 1997 to December 2000, the Unit received a total of 206 domestic reports: 92 from financial institutions, 51 from the Police, 50 from the Customs Department, and 13 from other sources. - No formal mechanism requires the Unit to communicate such information to supervisors, but informal channels are customarily used. - CBC not empowered to exchange information directly with other domestic or foreign supervisors; under PSMLA the Unit is the competent authority to cooperate with overseas Units. - Assessment: Largely Compliant. - Identified weaknesses and recommendations: - Improve identification of beneficial owners and reporting of suspicious transactions. - Extend CBC’s November 23, 2000 Guidance Note list of jurisdictions to include additional jurisdictions with deficient AML frameworks. - Statutorily define what constitutes satisfactory evidence of identity and make obtaining satisfactory evidence a statutory requirement. - Strengthen trustee/nominee account procedures to ensure beneficial owners are appropriately disclosed. - Enhance collection of ordering-customer information on incoming fund transfers; discretion-based practices do not ensure consistent collection. - Increase frequency of onsite reviews, particularly for high-risk institutions. - Licensing investigations should make greater use of independent sources (e.g., police clearance certificates). - CBC must ensure it will always receive reports about suspicious activities, including names of supervised entities, to assist surveillance. ### Principle 16 — On-site and off-site supervision - Legal powers and reporting: - Banking Law Section 25 and Section 26 grant CBC extensive powers to obtain information and access books/records with secrecy protections (Section 26(3)). - Section 27(1) permits CBC to provide appropriate overseas supervisory authorities information enabling their supervisory functions; Section 27(2) prohibits divulging individual deposit account information. - Off-site monitoring and returns: - Periodic returns include monthly balance sheet, profit and loss account, capital adequacy, capital base computation, prudential liquidity, monitoring and control of credit facilities, foreign currency exposure, analysis of assets and liabilities by country, AML procedures, etc. - CBC analyzes, trends and compares findings to monitor condition and compliance. - On-site examination scope and frequency criteria: - Objectives include compliance checks, verification of risk management/internal controls, information reliability, and evaluation of condition and prospects. - Frequency/scope criteria: size, growth, contribution to group, offsite results, special issues, and availability of resources. - Communication and interaction: - On-site findings communicated via management letters and discussed with CEO and senior management; reports escalated to the Governor. - CBC meets external auditors and may require auditing of returns; Section 28 mandates annual trilateral meetings. - Assessment: Largely Compliant. - Resourcing and procedural gaps: - Frequency of onsite inspections needs stepping up; resources must increase to meet planned frequencies. - CBC should consider early-warning systems drawing on prudential reports to detect problems earlier. ### Principle 17 — Regular contact with bank management - Practice: - Off-site monitoring, on-site examinations, and trilateral meetings deliver regular contact and understanding of management and operations. - CBC holds at least once-a-year trilateral meetings with each bank and its external auditors (Section 28). - Section 40 requires banks to inform CBC forthwith if they have indication they may face serious difficulties or be unable to meet obligations or are about to suspend payment. - Observations and recommendations: - Market complexity low; no in-house resources specifically devoted to market monitoring. - In-depth onsite meetings are becoming less frequent because of staff shortages; some institutions have not had an onsite review for more than three years. - Recommendation: CBC should make it mandatory for supervised institutions to report any material adverse change in condition as early as possible (e.g., dismissal of a senior officer). ### Principle 18 — Prudential reporting and consolidated basis - Status: - CBC collects, reviews and analyses prudential reports and statistical returns for solo and consolidated basis where applicable. - International Banking Units are not permitted to have subsidiaries or branches abroad; consolidated supervision not applicable to IBUs under current restrictions. ### CBC authority to obtain information, auditor roles, and disclosure requirements - Authority and returns: - Banking Law Section 26 gives CBC authority to obtain any information at necessary frequency; standardized returns required across categories. - Periodic returns include monthly balance sheet, liquidity return, analysis by country, foreign currency exposure, six-monthly profit and loss analysis, capital adequacy, large credit exposures, etc. - Auditor interaction and validation: - On-site examiners validate supervisory information; external auditors may be appointed and required to report directly to CBC in special circumstances. - External auditors must be expressly authorized by CBC prior to appointment; in practice banks audited by big five international firms. - Section 28 requires annual trilateral meetings and protects auditors when reporting in good faith to CBC. - Accounting and disclosure: - Section 24(1): banks must submit audited balance sheet and profit and loss account within four months from end of financial year, certified by an approved auditor. - CBC may prescribe accounting form and has adopted international accounting standards with slight modifications to harmonize with EU directives. - Financial statements required to be prepared on a consolidated basis for banks incorporated in the Republic; branches of foreign incorporated banks not required to publish financial statements. - For IBUs/ABUs, license conditions require making audited accounts and auditors’ reports available to interested users. - CBC publishes key banking statistics obtained from returns and updates information on licensees, senior management and authorized signatories. - Assessment: Compliant. ### Supervisory powers, remedial measures, and penalties - Remedial powers and consultation requirement: - Section 30 provides remedial powers including prohibition of deposits/credit, assuming control, and revocation of licence; consultation with the Minister required before taking most remedial measures. - Administrative fines under Section 42 range from one thousand to ten thousand pounds for failure to provide information within specified time limits. - CBC does not have authority to apply penalties to individual members of bank management or board; CBC views Exchange Control Law as providing sufficient authority to effect management/board changes. - Examples of license revocations: - November 18, 1998: banking license of the Cyprus branch of Inkombank revoked. - June 1, 1999: banking license of the Cyprus branch of Menatep revoked. - May 3, 2000: banking license of the Cyprus branch of Beogradska Banka revoked to safeguard depositors and third parties amid going concern problems. - Assessment: Largely compliant. - Recommendation: - Delete requirement for consultation with the Minister before supervisory action to ensure full independence of the supervisor. ### Consolidated supervision, cross-border cooperation, MOUs and standards for foreign banks - Cross-border cooperation: - MOUs signed with Russia, Belarus, Bulgaria and Ukraine; negotiations ongoing with United Kingdom, Greece, Romania, France and Austria. - MOUs cover scope of information, transactions, accounts and deposits, cooperation on onsite examinations and confidentiality. - CBC allows foreign home supervisors to conduct onsite inspections in Cyprus and share files including individual depositor information. - Examples of foreign onsite reviews: Central Banks of Lebanon, Jordan, Russia, Bulgaria, and Yugoslavia. - Local operations of foreign banks: - Local branches of foreign banks exempt from own capital and capital adequacy requirements but inspection and reporting requirements similar to domestic banks. - CBC seeks permission from home supervisors during licensing and informs home supervisors where material matters occur. - Assessment: Compliant where applicable; Principles on consolidated supervision (Principle 20) marked Not applicable given policy preventing IBUs/ABUs from establishing foreign subsidiaries. *Source: International Monetary Fund assessment at the request of the Governor of the Central Bank of Cyprus (invitation received March 2001).* ### Preface................................................................................................................. ### Preface ### Scope and purpose - The Governor of the Central Bank of Cyprus (CBC) invited the International Monetary Fund to carry out an assessment in March 2001 of the extent to which Cypriot supervisory arrangements for the offshore financial sector complied with internationally accepted standards. - The assessment used the “Module 2” approach described in the paper “Offshore Financial CentersThe Role of the IMF” (July 2000). - This document contains a detailed assessment of compliance with the individual Basel Core Principles for Effective Banking Supervision in respect of the offshore banking sector in Cyprus; principal conclusions are summarized in a separate main report. ### Principle 1 — Clear responsibilities and objectives; independence; legal framework; powers; protections; information sharing - Principle 1 summary: An effective system of banking supervision requires clear responsibilities and objectives for each supervisory agency; operational independence and adequate resources; a suitable legal framework covering authorization and ongoing supervision; powers to address legal compliance and safety-and-soundness concerns; legal protection for supervisors; and arrangements for information sharing and confidentiality. H3: 1(1) Clear responsibilities and objectives - Description: - The Central Bank of Cyprus Law came into effect in 1963. - Section 6 of the Central Bank of Cyprus Law provides the CBC shall have power: - To regulate the supply of money and credit; - To manage and administer the international reserves of the Republic; - To supervise banks in the Republic; - To act as banker and financial agent of the Government of the Republic. - Section 34 of the Central Bank of Cyprus Law makes the Bank responsible, as agent of the Ministry of Finance, for administration of foreign exchange control legislation then in force. - The Banking Law provides in Section 26 that the CBC is responsible for the supervision of banks to ensure the orderly functioning of the banking system. - All responsibilities for banking supervision rest solely with the CBC; the CBC decides when and how to effect the orderly resolution of a problem bank. - Under the Banking Law (Section 30(3)) the CBC is required before acting to consult with the Minister of Finance with respect to certain enforcement actions: (i) completely prohibiting until further notice the acceptance of deposits or the granting of credit facilities by the bank, or both; (ii) consulting with other banks with a view to determining the action to be taken; (iii) assuming control of, and carrying on in the bank’s name the business of the bank; and (iv) revoking the license of the bank. - The CBC determines policy with respect to granting licenses after consultation with the Minister according to Section 4 (5) of the Banking Law. - The Banking Law was enacted in 1997 and amended on June 25, 1999 and June 30, 2000. - Assessment: Compliant. H3: 1(2) Operational independence and adequate resources - Description and facts: - The CBC is an independent organization, separate from the government or governmental agencies. - Management of the CBC is vested in a Board of Directors consisting of the Governor and five Directors. - The President of the Republic appoints the Governor for a term of office of up to five years; the Governor may be removed before end of tenure and subject to compensation specified in his service contract; current law does not specify reasons required for removal nor require public disclosure of reasons. - A new law is being prepared to ensure complete independence of the CBC, including preventing removal of the Governor prior to expiry of term. - The Banking Law stipulates the minimum capital base in Section 20; the CBC sets minimal prudential standards, capital composition, ongoing capital requirements, risk limitations and risk management. - Supervision is divided between domestic and international sections. Total staff: 35, of whom 12 are responsible for monitoring and examining 31 International Business Units/Administered Banking Units, 116 International Finance Companies and 12 International Trust companies. - There are currently four staff vacancies. - Average experience of staff related to banking supervision is 15 years. - Salary levels have reportedly fallen below industry levels in recent years. - The CBC can seek reimbursement of costs for on-site examination but has not made use of this right; this is included as part of conditions imposed on IBU licenses. - The head of supervision has had substantial experience. - Training programs involve FDIC, Bank of England, the Netherlands Bank and other central banks; staff attend Offshore Group of Banking Supervisors meetings and regulatory visits. - The CBC places significant emphasis on developing and maintaining an information technology infrastructure for bank supervision. - The Minister’s representative on the Board can delay some decisions for five days if thought in the public interest; such decision can be appealed to the Council of Ministers. - The CBC has general powers under Section 30 of the Banking Law to issue guidelines relating to any function it supervises. - Targets for on-site review completion: once a year for locally incorporated banks and once every two years for branches; some banks have not had a full review for more than three years. - Assessment: Materially noncompliant. - Recommendations and key operational findings: - Shortcomings in the law regarding reasons for removal of the Governor are being addressed in the new law under preparation. - The CBC should publish supervisory commentary in its annual report to inform the public about supervisory activities and how they have been discharged. - Staffing is insufficient: 12 persons currently supervise IBUs/ABUs/IFCs; more staff are required to shorten intervals between on-site visits and meet CBC targets. - Vacant positions (four) should be filled at an early date to enable increased on-site reviews and reduce intervals between reviews. H3: 1(3) Legal framework for authorization and ongoing supervision - Description: - The CBC is designated as the Banking Supervisory authority under the Central Bank of Cyprus Law (Section 6) and the Banking Law (Section 26) for granting and withdrawing banking licenses. - The Superintendent of Co-operative Development supervises Co-operative Credit Societies under the Co-operative Societies Law. - The Banking Law (Section 30) empowers the CBC to require banks to take actions it considers necessary; to prohibit acceptance of deposits or granting of credit; to assume control of a bank; or to revoke a bank’s licence. - Banking Law (Section 26) requires banks to make available to the CBC all books and records and to provide information in the form and frequency the CBC deems necessary. - The CBC has unfettered access to banks' files to review compliance with internal rules and external laws and regulations. - All formal actions, including closures, would be acted upon by the Governor on advice of the Head of the Supervision department; decisions of the CBC are subject to appeal to the High Court of Justice. - Amendments to legislation are frequently suggested by the CBC to the Government to reflect changing international standards and EU harmonization objectives; Cyprus is working towards accession to the EU. - The CBC publishes an annual report and current and historical statistics; all locally incorporated banks must file audited financial statements with the CBC. - Assessment: Compliant. H3: 1(4) Powers to address compliance and safety-and-soundness concerns - Description and facts: - The Banking Law empowers the CBC to set prudential rules autonomously and administratively (Section 41), except with regard to policy of granting banking licenses (Section 4.5). - Under Section 30(1) the CBC may take remedial measures when a bank fails to comply with the Law, regulations issued by the CBC, conditions of its license, or when asset liquidity is impaired or there is a risk the bank cannot meet obligations, or when necessary for safeguarding depositors and creditors. Measures include prohibiting acceptance of deposits or granting credit, assuming control of the bank, and revocation of license after consultation with the Minister of Finance. - Section 26 gives the CBC unfettered access to institutions' records and books. - Assessment: Largely compliant. - Key findings and recommendation: - Consultation requirements with the Minister of Finance (for remedial measures and license policy) may potentially delay operational decisions; while consultation has not inhibited past actions, consultation should be formally limited to policy issues to ensure full operational autonomy in exercising powers over individual institutions. H3: 1(5) Legal protection for supervisors - Description: - Section 32 of the Banking Law provides that neither the Central Bank nor any Director or officer shall be liable in any action for damages for actions or omissions in discharge or purported discharge of functions under the Law unless it is shown the act or omission was not in good faith or was the result of gross negligence. - Assessment: Compliant. H3: 1(6) Arrangements for information sharing and confidentiality - Description and facts: - The CBC is responsible for both domestic and international banking supervision and also responsible for operations of international companies and trusts by virtue of its administration of the Exchange Control Law. - There are no formal arrangements in place, but the CBC has continuing and good contacts with the Superintendent of Insurance, the Registrar of Companies and the Head of the Unit for Combating Money Laundering Offences. - Before establishment of the Unit for Combating Money Laundering, the CBC undertook money-laundering surveillance relating to banks; CBC officers have attended international meetings related to money laundering and continue close involvement, often accompanying the Head of the Unit for Combating Money Laundering to meetings and joint training sessions. - With regard to securities and investment business, a member of the CBC’s staff is on the Board of the Securities and Exchange Commission. - Banking Law (Section 27) enables the CBC to provide to the supervisory authority of the home country information which enables the home supervisor to exercise consolidated supervision; information on individual accounts is excluded. In practice such information can be passed by the subsidiary to its head office or the foreign regulator may obtain permission to come to Cyprus to conduct an on-site review. - Memoranda of understanding have been signed with Russia, Belarus, Bulgaria and Ukraine; negotiations have been started with supervisory authorities of the United Kingdom, Greece, Romania, France, and Austria. - Findings: - Formal written arrangements for routine information sharing are limited, though multiple bilateral MOUs exist or are under negotiation and practical cooperation is active. *Source: International Monetary Fund assessment at the request of the Governor of the Central Bank of Cyprus (invitation received March 2001).* ### Section 17(4) of the CBC Law provides that every director, officer or employee of the Bank ### Section 17(4) of the CBC Law provides that every director, officer or employee of the Bank ### Confidentiality, secrecy, and permitted disclosures - Section 17(4) of the CBC Law: every director, officer or employee of the Bank shall be bound to secrecy. - Section 18 of the CBC Law: the Bank’s Governor, Directors, officers and employees must take the oath of fidelity and secrecy before assuming their duties. - Section 29(1) of the Banking Law: persons who have access to the records of banks (e.g., bank supervisors) shall not give, divulge, reveal or use for their own benefit any information regarding the account of any individual customer, except in the following cases: - The customer or his personal representatives gives or give his or their written permission to do so; - The customer is declared bankrupt or if the customer is a company, the company is being wound up; - Civil proceedings are instituted between the bank and the customer or his guarantor relating to the customer’s account; - The information is given to the police under the provisions of any law or to a public officer who is duly authorized under that law to obtain that information or to a court in the investigation or prosecution of a criminal offence under any such law; - The bank has been served with a garnishee order attaching moneys in the account of the customer; - The information is required in the course of his duties by a colleague in the employment of the same bank or its holding company or an auditor or legal representative of the bank; - The information is required to assess the creditworthiness of a customer in connection with or relating to a bona fide commercial transaction or a prospective commercial transaction so long as the information required is of a general nature and in no way related to the details of a customer’s account; - The provision of the information is necessary for reasons of public interest or for the protection of the interests of the bank. - Assessment: Compliant. - Both legislation and practice provide for a full range of information to be shared with domestic and foreign regulators. *Source: IMF assessment of Cyprus Banking Law and CBC practice.* ### Principle 2 — Permissible activities of licensed banks and control of the word “bank” - Licensed banks are authorized to carry on banking business as defined in Section 2 of the Banking Law. - Section 2 definition: banking business is the lending of funds acquired from the assumption of obligations to the public, whether in the form of deposits, securities or other evidence of debt. - Section 13: licensed banks may carry out, directly or through subsidiaries, activities integral or closely related to banking business. - Section 13(3): banks are allowed to engage, directly or through subsidiaries, in securities activities such as trading for own account or for account of customers in securities, participation in securities issues and the provision of services related to such issues as well as portfolio management and advice. - Banks typically conduct investment/insurance business through separate subsidiaries. - Section 13(1): a bank is limited from holding directly or indirectly more than ten percent of the share capital of any other company or having control over such company. - For a bank incorporated in Cyprus: aggregate of shares held for all companies shall not exceed 25 percent of the bank’s capital base. - Section 15: prohibition against acquiring and dealing in its own shares. - Licensed banks may engage in insurance brokerage services and may hold up to 100 percent of the share capital in an insurance company provided that such company is incorporated in the Republic. - Under the new supervision regime for the securities business, banks will be allowed to carry out securities business in the same way as investment firms. - Section 5 of the Banking Law: no person other than a bank shall use in any language the word bank or any variation thereof unless prior written approval is given by the Central Bank. - Section 6: prohibits the advertising for deposits by any person other than a bank or a cooperative society or Housing Finance Corporation. - The term “bank” is defined in the Banking Law as a body corporate licensed to carry on banking business under the provisions of the Banking Law. - Section 3: no person, other than a bank, shall engage in banking business or in the business of accepting deposits; taking of deposits is reserved for licensed institutions. - Assessment: Compliant. - Use of the titles “bank” and “banking” and all grammatical variations is limited as provided in Section 5 of the Banking Law. *Source: IMF assessment of Cyprus Banking Law and CBC practice.* ### Principle 3 — Licensing authority powers, criteria, and processes - Licensing authority: the CBC is both the licensing and supervisory authority for banks. - The Banking Law provides for one type of license; CBC may grant a license without any condition, impose conditions, or refuse to grant a license (Section 4 of the Banking Law). - All licensees are required to establish a real presence in Cyprus and actually carry out real business; must operate as fully staffed units as required by the scale of operations. - Example staffing scale: at least one IBU with almost 100 persons; one Unit is considered fully staffed with one person. - Exception: Administered Banking Units (ABUs) carry on banking business in their own name but have day-to-day administration conducted by another bank (the administering bank). - CBC powers: - May grant a license “subject to such conditions, as the Central Bank may consider proper to impose.” - Section 20 permits the CBC to set higher than the minimum amount of capital. - Section 4: CBC may refuse to grant a license with an adequately reasoned decision. - Section 30: CBC may revoke a banking license in circumstances where a bank’s condition is irretrievably impaired. - Principal licensing criteria applied by the CBC: - At least two directors are required to participate and concur in the effective direction and management of the bank (Section 19). - Minimum capital for a bank incorporated in the Republic: not less than C£3m or such other higher amount that the CBC might determine (Section 20). - Directors, Chief Executives and Managers must satisfy the CBC that they are fit and proper persons. - Short history and business objectives of the applicant bank including reasons for establishing a presence in Cyprus. - Detailed description of proposed banking operations, services, and management structure. - Feasibility study incorporating projected financial statements for the first five years. - For foreign banking organizations: CBC approaches the applicant bank’s home supervisory authority, obtains its consent and undertaking to exercise consolidated supervision over global activities, and obtains Letters of Comfort from principal shareholders. - IBUs/ABUs restrictions: restricted to deal primarily with non-residents and in currencies other than the Cyprus Pound; since January 1, 2001, IBUs/ABUs have been allowed to make foreign currency loans to residents. - Recent licensing activity and outcomes: - In the last two years five applications for banking licenses were received (one for a domestic bank and four for IBUs). - One domestic-bank application was rejected because a major prospective shareholder was unsuitable. - Two applications were successful; two did not satisfy eligibility criteria. - CBC policy and coordination: - CBC discourages submissions from banks that do not meet eligibility criteria via its “Policy Statement and Guidelines for the establishment and operation of IBUs/ABUs.” - Prospective applicant banks are required to obtain prior approval and support of their home banking regulatory/supervisory authority before formal application. - CBC policy is to license only branches or subsidiaries of existing international banks to ensure transparency of ownership and source of capital. - Section 4.5: policy with respect to granting licenses is determined by the Central Bank after consultation with the Minister; once policy is set CBC operates within that framework. - Ongoing supervision: CBC has a process of ongoing supervision and monitoring to determine whether licensing criteria continue to be met and that institutions meet business goals. - CBC is home supervisor for 17 banks (10 domestic and 7 IBUs/ABUs). - Three of the domestic banks maintain branches/subsidiaries in foreign jurisdictions. - Assessment: Largely Complaint. - Identified area for improvement: - More emphasis could be placed on obtaining information directly from foreign law enforcement agencies and judicial systems in addition to reliance on private investigations to ensure a more comprehensive investigation into the character and reputation of persons associated with the financial services sector in Cyprus. *Source: IMF assessment of Cyprus Banking Law and CBC practice.* ### Principle 4 — Authority over transfers of significant ownership or control - Section 17 of the Banking Law: no person shall be allowed to acquire or have control over a bank without the prior written approval of the CBC. - Control definition: beneficial ownership by a person of the bank’s share capital, which carries 10 percent or more of its voting rights. - Section 16: a bank shall not sell or dispose the whole or part of its business by amalgamation or otherwise, except with the prior written approval of the CBC. - CBC decision factors when granting approval: - Exclude persons of dubious reputation or persons who may pose a threat to the interest of depositors and integrity of the bank. - Take into account the need to maintain adequate competition in the banking system. - IBUs/ABUs ownership considerations: - CBC considers applications only from banks licensed in jurisdictions which, in its judgment, exercise proper licensing and banking supervision. - Applicant banks must enjoy a good reputation internationally and have an established record of growth and profitable operation. - CBC never licenses de novo institutions. - Through a condition of their banking license, locally incorporated IBUs/ABUs may not, without written CBC approval, issue any further capital other than to existing beneficial shareholders and other than pro-rata their present shareholdings or register a transfer of any of its shares. - Assessment: Complaint. - Note: Banks operating in the offshore sector in Cyprus are branches or subsidiaries of banks that are widely owned; many are listed on stock exchanges. *Source: IMF assessment of Cyprus Banking Law and CBC practice.* ### Section 13 of the Banking Law regulates investments by banks and sets limits on the ### Section 13 of the Banking Law regulates investments by banks and sets limits on the ### Investment limits and approvals (Section 13) - The Banking Law provides that a bank shall not acquire or hold directly or indirectly more than 10 percent of the share capital of any other company. - For a bank incorporated in the Republic: - The value of any share capital held in any other company shall not exceed 10 percent of the bank’s capital base. - The aggregate value for all companies shall not exceed 25 percent of the bank’s capital base. - These limits apply to all investments excluding: - Investments in shares of insurance companies; and - Companies which carry out banking business or functions integral to or closely related to banking business, provided such companies are incorporated in Cyprus. - Any bank investments exceeding the limits prescribed under Section 13 require the prior written approval of the CBC. - Under Section 13, banks are not allowed to expand their direct or indirect operations outside Cyprus without the prior written approval of the CBC. - CBC approval is conditional upon the on-going availability of information from the overseas operation, including the ability to carry out on-site examination and to exercise consolidated supervision. - In granting approval the CBC reviews the business plan of the proposed operation and takes into account the existence and size of ethnic community (Greek or Cypriot) in the proposed country of operation. ### Real estate restrictions (Section 12) - Section 12 of the Banking Law prohibits the acquisition or purchase of immovable property by banks except in certain cases as provided in Section 12. ### Conditions for IBUs/ABUs incorporated in Cyprus - IBUs/ABUs incorporated in Cyprus must obtain the CBC’s prior written approval, as a condition in their banking business license, to: - Issue any further capital other than to its existing beneficial shareholders and other than pro-rata their present shareholdings; - Register a transfer of any of its shares; - Create any subsidiary companies; - Participate in the share capital of another bank or credit or financial services enterprise; - Open a place of business in the form of a branch or Representative Office. - Assessment of Section 13 and related licensing requirements: Complaint. ### Capital adequacy (Principle 6) - The Banking Law, Section 20, provides for a minimum capital base of not less than £3m for all banks incorporated in the Republic. - Banks incorporated in Cyprus are required to maintain a capital adequacy ratio at such minimum level as may be determined by the CBC from time to time (Section 21). - At present, the required capital adequacy ratio stands at 10 percent. - It was increased from 9 percent to 10 percent with effect from 1.1. 2001. - The capital adequacy ratio is in the form of a mandatory maintenance of a capital base in relation to total assets, including off-balance sheet exposures (Section 21). - The CBC has issued two directives (January 1999) on: - The computation of the capital base; and - The computation of the capital adequacy ratio. - These directives conform to the Basle recommendations and make use of the BIS risk weights and components of capital. - Capital adequacy ratios of banks are calculated on both a consolidated and solo basis. - Branches of foreign incorporated banks are not required to have capital and therefore do not maintain a capital adequacy ratio. - Treatment and limits for components: - Off-balance sheet risks, subordinated debt, revaluation gains and unrealized losses are treated in accordance with BIS recommendations. - Off-balance sheet items are grouped into four categories depending on risk and each carries a different risk conversion factor; adjusted values are multiplied by risk weightings attributable to counterparties. - Subordinated debt is included in tier two capital and cannot exceed 50 percent of tier one capital. - The total of tier two capital cannot exceed the total of tier one capital. - Revaluation gains are credited to revaluation reserve; the balance of this reserve is included in tier two capital. - Unrealized losses are debited to the revaluation reserve to the extent covered by revaluation gains; any shortfall is debited to the Profit and Loss Account, which is included in tier one capital. - Under Section 30.1 the CBC has broad powers to take remedial measures, including requiring corrective action where capital ratios fall below a certain limit. - Assessment of capital adequacy framework: Complaint. ### On-site examination and asset quality supervision (Principles 7 and 8) - All licensed banks are subject to regular on-site examination; a prime objective is to assess asset quality. - CBC examiners assess the quality of assets, especially major loan accounts, and the adequacy of loan loss reserves, and compare CBC results with those of the bank. - Examiners review procedures, practices and credit administration policies, including: - Appraisal and authorization of individual credit exposures; - Procedures for identification of substandard lending; and - Provisioning policy. - Banks are required to review asset quality at least once a year. - Under Section 28 the CBC can arrange at least once a year trilateral meetings with each bank and its auditors; auditors may freely report to the CBC any information relevant to supervisory responsibilities. - Asset quality classification criteria used by CBC examiners: - Pass: Facilities that do not present any weaknesses and are properly serviced. - Special Mention: Facilities that do not presently expose the bank to sufficient risk but possess credit deficiencies needing close attention; examples include: - Failure to obtain proper documentation; - Absence of adequate tangible security; - Excessive credit facilities in relation to turnover; - Economic or market conditions which may affect the borrower; and - Conditions imposed on approval of credit facilities not followed. - Substandard: Repayment ability is in some doubt though fully covered by realizable security. Characteristics include: - Inability of the borrower to settle facilities in accordance with agreed schedules; - Loan arrears and inability to bring excesses within limits; - Rescheduling of existing facilities; - Persistent hardcore borrowing; - Frequent requests for excesses; - Decline in sales; - Losses incurred; - Slow collection of debtors; - Increased bad debts; - Diversion of funds; - Increase in leverage; and - Increase in level of stocks. - Doubtful: All weaknesses of substandard with the added characteristic that they are not covered by realizable security; amounts classified as doubtful should be provided for up to the outstanding amount. - The CBC reviews the level and adequacy of provisions during on-site examinations; significant shortcomings are discussed with bank officials and taken up in the management letter. - If necessary the CBC may increase the capital requirement (Section 20) or apply powers under Section 30. - The CBC has developed no generally applicable criteria for classifying losses and provisioning policy and considers each bank individually; provisioning is determined by the bank in conjunction with its external auditors in accordance with accounting standards. - External auditors review provisioning policies as part of audits (Section 12 c of the Notice issued by the CBC on the Relation between the CBC and the external auditors). - The internationally recommended standard for classifying loans (the Basle additional criteria) is defined to include at least any loan on which payments are contractually a minimum number of days in arrears e.g., 30, 60 and 90 days. - Assessment of supervisory practice on asset classification and provisioning: - Principle 7: Complaint. - Principle 8: Largely compliant. - Observations and supervisory recommendations: - CBC examiners are able to review more than 50 percent of the Balance Sheet value of bank loans, with samples biased to large/problematic loans. - Some banks reported no onsite review of loan portfolios by the CBC for more than three years. - CBC should develop generally applicable criteria for assessing banks’ loan classification and provisioning policies to ensure compliance with best international practices. - The CBC should adopt a more conservative stance; banks deviating from the “90 day rule” should demonstrate that collateral has sufficiently high net realizable value so as not to require classification; refinancing and restructuring do not change loan status. ### Concentration limits and connected lending (Principles 9 and 10) - Section 11 sets statutory concentration limits: - Lending to a single person may not exceed 25 percent of the bank’s capital base. - Aggregate of all large facilities as defined in Section 11(4)(b) may not exceed 800 percent of the bank’s capital base. - Aggregate of all credit facilities granted to the bank’s directors may not exceed 40 percent of its capital base. - Total value of any unsecured facilities granted to all the directors of the bank may not exceed 5 percent of the bank’s capital base. - The Law requires that lending to connected persons be grouped for compliance with the percentages above and empowers the CBC to determine that two or more persons’ interests are so interrelated they should be considered as one. - The CBC has issued a directive on the monitoring and control of credit facilities; banks must submit returns on concentration of lending for CBC monitoring on a solo and consolidated basis. - The CBC verifies concentration information during on-site examinations and assesses whether banks’ management information systems identify concentrations on a solo and consolidated basis. - Any infringement of statutory limits on loan concentrations constitutes a criminal offence for which the bank and its officers are liable (Sections 11 and 43). - Assessment of concentration framework: Complaint. *073001a - Section 13 of the Banking Law regulates investments by banks and sets limits on the* ### Section 11 of the Banking Law as well as the CBC directive on the monitoring and control of ### Section 11 of the Banking Law as well as the CBC directive on the monitoring and control of credit facilities ### Legal requirements for transactions with related parties - Section 11(1)(c) of the Banking Law requires that lending to directors be approved by a resolution of the Board without the director concerned voting on the resolution. - Section 11(1)(c) of the Banking Law requires that any transactions with related parties be on an arms-length basis. ### Limits on lending to directors - Sections 11(1)(c) and 11(1)(d) of the Banking Law set quantitative limits: - The aggregate of all credit facilities granted to the bank’s directors may not exceed 40 percent of its capital base. - The total value of any unsecured facilities granted to all the directors of the bank may not exceed 5 percent of the bank’s capital base. ### Aggregation rules and treatment of connected persons - Facilities to directors are combined with those to connected persons and entities when determining compliance with the above limits. - The CBC may determine that the interests of a director are so interrelated with the interests of another person or persons that the director and any such person shall be considered as one person for purposes of determining compliance with the limits. ### CBC directive on control and monitoring of credit facilities - The CBC’s directive on the control of credit facilities provides further guidance to banks on transactions with related parties and compliance with the Banking Law. - Banks are required to submit a return on the concentration of lending so that the CBC can monitor compliance with the requirements of the Law. - Banks are required to ensure that any transactions with related parties are at arms-length. *Source: Section 11 of the Banking Law and the CBC directive on the monitoring and control of credit facilities.* ### Section 11(1)(c) of the Banking Law. With regard to affiliates any lending which is not at ### Section 11(1)(c) of the Banking Law. With regard to affiliates any lending which is not at ### Lending to affiliates and related-party treatment - Section 11(1)(c) of the Banking Law: any lending to affiliates which is not at arms length is regarded as lending of a capital nature and deducted from the bank’s capital base. - Transactions between banks and their related parties receive special attention in on-site examinations. - Banking Law Section 11(3) and the Directive to Banks, Monitoring and Control of Credit Facilities (April 2000): - where the interests of two or more persons are so intertwined that they should be considered one person, the credit facilities shall be combined. - The CBC list indicates those directors, spouses, a legal entity and its holding company, which have an interest of 20 percent or more in any class of shares in the share capital of that company. - Assessment: Complaint. *The CBC’s supervisory framework and banking law provisions govern related-party lending and capital treatment.* ### Principle 11 — Country risk and transfer risk - Principle: supervisors must be satisfied that banks have adequate policies and procedures for identifying, monitoring and controlling country risk and transfer risk and for maintaining appropriate reserves. - Description of practice: - No formal limits regarding country risk and transfer risk. - The CBC obtains monthly reports that include data on country exposures. - The CBC has from time to time issued letters directing banks to limit their risks to certain countries. - Assessment: Largely compliant. - Recommendation: The CBC should consider requiring banks to set formal limits or ensure that head offices and parent banks do so and notify them to the CBC. *The CBC monitors country and transfer risk via reporting and discretionary directives; formal limit-setting is advised.* ### Principle 12 — Market risk measurement and control - Principle: supervisors must be satisfied that banks have systems to accurately measure, monitor and adequately control market risks; supervisors should have powers to impose limits and/or a capital charge if warranted. - CBC regulations on foreign exchange risk: - Banks are required to contain their foreign currency exposure for each currency to no more than 10 percent of their capital base. - Overall exposure for all currencies together is limited to 15 percent of capital base. - The overall open foreign currency position is the sum of all the net short positions or the net long positions whichever is greater. - If the overall net foreign exchange position exceeds 2 percent of a bank’s capital base, a capital charge of 10 percent as from 1.1.2001 is required to be set-aside on the amount in excess. - Supervisory practice: - During onsite inspections the CBC verifies banks’ information systems, risk management systems and internal controls for monitoring these risks. - Current rules are under review: CBC proposes to lower the limits with respect to foreign currency exposures, introduce different limits for intra day and overnight positions, require stop loss limits on a daily and cumulative basis, and require demonstration of monitoring ability. - There are no other regulations or guidelines regarding other market risks (interest rate risk or risk run in securities positions). - The CBC views business sophistication in IBUs’ market activities as low—no options or derivatives trading—facilitating examiner review. - Assessment: Materially noncompliant. - Key issues and intent: - Prudential systems do not provide a basis for comprehensive supervision of market risks. - CBC intends to implement policies by the end of the year requiring banks to hold capital in relation to market risks and to align with the EU’s Capital Adequacy Directive (CAD). The CAD reporting system will at least enable CBC to monitor risks even if a capital charge is not applied. *Foreign exchange exposures are regulated with exact numeric limits; supervision of other market risks is inadequate and subject to planned reform.* ### Principle 13 — Comprehensive risk management (other material risks) - Principle: supervisors must be satisfied banks have comprehensive risk management (board and senior management oversight) to identify, measure, monitor and control material risks and hold capital where appropriate. - Liquidity framework: - CBC directive on prudential liquidity requires banks to place assets and liabilities in time bands by remaining time to maturity. - A maturity mismatch approach: banks’ excess liabilities over assets in specified time bands may not exceed maximum allowable mismatch ratios set by the CBC. - Banks are required to monitor liquidity daily and submit a liquidity return to the CBC on a quarterly basis. - Implemented from the middle of 2000 for domestic banks; a similar return exists for IBUs/ABUs but allowable mismatch ratios for IBUs/ABUs have not yet been determined (expected in the very near future). - Supervisory review: - On-site examiners verify internal controls to minimize operational risks and secure business continuity; compliance with anti-money laundering legislation is verified. - CBC has authority under Section 30 of the Banking Law to require a bank to hold capital against any risks. - Interest rate and operational risk: - Banks set their own internal limits for interest rate risk; CBC examiners review these during onsite inspections and believe banks’ limits are conservative. - For operational risk, banks have back-up facilities and internal auditors regularly review operational risks; CBC verifies during onsite exams. - Assessment: Compliant. *Liquidity, operational and interest rate risk frameworks exist with supervisory verification; some calibration (IBU mismatch ratios) remains outstanding.* ### Principle 14 — Internal controls and governance - Principle: supervisors must determine banks have internal controls adequate for the nature and scale of their business including segregation of duties, reconciliations, safeguarding assets, and independent audit/compliance functions. - CBC on-site review covers: - Internal audit/controls; - Credit administration; - Credit control; - Credit review; - Treasury management; - Management information system. - IBU/ABU licensing and external audit: - IBU/ABU banking licenses require external auditors to report directly to the CBC on adequacy of internal control systems and on adequacy of information to Head Office/parent bank; external auditors must report inadequate internal audit resourcing. - Internal audit supervision: - CBC reviews adequacy, efficiency, access to all business lines, staff adequacy, independence and reporting lines; weaknesses are communicated to management. - Supervisory review includes meetings with internal auditors and compliance officers without restrictions on content. - Board and management fit & proper: - Licensing stage requires detailed personal questionnaires for directors and senior management; CBC obtains independent verification and maintains close contact to assess skills and competence. - Interaction with head offices: - International banking units are branches/subsidiaries of international banking organizations and often rely on parent internal audit/compliance inputs; CBC may meet head office personnel. - Assessment: Compliant. - Legal powers and limits: - The Banking Law does not identify directors’ responsibilities with respect to corporate governance principles or expressly empower the CBC to require changes in composition and management. - CBC believes it can indirectly effect changes via Section 30 of the Banking Law, but this is cumbersome. *Internal control review processes are robust in practice; statutory authority to compel board or management changes is limited and indirect.* ### Principle 15 — Anti–money laundering (AML) and know-your-customer (KYC) - Principle: supervisors must determine banks have adequate policies, practices and procedures, including strict KYC, to promote ethical standards and prevent misuse by criminal elements. - Legal framework: - Prevention and Suppression of Money Laundering Activities Law (PSMLA), enacted in 1996, establishes the framework. - Salient features of the Law include criminalization of laundering, confiscation powers, freezing and restraint orders, mandatory reporting of suspicions to the Unit for Combating Money Laundering (UCML), court powers to order disclosure and production of information, requirements for customer identification, record keeping, internal control, communication and staff training, and enforcement of foreign orders. - CBC guidance and supervisory role: - Under Section 60(3) of PSMLA, the CBC issued a Guidance Note to all banks and similar Guidance to IFCs, ITCs, ICISs and their Managers/Trustees. - Supervisory authorities must refer failures to comply with the Law to the Attorney General. - CBC on-site examinations assess licensees’ compliance with AML obligations and require appointment of Money Laundering Compliance Officers. - CBC Guidance Note includes duties of compliance officers and internal reporting procedures. - KYC and exemptions: - PSMLA requires institutions to obtain and verify customer identity when establishing account relationships and prior to transactions, except where the Law states identification need not be made (e.g., customers reasonably believed to be persons carrying on relevant financial business). - For trustee or nominee accounts, CBC Guidance Note permits banks, at their own peril and only in exceptional circumstances, to open accounts without identification of beneficial owners if strict conditions are met (trust in trustees/nominees, estimate of likely turnover, undertaking regarding beneficial owner identity, and at least biannual review notes). - Acceptance of companies with bearer share issuance is permitted only in exceptional circumstances subject to strict conditions (CBC Guidance Note paragraph 2.7 of Section 2). - Training and reporting: - PSMLA requires training for employees in recognizing and handling suspicious transactions; reporting in good faith shields staff from liability. - CBC Guidance Note provides examples of suspicious transactions. - Reporting statistics and information exchange: - From January 1997 to December 2000, the Unit received a total of 206 domestic reports: 92 from financial institutions, 51 from the Police, 50 from the Customs Department, and 13 from other sources. - No formal mechanism requires the Unit to communicate such information to supervisors, but informal channels are customarily used. - CBC is not empowered to exchange information directly with other domestic or foreign supervisors; under PSMLA the Unit is the competent authority to cooperate with overseas Units. - Assessment: Largely Compliant. - Identified weaknesses and recommendations: - Scope for improving identification of beneficial owners and reporting of suspicious transactions by financial institutions. - Scrutiny of transactions from countries with deficient AML frameworks should be enhanced; the CBC’s November 23, 2000 Guidance Note list of jurisdictions should be extended to include certain such jurisdictions. - The Law does not define what constitutes satisfactory evidence of identity; the CBC should make obtaining satisfactory evidence a statutory requirement rather than an expectation. - Trustee/nominee account procedures do not ensure beneficial owners are appropriately disclosed to banks. - Incoming fund transfer information: banks may request originator information or ask for confirmation that information is available; this discretion does not ensure consistent collection of satisfactory ordering-customer information. - Internal reporting: small number of internal reports suggests CBC should continue to encourage compliance and develop training programs based on actual transactions (e.g., large cash deposits and fund transfers). - CBC needs to carry out more frequent onsite reviews, particularly for high-risk institutions. - Licensing investigations into fitness and properness could make more use of independent sources (e.g., police clearance certificates). - CBC must ensure it will always receive reports about suspicious activities, including names of supervised entities, to assist surveillance and to focus attention on sectors with few reports. *AML framework is established and supervised, but gaps in KYC definitions, beneficial owner disclosure, information exchange, and supervisory resourcing remain.* ### Principle 16 — On-site and off-site supervision - Principle: effective supervision should consist of both on-site and off-site supervision. - Legal powers and reporting: - Under the Banking Law, the CBC has extensive powers to obtain information (Section 25) and access any books or records (Section 26). No differences apply to IBUs/ABUs. - Section 26(3): information obtained is secret and used only for Banking Law and Central Bank Law purposes. - Section 27(1): CBC may provide appropriate overseas supervisory authorities any information enabling their supervisory functions; Section 27(2) prohibits divulging information relative to individual deposit accounts. - Off-site monitoring: - Periodic returns include monthly balance sheet, profit and loss account, capital adequacy, capital base computation, prudential liquidity, monitoring and control of credit facilities, foreign currency exposure, analysis of assets and liabilities by country, anti-money laundering procedures, etc. - CBC analyzes, trends and compares findings to monitor condition and compliance. - On-site examination purpose and scope: - Objectives: check compliance with law and prudential regulations, verify risk management and internal controls, determine reliability of information, and evaluate condition and prospects. - Main areas covered: management quality and internal controls; loan portfolio and provisioning; treasury operations and risk management; profitability and returns; compliance with license conditions and CBC directives; AML adherence; adequacy of internal controls. - Criteria for frequency/scope of on-site reviews: - The relative size of the banking operation; - The annual growth rate of the operation; - The relative contribution of the operation to the group as a whole; - The results of the offsite review; - Special issues; - The availability of resources. - Communication and reporting: - On-site findings are communicated to bank management and discussed with CEO and senior management; a management letter is issued summarizing findings and recommendations and requesting written comments and remediation plans. - Bank examination report findings and analysis of periodic returns are reported to the Governor of the CBC. - CBC may conduct ad hoc on-site examinations for special issues. - Interaction with auditors and overseas supervisors: - CBC meets external auditors to discuss corporate governance, risk management and internal control issues (Section 28). - For overseas branches/subsidiaries, CBC maintains close contact with the supervisory authorities of the country concerned. - IBUs/ABUs standard license conditions require provision of management letters and similar correspondence from external auditors to the CBC; CBC may require auditing of returns by external auditors. - Assessment: Largely Compliant. - Resourcing and procedural gaps: - Frequency of onsite inspections needs to be stepped up given some banks are from jurisdictions not regarded as having robust supervisory regimes. - Resources need to be increased to allow planned frequency of on-site examinations. - Early warning systems drawing on prudential reports should be surveyed and considered for implementation to detect problems earlier and expand supervisory options. *CBC operates both off-site and on-site supervision with statutory powers and established procedures; inspection frequency and resource constraints limit effectiveness.* ### Principle 17 — Regular contact with bank management - Principle: supervisors must have regular contact with bank management and thorough understanding of operations. - CBC practice: - Off-site monitoring and on-site examinations provide frequent contact and understanding of management and operations. - CBC maintains close contact with management through ad-hoc meetings and on-site assessments of skills and competence. - CBC holds meetings with CEO and senior management after on-site examinations and arranges at least once-a-year trilateral meetings with each bank and its external auditors (Section 28). - Market complexity and resources: - Market activity complexity has been very low; market risk minimal; no in-house resources specifically devoted to monitoring such activities. - CBC intends to implement the CAD in 2001. - Reporting obligations and timeliness: - Banks are expected to report immediately any material change in circumstances; Section 40 requires banks to inform the CBC forthwith if they have indication they may face serious difficulties or be unable to meet obligations or about to suspend payment. - Recommendation: there should be a requirement to report all significant issues at the earliest possible time (e.g., dismissal of a senior officer). - Resourcing effects: - In-depth onsite meetings are becoming less frequent because of staff shortages; some institutions have not had an onsite review for more than three years. - Recommendation: CBC should make it mandatory for supervised institutions to report any material adverse change in condition as early as possible. *Regular supervisory contact exists but is hampered by staff shortages and lacks mandatory early reporting for many significant issues.* ### Principle 18 — Prudential reporting and consolidated basis - Principle: supervisors must have means of collecting, reviewing and analysing prudential reports and statistical returns from banks on a solo and consolidated basis. - Current status: - International Banking Units are not permitted to have subsidiaries or branches abroad; therefore, there is no scope for consolidated supervision. *Consolidated supervision is not applicable given current restrictions on IBUs.* _The CBC (Central Bank of Cyprus) and the Banking Law are the primary authorities and legal instruments referenced in the assessments and descriptions above._ ### Section 26 of the Banking Law gives the CBC the authority to obtain from banks any ### Section 26 of the Banking Law gives the CBC the authority to obtain from banks any ### CBC authority to obtain information and reporting requirements - The Banking Law, Section 26 gives the Central Bank of Cyprus (CBC) authority to obtain from banks any information and with whatever frequency that it deems necessary. - Banks submit regular data on their financial condition and performance; banks in the same category (domestic, IBUs/ABUs) must submit the same information with the same frequency. - Standardized returns with comprehensive instructions are issued by the CBC and must be completed by all banks. - Periodic returns used in off-site monitoring include: monthly balance sheet, liquidity return, analysis of assets and liabilities by country, foreign currency exposure return, analytical six-monthly profit and loss account, analysis of liabilities and assets by class of customer, capital adequacy return, large credit exposures, etc. ### Off-site monitoring, on-site examination, and early-warning capabilities - Off-site monitoring and on-site examination are used as early warning systems to predict potential financial difficulties in banks. - Information submitted is analyzed to predict potential problems (examples: balance sheet monthly comments, level and adequacy of provisioning). - On-site examiners verify accuracy, classification, and disclosure of information contained in returns. - The salient features of both off-site and on-site supervision were described under Principle 17. - Apart from off-site and on-site systems, there is no other early-warning system in place. - Recommendation: The CBC should update itself with international experience in early-warning systems that use prudential reports and other data. ### Validation of supervisory information; role of external auditors - Principle 19: supervisors must have a means of independent validation of supervisory information through on-site examinations or use of external auditors. - Under Section 26 there are no restrictions on CBC access to information about any aspect of a bank’s business. - As part of licensing, IBUs are required to keep books and records in the jurisdiction. - Findings from on-site reviews are discussed between the CBC and external auditors; external auditors’ reports may give rise to supervisory measures (example cited: removal of Beogradska Banka’s banking business license). - CBC examiners may be assisted by a duly qualified person nominated by the CBC, who is bound by the same confidentiality requirements (Section 26). - For IBUs/ABUs, a standard license condition allows the CBC to appoint a professional firm of accountants/auditors, other than the IBU’s/ABU’s external auditors, to investigate and report directly to the CBC. - The CBC has not invoked the above appointment provisions in the last two years. - External auditors must be expressly authorized by the CBC prior to appointment (Sections 2 and 24); in practice, banks are audited by the big five international firms. ### Auditor communication, trilateral meetings, and reporting duties - Section 28 requires the CBC to arrange, at least once a year, trilateral meetings with each bank and its auditors to discuss audit-related supervisory matters. - Under Section 28 an auditor may freely report to the CBC any information relevant to the CBC’s supervisory responsibilities; the Law protects auditors from consequences of breaching confidentiality when communicating in good faith to the CBC. - For IBUs/ABUs, external auditors have special duties to report directly to the CBC on: any non-compliance with license conditions; adequacy of internal control system; adequacy and accuracy of information sent to Head Office/Parent Bank. - All such special reports received in the last two years were satisfactory. - Assessment stated: Compliant. ### Accounting, financial statements, and disclosure requirements - Section 24 (1) requires each bank to submit to the CBC, within four months from the end of each financial year, a copy of the balance sheet and profit and loss account in the form prescribed by the CBC; the return must be certified by an approved auditor together with a signed copy of his report. - The CBC may prescribe the manner and form in which accounts have to be prepared and has set accounting standards guided by international practice and EU directives (Section 41). - The CBC has adopted international accounting standards with slight modifications to harmonize with the EU directive on bank accounts; directives specify content and presentation of financial statements. - Financial statements are required to be prepared on a consolidated basis; for IBUs/ABUs this requirement is not applicable because licensed offshore banks are subsidiaries or branches of foreign incorporated banks and do not have subsidiaries of their own. - The Banking Law requires banks incorporated in the Republic to publish, within six months from the end of each financial year, the balance sheet and profit and loss account together with the auditor’s report (Section 24). - For IBUs/ABUs that are subsidiaries of foreign banks, license conditions require making available to any interested user a copy of the latest audited accounts and auditors’ reports; branches of foreign incorporated banks are not required to publish financial statements. - The CBC’s website provides information concerning licensees, scope of authorized activities, identity of senior management and those authorized to act in the name of the licensee; CBC supervisory staff updates the website regularly. - The Cyprus Institute of Certified Public Accountants requires auditors to conduct audits in accordance with International Auditing Standards; auditors’ reports must state this fact. - Section 28 (1) requires the CBC to arrange trilateral meetings no less frequently than once a year. - The CBC publishes key banking statistics obtained from banking returns to provide the industry and public with information about banking activity. - Assessment stated: Compliant. ### Supervisory powers, remedial measures, and penalties - Section 30 provides the CBC with remedial powers including: prohibit acceptance of deposits or granting of credit facilities; assume control of the business of a bank; revoke a bank’s license. - Under the Law the CBC needs to consult with the Minister of Finance before taking most remedial measures (examples listed: prohibition on deposits/credit, assumption of control, revocation of license). - Section 42 empowers the CBC to impose administrative fines for failure to provide information within specified time limits; other offences and penalties are covered in Sections 42 and 44. - Administrative fines range from one thousand to ten thousand pounds depending on the severity of the contravention. - Administrative penalties have been threatened but not imposed so far. - The CBC Law (Sections 12 (6) and 13 (1)(a)) permits the Minister’s representative on the board to suspend the operation of board decisions for five days if deemed incompatible with Central Bank Law purposes or contrary to public interest; the board may appeal to the Council of Ministers. These provisions have never been invoked. - The CBC does not have authority to apply penalties to members of a bank’s management or board; the CBC believes the Exchange Control Law provides sufficient authority to effect changes in management or board. - Examples of license revocations and restrictions: - November 18, 1998: banking license of the Cyprus branch of Inkombank revoked. - June 1, 1999: banking license of the Cyprus branch of Menatep revoked. - May 3, 2000: banking license of the Cyprus branch of Beogradska Banka revoked to safeguard depositors and third parties amid going concern problems. - CBC has, in a number of cases, imposed restrictions on the level of business that an IBU may assume in response to similar action by the home supervisor. - Assessment stated: Largely compliant. - Recommendation: The requirement for consultation with the Minister before supervisory action should be deleted to ensure full independence of the supervisor. ### Consolidated supervision, cross-border cooperation, and MOUs - Principle 20 and Principle 23: CBC policy generally prevents locally incorporated IBUs/ABUs from establishing branches or subsidiaries in foreign jurisdictions; assessments for these principles were marked Not applicable. - The CBC exchanges information with foreign supervisors during licensing and ongoing supervision; for license applicants the CBC contacts the home supervisor for views and approval. - Memoranda of Understanding have been signed with banking supervisory authorities of Russia, Belarus, Bulgaria and Ukraine; negotiations on MOUs have been started with the United Kingdom, Greece, Romania, France and Austria. - The MOUs include statements on scope of information to be forwarded, information about transactions, accounts and deposits, cooperation on onsite examinations, and confidentiality of information received. - The CBC allows foreign home supervisors to conduct onsite inspections in Cyprus; foreign examiners are allowed to see any files including information on individual depositors. - Examples of foreign onsite reviews in Cyprus: Central Banks of Lebanon, Jordan, Russia, Bulgaria, and Yugoslavia. - Assessment stated: Compliant. ### Standards for local operations of foreign banks and supervisory coordination - Local branches of foreign banks are exempt from own capital and capital adequacy requirements; inspection and regulatory reporting requirements for foreign banks are similar to those for domestic banks. - For licensing and ongoing supervision the CBC visits jurisdictions and obtains information from home supervisors regarding financial soundness and prudent management; a licence will not be granted unless the applicant obtains permission from its home authority. - Where a material matter occurs, the CBC would inform the home country supervisor of any action it has sought from the institution. - Assessment stated: Compliant. --- _Source: https://www.imf.org/-/media/files/publications/ofca/english/073001a.pdf_