Cyprus, an island in the eastern part of the Mediterranean, was an agricultural country for many years but made great strides after gaining independence from Britain in 1960. It evolved from an exporter of agricultural products and minerals in the 1960s and 1970s to a tourist and international business centre in the 1990s. The country has a well-functioning market-oriented system, with most economic activity taking place in the private sector. Nowadays, the economy is dependent mostly on tourism and services. Per capita GDP for 2001 is estimated at about €15,000. The macroeconomic environment has been stable, and economic growth strong in recent years, with annual GDP growth averaging 4.2% in the years 1995-2000, while unemployment and inflation have been low. Unemployment averaged 3.3% and inflation 2.9% over the same period.

The financial sector has exhibited rapid growth in recent years, both in the level of financial intermediation and in the range and quality of services. This is associated with the good performance of the economy, stable macroeconomic conditions, the development of Cyprus as an international business centre and the gradual liberalisation of the past few years.

The contribution of the financial sector to GDP is estimated at 7.5% for 2000, compared to 4.9% in 1995, with the banking sector dominating. Employment in the sector rose to about 16,000 persons or 5.2% of the gainfully employed population in 2000, compared with 4.3% in 1995.

Supervision in the financial sector is divided between different bodies, reflecting the traditional segregation of the various segments of the financial sector. The Central Bank of Cyprus has responsibility for the regulation, including licensing and prudential supervision, of banks. Co-operative credit societies are supervised by the Commissioner of Co-operative Development, under the Minister of Commerce, Industry and Tourism. The Superintendent of Insurance, under the Minister of Finance, is the regulator of insurance business, and the Cyprus Securities and Exchange Commission is the regulator of the securities markets and has responsibility for the overall supervision for the functioning of the Stock Exchange. It should be mentioned that there is no legislation governing the provision of financial and investment services. A draft bill, which is in line with the EU directives on these matters, has been prepared and submitted to the House of Representatives for review and enactment. It is expected to be enacted soon and thus fill this legal vacuum.

Banking plays a dominant role in the financial sector. Although non-bank financial firms such as insurance companies, investment companies and mutual funds are increasing in number, their contribution in mobilising savings and allocating resources for investment purposes is still very limited. The banking system is well developed and stable. Banks are adequately capitalised and have a good record of profitability. The rest of the financial sector is developing steadily.

With regard to foreign exchange policy, following a successful ECU-peg policy since 1992, the Cyprus pound was pegged to the euro on 1 January 1999, with the same central parity rate (CYP 1 = €1.7086) and, initially, the same fluctuation bands of +/-2.25%. In view of capital account liberalisation, wider bands of +/-15% were introduced on 1 January 2001, which coexisted temporarily with the narrower “softer” bands of +/-2.25%. On 13 August 2001 the narrower bands were abolished, so that only the +/-15% bands are currently in place. Cyprus is therefore unilaterally shadowing ERM II.

The decision of the government to apply for membership to the EU propelled reforms and changes in the economy and the financial sector in particular. The statutory ceiling on interest rates was abolished on 1 January 2001, enabling the Central Bank to proceed further with the gradual liberalisation of exchange controls on capital flows. The enactment of the Law liberalising interest rates enhanced competition in the banking market. Banks have been expanding the range of their products and services, offering a wider choice to the public and better terms to borrowers.

Further to that, the authorities have intensified their efforts for the adoption of the EU acquis. Harmonisation measures include the enactment of legislation transposing the EU directives and also strengthening the administrative capacity. The Central Bank speeded up the process of harmonisation of the banking legislation with that of the EU, and strengthened banking supervision. The legal and regulatory framework is in line with EU directives and BIS standards. International Accounting Standards are also in place.

From Financial Sectors in EU Accession Countries, Editor: Christian Thimann, Published by: European Central Bank, July 2002