The Central Bank of Cyprus was established in 1963, shortly after Cyprus gained its independence, as an autonomous institution in accordance with the Central Bank of Cyprus Law 1963 and the relevant articles of the Constitution. Today the Bank is governed by the Central Bank of Cyprus Laws 2002-2007, which ensure the Bank’s independence as well as compatibility with the relevant provisions of the Treaty establishing the European Community and the Statute of the European System of Central Banks and of the European Central Bank. The law’s amendment in March 2007 paved the way for the legal integration of the Bank into the Eurosystem in January 2008.
The main functions of the Central Bank include:
implementing the European Central Bank’s monetary policy decisions;
holding and managing the official international reserves;
safeguarding the stability of the financial system;
promoting, regulating and overseeing the smooth operation of payment and settlement systems;
acting as banker for the government.
During the early years of its operation, the Bank undertook fully the functions of banker to the government and the management of international reserves as well as the administration of exchange controls. In parallel, the Bank strengthened its internal structure and prepared the regulatory framework for banking supervision, also setting up the operational framework for the implementation of monetary policy. In the late 1960s and early 1970s, monetary policy became more active, while bank supervision was formalised. During this period government stocks were first issued, with a view to promoting savings and the non-inflationary financing of fiscal deficits.
Following the economic dislocation and disruption caused by the Turkish invasion in 1974, the Central Bank was actively involved in the reactivation of the economy. Thus, the Bank pursued an expansionary monetary policy and facilitated the financing of the housing needs of the refugees and the replenishment of lost capital stock and infrastructure. The role of the Bank was instrumental in the achievement of a rapid improvement in economic conditions that took place subsequently. During the post-invasion period the Bank also assumed a leading role in promoting Cyprus as a regional financial and business centre. Over the years, the international business sector, in particular, has shown a rapid progress and expansion, making a significant contribution to foreign exchange earnings and employment in the island.
Prior to accession to the EU in 2004, the Central Bank began to intensify its efforts towards the liberalisation of the financial sector, which was necessitated both by economic considerations as well as by the need to harmonise Cypriot economic structures and policies with those of the EU.
In 1996 the Central Bank moved away from the use of direct instruments for monitoring liquidity in the economy in favour of market-based tools. Thus, the liquid assets ratio, which was the main instrument of monetary policy, was abandoned. Main refinancing operations allotted through tenders were introduced as the primary tool of liquidity management. Auctions for the acceptance of deposits were also introduced as a means to mop-up excess liquidity. Under the current monetary policy framework, the minimum reserve account is the only operational account banks need to maintain with the Central Bank and there are two standing facilities aimed at providing and absorbing overnight liquidity, respectively. Since the beginning of 1996 government paper has been issued by the auction technique, which allows the interest rate to reflect market conditions. Thus, the operational set-up of monetary policy is broadly in line with EU practices.
A landmark in the liberalisation process of the financial sector was the abolition of the statutory interest rate ceiling on 1 January 2001.
In the area of capital movement liberalisation, the Capital Movement Law was enacted in July 2003 and came into force on 1 May 2004, the date of Cyprus's accession to the EU. This law, inter alia, repealed the Exchange Control Law thus abolishing all remaining exchange control restrictions.
As regards banking supervision, the objective of the Central Bank is to ensure the stability of the banking system, the minimization of systemic risk and the protection of depositors. The rules, policies and practices of the Bank are in line with the EU directives and the recommendations of the Basel Committee on Banking Supervision. The Banking Law 1997 as amended, which establishes the legal framework within which banking business can be pursued, reflects the principles and rules of the EU directives on credit institutions. Furthermore, in accordance with the Prevention and Suppression of Money Laundering Activities Laws 1996 - 2004, the Central Bank is the supervisory authority for banks in this respect. In this connection, the Central Bank has issued a series of directives to banks concerning strict customer identification procedures, record keeping, recognition and reporting of suspicious transactions, the appointment and duties of money laundering compliance officers, and education and training of bank employees in anti-money laundering matters and in combating the finance of terrorism.
On 2 May 2005 the Cyprus pound joined the Exchange Rate Mechanism II (ERM II) at the pre-existing central parity of €1=CY£0,585274, unchanged from the parity at which it had been unilaterally pegged to the euro since 1999. The standard fluctuation margins of + 15% were maintained, although in practice the pound fluctuated within the narrower range of + 2,25, both before and after ERM II entry.
On 1 January 2008 Cyprus joined the euro area thus bringing to fruition the island’s goal of becoming a fully integrated member of the EU. The conversion rate between the euro and the Cyprus pound was set at CY£0,585274 by the ECOFIN Council on 10 July 2007, in other words the same rate at which the Cyprus pound joined ERM II.
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