A. General

1. With the agreement of the Central Bank of Cyprus (CBC) and the Cooperative Societies’ Supervision and Development Authority (CSSDA), the mission assessed these institutions’ compliance with the Basel Core Principles for Effective Banking Supervision (BCP) using the Core Principles Methodology. The assessments were undertaken in the context of the Offshore Financial Center (OFC) Assessment Program.

2. The domestic and offshore sectors of the banking sector were not subject to individual assessments since they are both covered by the same legislation and are similarly supervised by the Banking Supervision and Regulation Division (BSD) of the CBC.

3. The assessment of the CSSDA took note of its ongoing program to substantially expand and enhance its supervisory capacity and activities and the effects of the transition period available to the credit cooperative institutions to achieve required prudential standards or affiliate with the Cooperative Central Bank (Central Body), pursuant to an arrangement reached by the government as a part of its accession to the European Union (EU).

4. The assessments took place in March and April 2005 and were undertaken by Marcel Maes, formerly with the Commission of Banking, Finance, and Insurance of Belgium, and Timothy Sullivan, formerly with the Office of the Comptroller of the Currency of the United States.

B. Information and Methodology used for Assessment

5. The assessment of compliance with the core principles is not, and is not intended to be an exact science. Banking systems differ from one country to the next as do their domestic circumstances. Furthermore, banking activities are changing rapidly around the world, and theories, policies, and best practices of supervision are swiftly evolving. Nevertheless, it is internationally acknowledged that the core principles are seen as minimum standards.

6. This assessment of compliance with each principle has been made on a qualitative basis. A five-part assessment system is used: compliant, largely compliant, materially noncompliant, noncompliant, and not applicable. To achieve a “compliant” assessment with a principle, all “essential” criteria generally must be met without any significant deficiencies. There may be instances where a country can demonstrate that the principle has been achieved through different means. Conversely, due to specific conditions in individual countries, the essential criteria may not always be sufficient to achieve the objective of the principle, and therefore, one or more additional criteria and/or other measures may also be deemed necessary by the assessor to judge that compliance is achieved. A “largely compliant” assessment is given if only minor shortcomings are observed, and these are not seen as sufficient to raise serious doubts about the authority’s ability to achieve the objective of that principle. A “materially noncompliant assessment” is given when the shortcoming is sufficient to raise doubts about the authority’s ability to achieve compliance, but substantive progress had been made. A “noncompliant” assessment is given when no substantive progress towards compliance has been achieved, or when insufficient information was available to allow a reliable determination that substantive progress had been made towards compliance. An assessment of “not applicable” is rendered for a principle deemed by the assessors to not have relevance.

7. The assessment was based on a review of the applicable laws, regulations, and prudential guidelines, although the assessment of the CSSDA was affected by the absence of English-language translations of many documents. The assessors held discussions with officers and staff of the CBC and the CCSDA. They also met with the auditor general of Cyprus and the Director of the Audit Office of Cooperative Societies (AOCS), officers and staff of the Cooperative Central Bank, representatives of individual financial institutions, professional associations, and bank external auditors. Before the mission, both the CBC and the CSSDA had seperately prepared formal self assessments.

C. Institutional and Macroprudential setting, Market structure

8. Cyprus, as a recent entry to the European Union (EU) (in May 2004), has benefited from the structure, institutions, and rules whose adoption is required for acceptance. From being a relatively closely controlled system, the requirements of accession resulted in both a liberalization and a tightening of prudential regulation. Thus, on January 1, 2001, a nine percent ceiling on interest rates that had been in place since 1944 was removed as an initial step to capital account liberalization. At the same time, the authorities instituted a three-phase process of exchange control relaxation which was completed on accession at May 1, 2004, when the Capital Movement Law repealed the Exchange Control Law. The exchange rate of the Cypriot pound, whose central rate has been pegged to the Euro since January 1999, had its fluctuation margins widened to ±15 percent in August 2001, and the authorities are pursuing a Euro-adoption strategy. This will foster required fiscal adjustment. Inflation, averaging about three percent a year over the past four years, is expected to remain subdued.

9. Cyprus adopted International Accounting Standards (IAS) in 1981 and has a large professional body of accountants as well as a strong association of certified accountants who have disciplinary powers and arrangements. The big four accounting firms are represented.

10. Deposit protection schemes were established in September 2000 for banks and cooperative societies. Compensation is set at 90 percent of total deposits of each depositor up to a maximum of EUR 20,000. In addition, the cooperative societies laws (CSL) provides that the CSSDA, in cooperation with the Pancyprian Cooperative Confederation Ltd., can issue a legally binding regulation requiring the establishment of a solidarity fund in which cooperative credit institutions’ (CCIs) participation is mandatory. The solidarity fund would be used to address liquidity or solvency issues before the deposit protection scheme. A preliminary regulation is in draft.

11. Through their participation in the work of the Banking Supervision Committee of the European System of Central Banks, its Working Group on Macro-prudential Analysis, and in the “Coordinated Compilation Exercise for Financial Soundness Indicators,” the CBC has established the basis for developing a framework for macro-prudential surveillance and analysis.

12. The banking industry consists of three distinct segments. The domestic market is supplied by two: 11 commercial banks with three specialized institutions (each of which has a commercial banking license) and some 358 cooperative credit institutions. Domestic commercial banking is dominated by three banks which together hold about 70 percent of system assets, excluding the cooperative banks, and about half of system assets, including the cooperatives.¹ The three largest banks, all locally owned, are international groups² with major insurance companies as subsidiaries. The three specialized institutions are a mortgage bank (a subsidiary of the largest commercial bank) which lends longer term for tourism and manufacturing, the Cyprus Development Bank which, in addition to standard development bank services, provides consulting services, and the Housing Finance Corporation which provides long-term housing loans to low and middle-income families. The latter two are publicly owned, but total assets of the three are only a small portion of the banking system. The remaining domestic banks include 3 small local banks and foreign-owned branches (2) and subsidiaries (3).

13. Cooperative credit institutions³ have maintained a strong role, with their deposits representing 32 percent of total deposits in local currency at end-2004. As a result of their nonprofit nature, lower operating costs and lower regulatory costs, they have been able to compete effectively with commercial banks. Most Cypriots continue to deposit with their local cooperatives. Their clearing agent, the Cooperative Central Bank, is a licensed commercial bank.

14. The third segment of the banking market are the 26 international banking units, the largest number of which are from Lebanon (8), Jordan (4), and Russia (3). Until recently, with the new rules introduced by EU accession, they were ring-fenced from the domestic market, although subject to supervision by the central bank similar to that of domestic commercial banks. At the end of 2004, IBU assets of $12.5 billion represented 30 percent of domestic banking assets (excluding the cooperatives).

15. The economy of government-controlled Cyprus is heavily banked. As a result, the larger banks are expanding by establishing branches and subsidiaries in overseas markets with important Greek communities.

16. As a result of the fallout from the bursting of the 1999 stock market bubble, lower output in the tourism sector and depressed activity in the world economy, domestic banks have had losses in both 2002 (negative return on equity of 11.1 percent) and 2003 (negative 4.7 percent). In 2004, however, performance improved to a positive 4.3 percent ROE at mid-2004. Non-performing loans to total gross loans were 11.7 percent at mid-2004. The central bank has begun to require the suspension of interest on non-performing loans by the banks. Despite improved collections, the reported NPL ratio may deteriorate when the calculation is brought fully into line with EU requirements at start-2006. Overall risk-weighted capital remains adequate at roughly 13 percent in 2004.

17. The principle-by-principle assessments for banking in this volume (see Tables 1 and 2) reflect the different supervisory regimes applied in the market. While domestic commercial banks and international banking units are similarly supervised by the CBC, CCIs are supervised by the CSSDA.

Table 1.

Detailed Assessment of Compliance of the Basel Core Principles (CBC)

Table 1.

Detailed Assessment of Compliance of the Basel Core Principles (CBC)

Principle 1.	Objectives, Autonomy, Powers, and Resources An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks. Each such agency should possess operational independence and adequate resources. A suitable legal framework for banking supervision is also necessary, including provisions relating to the authorization of banking establishments and their ongoing supervision; powers to address compliance with laws, as well as safety and soundness concerns; and legal protection for supervisors. Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Principle 1(1)	An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks.
Description	The Banking Law N°66(1) of 1997 (the BL) provides in Section 26 that the Central Bank of Cyprus (the CBC) is responsible for the supervision of banks in order to ensure the orderly functioning of the banking system. The original law setting up the Central Bank of Cyprus came into effect in 1963. The new Central Bank of Cyprus Law of 2002 (N. 138(1) 2002 (the CBC Law) defines the main tasks of the Bank as follows: The definition and implementation of monetary policy; The conduct of the exchange-rate policy and the management of the official foreign reserves of the Republic; The supervision of banks in the Republic; The promotion, regulation, and oversight of the smooth operation of payments and settlements systems; To act as banker and financial agent of the Government of the Republic. All responsibilities for banking supervision rest solely and entirely with the CBC. According to Section 30(1) of the BL, the CBC may take the necessary measures when a bank fails to comply with any provision of the BL or with any regulations made under the BL. The minimum prudential standards that banks should meet are the following: Limitation of credit exposures; Limitation on holdings of immovable property; Limitation of shareholdings; Prohibition of commercial trading; Prohibition of dealing in own shares; Prior approval for amalgamation; Limitations on large shareholdings; Persons disqualified to act as directors in banks; Direction and management by at least two individuals (Four-eyes principle); Minimum capital; Capital adequacy ratio; Computation of capital; Minimum liquidity; Compensation of depositors (Deposit Protection Scheme). The CBC is empowered to issue directives for the purpose of implementing the objectives and provisions of the BL. Banks are required to comply with both the provisions of the BL and the directives of the CBC. To this effect, the CBC has issued directives on the following: Computation of prudential liquidity; Computation of the capital base of banks; Computation of banks’ capital adequacy ratio; Capital adequacy; Layout and contents of banks’ annual accounts; Monitoring and control of credit facilities (large exposures); Framework for the evaluation of internal control systems; Foreign currency positions and exposures; Employment of funds derived from foreign currency deposit liabilities; Cross-border credit transfers; Establishment and operation of the Deposit Protection Scheme; Freedom of establishment and freedom to provide banking related activities by European Union authorized credit institutions. The above directives issued by the CBC are based on respective European Union (“EU”) Directives and the recommendations of the Basel Committee on Banking Supervision (“BCBS”). The CBC has also issued a notice on the following: Relationship between the CBC and the external auditors of banks. Regulations have also been issued on the following: Establishment and Operation of an Investor Compensation Fund for Clients of Banks. Cyprus’s accession to the EU has triggered a number of fundamental amendments to the regulatory framework in view of the necessary and timely harmonization of supervision with the acquis communautaire. In April 2004, the Banking Amendment No. 2 Law was enacted in order to harmonize Cyprus’s legislation with Directive 2001/24/EC, which introduces the principle of mutual recognition by the EU member states with regard to the reorganization measures or winding up proceedings adopted by the home country of credit institution, in case these run into difficulties. The CBC decides when and how to effect the orderly resolution of a problem bank situation. The CBC publishes an Annual Report of its activities in each financial year, which covers its banking regulatory and supervisory activities. The CBC Annual Report also includes a short description of the developments in the banking industry in Cyprus as well as a brief assessment of the performance of the above sector for the year under review. In addition, the CBC publishes current and historical statistics on the banking industry. Moreover, all Cyprus incorporated banks are required to publish, within six months from the end of each financial year, the balance sheet and profit and loss account for that year together with the auditor’s report.
Assessment	Compliant.
Comments	None.
Principle 1(2)	Each such agency should possess operational independence and adequate resources.
Description	Section 7 of the CBC Law states that when carrying out the tasks conferred upon them under this, neither the Bank nor any member of its decision-making bodies shall seek or take instructions from the government or any other body. The CBC is therefore an independent organization, separate from the government or governmental agencies. There is, in practice, no evidence of government or industry interference in the operational independence of the CBC and in its ability to obtain and deploy the resources needed to carry out its mandate. The management of the CBC is in the hands of the board of directors consisting of the governor, the deputy governor, and five directors. The governor and the deputy governor are appointed by the president and the vice resident of the Republic, respectively. The independence of the CBC is secured by the Cyprus Constitution. The supervision of banks is carried out by the Banking Supervision and Regulation Division, which consists of two departments. The total number of staff in each department is as follows: a) Domestic Banks Supervision Department: 32 staff members. b) Supervision of International Banks, Regulation and Financial Stability Department: 19 staff members. The senior manager of the Banking Supervision and Regulation Division as well as the managers of the two departments mentioned above, in addition to their academic/professional qualifications, have had a long experience in their respective positions having been promoted from the ranks. Supervisory staff are also well educated being in possession of academic/professional qualifications and have had considerable hands-on experience in the supervision of banks. Salary levels of the supervisory staff within the CBC (officers, administrative, and clerical staff) are comparable to the salary levels in the private banking industry. Salary levels of senior managers within the CBC remain, however, below the salary levels of general managers in the private banking sector. Training programs for bank supervisory staff cover a variety of areas related to banking supervision and regulation. Staff members regularly attend courses organized by the Financial Stability Institute of the Bank for International Settlements, the Bank of England, the Deutsche Bundesbank, the Banque de France, the Nederlandsche Bank, the United States (U.S.) Federal Deposit Insurance Corporation, the U.S. Federal Reserve System, and other central banks/banking supervisory authorities, as well as private institutions. Staff also visit other domestic regulators when that is deemed appropriate within the scope of the MOU between the CBC and the securities, insurance, and cooperative credit institutions supervisory authorities, as well as overseas supervisory authorities in accordance with MOUs signed with them. In addition, the CBC is a subscriber to the “FSI Connect” service provided by the Financial Stability Institute of the Bank for International Settlements, which is an online information resource and training tool for bank supervisors worldwide. Emphasis is also placed on developing and maintaining a modern information technology infrastructure to support the key activities of the Banking Supervision and Regulation Division. The budget of the CBC’s supervisory function (covering recruitment, hiring outside experts, training, information technology (IT) expenditure, travel etc.) forms part of the CBC’s overall budget. The CBC is also authorized to charge fees in connection with expenses incurred for the supervision and inspection of banks. The Governor of the CBC is appointed for a renewable term of office of five years. He may be relieved from office only if, in the opinion of the Council of Ministers, he no longer fulfills the conditions required for the performance of his duties or in the event of serious misconduct. This provision which is in accordance with the Statute of the European System of Central Banks has also been incorporated in the Cyprus constitution. Although the CBC Law does not specify that the reason for the Governor’s removal from office must be publicly disclosed, it is expected that, in such an event, the reasoning behind the decision will be made public in accordance with the established principles of administrative law.
Assessment	Largely Compliant.
Comments	The increasing demands on the Banking Supervision and Regulation Division’s officers and staff emanating from the substantial requirements relating to the accession of Cyprus to the EU, as well as other developments in the financial supervisory and regulatory sector, have interfered with the execution of a number of supervisory tasks and slowed the fulfillment of the regular on-and off-site supervisory programs. Since this problem is one of a permanent structural nature, the authorities should take action to ensure that properly trained and experienced staff are provided for in numbers that will assure timely and adequate fulfillment of the CBC’s supervisory reponsibilities.
Principle 1(3)	A suitable legal framework for banking supervision is also necessary, including provisions relating to authorization of banking establishments and their ongoing supervision.
Description	The CBC is the banking supervisory authority responsible for granting and withdrawing banking business licenses. The Cooperative Societies’ Supervision and Development Authority (CSSDA) is the supervisory and licensing authority of cooperative credit institutions in Cyprus (a separate assessment addresses the implementation of the Basel Core Principles for Effective Banking Supervision regarding the cooperative credit institutions). Section 3(3) of the BL authorizes the CBC to: grant a license without any condition or subject to such conditions as the CBC may consider proper to impose; or refuse to grant a license. The CBC may amend or cancel whenever, either permanently or temporarily, any condition imposed on a license, or impose any new conditions thereto [Section 3(4) of the BL]. The CBC shall not take into consideration the economic need criterion for purposes of granting a bank license [Section 4(5)]. The CBC is empowered to set prudential rules administratively for the following: Bank capital base (definition of the constituent parts; BL Section 22); Capital adequacy ratio [BL Section 21(1)]; Liquidity [BL Section 23(1)]. The CBC may, for the purpose of implementing the objectives of the BL and subject to the provisions of the BL, issue general or specific directives which are communicated in any manner that the CBC may determine [BL Section 41(1)]. In exercising its discretionary power under the Banking Law, the CBC is required to act after taking into consideration, by way of guidance, the international practice and the directives and regulations of the European Union. Sections 24 and 25 of the BL require licensed banks to submit prudential returns. The CBC is authorized to determine their contents and frequency.
Assessment	Compliant.
Comments	None.
Principle 1(4)	A suitable legal framework for banking supervision is also necessary, including powers to address compliance with laws, as well as safety and soundness concerns.
Description	The BL [Section 30(1)] enables the CBC to address compliance with laws and the safety and soundness of the banks under its supervision. The CBC is authorized to exercise qualitative judgment in applying these measures. Section 26 of the BL gives the CBC unfettered access to all of the institutions records and books. Section 30(1) of the BL determines the powers of the CBC where a bank fails to comply with laws and regulations or is likely to be engaged in unsafe or unsound practices. According to this section, the CBC requires the bank to take such action as deemed necessary to rectify the situation and is authorized to impose a range of sanctions, including the revocation of the license.
Assessment	Compliant.
Comments	None.
Principle 1(5)	A suitable legal framework for banking supervision is also necessary, including legal protection for supervisors.
Description	Neither, the CBC nor any person who is a director or an officer of the CBC, is liable in any action suit or other legal proceedings for damages for anything done or omitted in the discharge or purported discharge of the functions and responsibilities of the CBC under the BL, unless it is shown that the act or omission was not in good faith or was the result of gross negligence. The defense of CBC staff against lawsuits rests with the Office of the Attorney General and all legal expenses incurred are covered by the Cyprus government.
Assessment	Compliant.
Comments	None.
Principle 1(6)	Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Description	A memorandum of understanding (MOU) has been signed between the CBC, the Cyprus Securities and Exchange Commission, the Insurance Companies’ Control Service, and the Cooperatives Societies Supervision and Development Authority (CSSDA). The MOU came into effect on January 1, 2003. The four parties to this MOU meet at least quarterly to discuss matters of mutual interest. Also, at the technical level, supervisors meet at least on a monthly basis and communicate, if need be, on an ongoing basis. This MOU is based on the application of Section 27(1) which allows the competent supervisory authorities of the financial sector to cooperate and exchange information between them and/or with other supervisory authorities, whether in Cyprus or elsewhere, with a view of discharging their functions and responsibilities in a more effective manner. Any exchange of information will only take place when the CBC is satisfied that the information provided is subject to the same confidentiality rules in the hands of the receiving competent supervisory authority as apply to the CBC. Section 27(1) of the BL enables the CBC to provide to home country supervisory authorities information, which in the opinion of the CBC enables the home country supervisory authority to exercise consolidated supervision. Information on individual deposit accounts is excluded. However, in practice, such information can be passed by the affected subsidiary or branch to its parent or head office or the foreign regulator may choose to visit Cyprus to conduct an on-site review of the operations. The information exchange between the competent supervisory authorities is exclusively used in the discharge of their functions and responsibilities and is subject to confidentiality rules in the hands of the receiving supervisory authority as applied to the supervisory authority which provides the information on the basis of legislation in force from time to time. Confidential information exchanged between the competent supervisory authorities on the basis of the legislation in force may not be disclosed without the express agreement of the competent supervisory authority which disclosed it and, where appropriate, solely for the purposes for which this authority gave its agreement. Memoranda of Understanding (“MOUs”) have been signed, largely on the initiative of the CBC, with the following overseas banking supervisory authorities: Central Bank of the Russian Federation; Bulgarian National Bank; National Bank of the Republic of Belarus; National Bank of Ukraine; National Bank of Yugoslavia; National Bank of Romania; Financial and Capital Market Commission of the Republic of Latvia; National Bank of Slovakia; Bank of Tanzania; Central Bank of Jordan; Bank of Greece; Central Bank of the Lebanon. In addition, MOUs are under negotiation with a number of overseas banking regulatory and supervisory authorities, including authorities in the United Kingdom and Ireland. MOUs have been signed with the following overseas regulators in the field of international financial services: Greek Capital Markets Commission; Federal Commission for the Securities Market of Russia; Czech Securities Commission; Lithuanian Securities Commission. With regard to the securities and investment business, a member of the CBC’s staff, appointed by the Governor of the CBC, participates on the Board of the Cyprus Securities and Exchange Commission. The above person does not have the right to vote but has the right to raise issues, participate in discussions, and convey the opinion of the CBC during Board meetings. The CBC also has on-going contact and cooperation with the Official Receiver and Registrar of Companies as well as with the Head of the Unit for Combating Money Laundering. The above unit is the investigative and law enforcement authority in regards to money laundering, whereas the CBC is the supervisory authority of the banking system in regard to anti-money laundering compliance. Every director, officer, or employee of the CBC is bound to secrecy. The CBC’s governor, directors, officers, and employees take the oath of fidelity and secrecy before assuming their duties.
Assessment	Compliant.
Comments	None.
Principle 2.	Permissible Activities The permissible activities of institutions that are licensed and subject to supervision as banks must be clearly defined, and the use of the word “bank” in names should be controlled as far as possible.
Description	The term “bank” is defined in the BL as a body corporate licensed to carry on banking business under the provisions of the BL. “Banking business” is defined as business carried on in Cyprus or abroad from within Cyprus consisting of lending of funds acquired from the assumption of obligations to the public, whether in the form of deposits, securities or other evidence of debt. Licensed banks are authorized to carry on banking business as defined in Section 2 of the BL. In addition, licensed banks are authorized to carry out, directly or through subsidiaries, the following activities which are integral or closely related to banking business (Section 13 of the BL): a) financial leasing, including hire purchase financing; b) money transmission services; c) issuing and administering means of payment including credit cards, travellers cheques and bankers drafts; d) guarantees and commitments; e) trading for own account or for account of customers in: (i) money market instruments including cheques, bills, CDs; (ii) foreign exchange; (iii) financial futures and options; (iv) exchange and interest rate instruments; (v) securities; f) participation in securities issues and the provision of services related to such issues; g) advice to undertakings on capital structure, industrial strategy and related questions and advice and services relating to mergers and the purchase of undertakings; h) money broking; i) portfolio management and advice; j) safekeeping and management of securities; k) credit reference services; l) safe custody services; m) data processing services; n) nsurance brokerage services; o) any other activity which may be specified by the CBC. No person, other than a bank, shall use in any language on use of the word “bank” or any grammatical variation thereof of the word “bank” in connection with any trade or business carried on by him unless the CBC has granted its prior written approval and subject to any conditions which the CBC may consider proper to impose.
Assessment	Compliant.
Comments	None.
Principle 3.	Licensing Criteria The licensing authority must have the right to set criteria and reject applications for establishments that do not meet the standards set. The licensing process, at a minimum, should consist of an assessment of the banking organization’s ownership structure, directors and senior management, its operating plan and internal controls, and its projected financial condition, including its capital base; where the proposed owner or parent organization is a foreign bank, the prior consent of its home country supervisor should be obtained.
Description	The statutory criteria for the licensing of a bank are contained in Sections 3 and 4 of the BL. The CBC is both the licensing and supervisory authority for banks. The CBC supervises domestic banks, International Banking Units (IBUs) (formerly “offshore banks”), as well as representative offices of foreign banks. At present, 14 domestic banks, 26 IBUs, and 1 representative office of a foreign bank operate in Cyprus. It should be clarified that the term International Banking Unit (IBU) is not a legal term but a purely descriptive term denoting banks licensed to operate in and from within Cyprus, which are owned by nonresidents of Cyprus and which by the conditions attached to their banking licenses deal in currencies other than the Cyprus Pound and primarily with other nonresidents. The above-mentioned category of banks is officially coming to an end when the transitional period allowed under the provisions of the Income Tax Law of 2002 expire on December 31, 2005. The BL provides for one type of license. The CBC may, with an adequately reasoned decision, grant a license without any condition or impose conditions on the license or refuse to grant a license (Section 4 of the BL). Due to a condition attached to all IBUs’ banking-business licenses, IBUs have in the past been prohibited from raising funds in the form of any deposits, extending credits facilities, or offering any banking services whatsoever to both residents and nonresidents in Cyprus pounds. However, upon accession of Cyprus to the EU on May 1, 2004, all exchange control restrictions have been abolished, and residents of Cyprus are now allowed to transfer funds operate payments, and deal in foreign currencies without any limitations or restrictions. As a result of all these changes, the CBC’s Circular Letter of May 25, 2004 has amended the range of permissible operations of the IBUs which operate in Cyprus today. Those IBUs, already subject to the ten percent tax rate, that was generally applicable to the domestic banks, either because they had been licensed after December 31, 2001 or have, subsequent to the 2002 tax reform, elected to be taxable at ten percent, were free to offer all types of banking services to permanent residents of Cyprus, the only restriction being, for the moment, the acceptance of deposits in Cyprus pounds. This restriction, which is the only one that distinguishes the operations of domestic banks from those of of IBUs, will be abolished on Cyprus’ entry into the Euro zone. Until that time, individual IBUs that may wish to engage in banking business in Cyprus pounds must request the CBC to delete the relevant condition attached to their banking business license. Those IBUs, which were licensed prior to December 31, 2001 and which have elected to continue generating their income exclusively outside Cyprus, thus paying a reduced rate of tax of 4.25 percent, are obliged to continue restricting their activities to transactions with nonresidents and in currencies other than the Cyprus pound, despite the repeal of the exchange control laws, until December 31, 2005. The licensing criteria applied by the CBC encompass compliance of the applicant with the requirements stipulated in the BL as well as a judgmental evaluation of the applicant by the CBC. Thus, the principal licensing criteria are the following: At least two directors are required to participate and concur in the effective direction and management of the bank (Section 19 of the BL). A bank incorporated in the Republic must have at all times a minimum capital of not less than £C 3 million or such other higher amount that the CBC might determine (Section 20 of the BL). Directors, chief executives, and managers of the proposed bank must satisfy the CBC that they are fit-and-proper persons (Section 18.2). Short history and business objectives of the applicant bank, including the reasons for wishing to establish a presence in Cyprus. Detailed description of the proposed banking operations, including details of the banking services proposed to be offered and the proposed management structure of the applicant bank. Feasibility study of the bank’s proposed banking operations incorporating projected financial statements for the first five years of its operation. In the case of foreign banking organizations the CBC, in addition to the licensing criteria above, approaches directly the applicant bank’s home supervisory authority and obtains its consent as well as undertaking that it will exercise consolidated supervision over the global activities of the applicant bank, including the operations proposed to be carried out in Cyprus. In the case of foreign banking organizations, the CBC also obtains Letters of Comfort or Letters of Guarantee from the principal shareholders. Upon accession of Cyprus to the EU on May 1, 2004, the provisions of the BL allowing freedom of establishment and cross-border provision of banking services by banks authorized in other member states of the EU entered into force and the BL has been amended to that effect (Banking Amendment Law of 2003). Conversely, banks incorporated in Cyprus are free to establish branches in another member state and/or provide cross-border provision of services in member states of the EU. Following these fundamental changes, the CBC has issued in July 2004 a “Policy statement and Guidelines on the establishment and cross-border provision of services in the Republic of Cyprus by a credit institution incorporated in another member state of the EU,” which includes the terms and conditions for the conduct of banking business in accordance with the above as well as details with regard to the procedure that must be followed. There is no time limit on banking licenses issued by the CBC. However, the CBC may, under Section 30 of the Banking Law, revoke a banking license in circumstances where a bank’s condition is irretrievably impaired. As part of the review process, information/references are also obtained from third parties, such as the applicant bank’s home supervisory authority, correspondent banks, etc. The information received from the applicant is reviewed and judgmentally assessed by the CBC. If all the above criteria are satisfied and the judgmental evaluation is positive, a banking license is issued by the CBC. Directors, chief executives and managers of licensed banks have to satisfy the CBC that they are”fit-and-proper persons” to be involved in the provision of banking services. The”fitness and propriety” of the above persons is determined, to the extent possible, by means of detailed questionnaires which are required to be completed by the persons concerned. In certain circumstances, applicants are currently required to submit a police clearance certificate from their country of origin. All licensees are required to establish a real presence in Cyprus and actually carry out real business. All licensees must, therefore, operate as fully staffed units as required by the scale of operations in each case. The scale of operations and, therefore, the size of staff varies considerably. There is at least one IBU with almost 100 persons and, on the other hand, one unit is considered fully staffed with three persons. In one of the cases (application for the establishment of a domestic bank), the CBC rejected the application as one of the major prospective shareholders was a company whose background and activities rendered it unsuitable. Two of the applications were successful, whereas two remaining cases were unable to satisfy the eligibility criteria. Notwithstanding the above, it should be noted that in the case of IBUs, the policy of the CBC is to discourage the submission of formal applications under the Banking Law by banks which do not meet the eligibility criteria as set out in the bank’s “Policy Statement and Guidelines for the establishment and operation of IBUs.” The CBC also requires prospective applicant banks to obtain the prior approval and support of their home banking regulatory/supervisory authority before submitting a formal application to the CBC for a banking license. In this way, besides the cases referred to in the preceding sentence, a number of prospective applicant banks have been discouraged in the last two years from actually submitting an application. With respect to the transparency of the ownership structure and the source of capital, the CBC indicated that its policy is to license only branches or subsidiaries of existing international banks. The CBC has in place a process of ongoing supervision and monitoring to determine whether the licensing criteria continue to be met and that the institution is meeting its business goals. The CBC is home supervisor for 16 banks (10 domestic and 6 IBUs). Three of the domestic banks maintain branches/subsidiaries in foreign jurisdictions. The CBC is empowered to revoke the licence of the bank if it is revealed that the decision to grant the licence of the bank was knowingly based on false information [Section 30(1)]. The applicant bank is required to submit to the CBC a list of the prospective shareholders with their proposed percentage shareholding in the bank. Major and/or controlling shareholders who are natural persons must submit a brief outline of their financial standing and complete a “Personal Questionnaire,” while corporate bodies must submit their full particulars and latest audited accounts. The CBC reserves the right to enquire into the individuals who control such corporate bodies. In this regard, the shareholders of the applicant bank must be able to supply additional financial support, if needed. Major and/or controlling shareholders are required to provide the CBC with appropriate “Letters of Comfort” or “Letters of Guarantee.” The CBC requires that the directors of the applicant bank must have substantial experience and sound knowledge of all types of financial activities the bank intends to pursue. Once licensed and following the commencement of its operations, the banking subsidiary or branch is subject to the supervision of the CBC through regular off-site monitoring and on-site examinations. The aim of on-site examinations is to assess the quality of the bank’s assets, its financial soundness, the adequacy of liquidity, its earning capacity, the adequacy and quality of management, the adequacy of internal control systems, the implementation of prudent policies, and its compliance with the conditions that may be attached to its banking licence.
Assessment	Compliant.
Comments	None.
Principle 4.	Ownership Banking supervisors must have the authority to review and reject any proposals to transfer significant ownership or controlling interests in existing banks to other parties.
Description	Section 17(1) of the BL stipulates that no person shall, without the prior written approval of the CBC, either alone or with an associate or associates, acquire or have control over any bank incorporated in Cyprus or its holding company. “Control” is defined in Section 2 of the BL as: a) beneficial ownership by a person of its share capital or of its holding company which carries ten percent or more of the voting power at any general meeting of the company or its holding company; or b) ability by a person to determine in any manner the election of a majority of the directors of the company or of its holding company. Regarding foreign banks’ ownership, the CBC considers applications only from banks licensed in jurisdictions, which, in its judgment, exercise proper licensing and banking supervision. In addition, applicant banks should be institutions enjoying a good reputation internationally and having an established record of growth and profitable operation. In addition, it must be noted that the CBC does not grant licenses to “de novo” banks or banks which are ultimately beneficially owned and/or controlled by a non-established, non-financial institution. Notwithstanding the provisions of any other law, section 16 of the BL stipulates that: a) a bank incorporated in Cyprus shall not sell or dispose the whole or part of its business in Cyprus by amalgamation or otherwise, except with the prior written approval of the CBC; and b) a bank other than a bank incorporated in Cyprus shall not sell or dispose the whole or part of its business in Cyprus, except with the prior written approval of the CBC. Moreover, no person shall, without the prior written approval of the CBC, either alone or with any associate or associates acquire or have control over any bank incorporated in Cyprus or its holding company. Any intention to increase the holding in a bank or its holding company above the level that has initially been approved by the CBC requires the prior approval of the CBC. Any intention to decrease a holding in a bank or its holding company will also require notification to the CBC [Section 17 (1)]. Notwithstanding any provisions of the Companies Law or any other law in force in Cyprus from time to time, if a holding in a bank or its holding company is acquired despite the opposition of the CBC, it shall, regardless of any other sanctions to be adopted, provide either for exercise of the corresponding voting rights to be suspended, or for the nullity of votes cast or for the possibility of their annulment [Section 17(2)]. The CBC, in deciding whether to grant a license approval, will ensure that persons of dubious reputation or persons who may pose a threat to the interest of depositors and integrity of the bank are excluded. In the course of on-site examinations, the CBC obtains the names and holdings of all significant shareholders.
Assessment	Compliant.
Comments	None.
Principle 5.	Investment Criteria Banking supervisors must have the authority to establish criteria for reviewing major acquisitions or investments by a bank and ensuring that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision.
Description	Section 13 of the BL regulates investments by banks and sets limits on the acquisition of shares by banks in other companies. Specifically, the BL [Section 13(1)] provides that a bank shall not acquire or hold directly or indirectly more than ten percent of the share capital of any other company, and, in the case of a bank incorporated in Cyprus, the value of any share capital held in any other company shall not exceed ten percent and for all companies in aggregate 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 which are integral to or closely related to banking business provided that such companies are incorporated in Cyprus. Any bank investments exceeding the limits mentioned above require the prior written approval of the CBC. Before granting its approval for any new acquisition by a bank, the CBC requires that any new acquisitions and investments do not expose the bank to undue risks or hinder effective supervision. The bank must demonstrate that it has, from the outset, adequate financial and organizational resources to handle the acquisition/investment. Investments in non-consolidated subsidiaries are deducted from the bank’s capital base for purposes of consolidated supervision. In the course of on-site examinations, the CBC inspectors ensure that investments in banking and non-banking companies do not expose the bank to undue risks. In addition, Section 12 of the BL prohibits the acquisition or purchase of immovable property by banks, except in certain cases as provided in Section 12 of the BL. Notification after the acquisition or investment is sufficient in the case of activities closely related to banking and where the investment is small relative to the bank’s capital. EU Directive 2000/12/EC, which is to be transposed, limits individual participation to 15 percent of capital and aggregate participation to 60 percent.
Assessment	Compliant.
Comments	None.
Principle 6.	Capital Adequacy Banking supervisors must set minimum capital adequacy requirements for banks that reflect the risks that the bank undertakes, and must define the components of capital, bearing in mind its ability to absorb losses. For internationally active banks, these requirements must not be less than those established in the Basel Capital Accord.
Description	Cyprus incorporated banks, including subsidiaries of foreign banks, are required to have a minimum capital and to maintain capital adequacy ratios. These requirements do not apply to branches of foreign incorporated banks. A bank incorporated in Cyprus should have at all times a minimum capital base of not less than £C 3 million (€5 million) or such other higher amount that the CBC might determine in line with EU requirements (Section 20). Banks incorporated in Cyprus are also required to maintain a capital adequacy ratio at such minimum level as may be determined by the CBC from time to time for each bank individually having regard to its circumstances provided that such ratio shall be uniform for all banks within the same class [Section 21(1)]. The capital adequacy ratio is in the form of mandatory maintenance of a capital base in relation to total assets including off-balance sheet exposures or to categories of assets specified by the CBC from time to time at such minimum ratio or ratios as is prescribed by the CBC [Section 21(2)]. At present, the required capital adequacy ratio stands at 10 percent. All banks comply with the ratio and the average ratio for the sector exceeds 14 percent. The CBC has issued two directives (January 1999) to all banks incorporated in Cyprus: Directive on the computation of the capital adequacy ratio in relation to credit risk (excluding risks arising from the trading book); and Capital adequacy directive in relation to a bank’s trading book business and in respect of the foreign exchange and commodity derivatives risks resulting from all of its business activities. These directives conform to the Basel recommendations and make use of the Basel risk weights and components of capital. The capital adequacy ratios of banks are calculated on both a consolidated and solo basis. Banks are required to report capital adequacy ratios and their components to the CBC on a semi-annual basis. The above ratios are verified in the course of on-site examinations. Off-balance sheet risks, subordinated debt, revaluation gains, and unrealized losses are treated in accordance with Basel recommendations for purposes of determining capital adequacy. Off-balance sheet items are grouped into four categories depending on the risk that they entail, and each category carries out a different risk conversion factor. Then the values of these items, as adjusted by the conversion factor, are multiplied by the risk weightings attributable to the relevant counterparties. Subordinated debt is included in tier two capital and cannot exceed 50 percent of tier one capital. Moreover, the total of tier two capital cannot exceed the total of tier one capital. Revaluation gains are credited to a revaluation reserve, and the balance of this reserve is included in tier two capital. Unrealized losses are debited to the revaluation reserve to the extent that these are covered by revaluation gains individually for each item concerned. Any shortfall is debited to the Profit and Loss Account, which is included in tier one capital. Under Section 30(1)of the BL, the CBC has broad powers to take remedial measures. This would no doubt include requiring institutions to take corrective action where their capital ratios fell below a certain limit. Branches of foreign incorporated banks are not required to have capital and, therefore, they do not maintain a capital adequacy ratio. Banks are required to have an internal process for assessing their overall capital adequacy in relation to their risk profile. Banks are required to provide the CBC with all the information necessary for the assessment of their compliance with the requirements of the Capital Adequacy Directive. The banks’ internal control mechanisms and administrative and accounting procedures should be such as to permit the CBC to verify the banks’ compliance with these requirements at all times. The adequacy of the internal process of banks for assessing their overall capital adequacy in relation to their risk profile is evaluated in the course of on-site examinations. In addition, the expansion of banks abroad, especially in Greece, requires additional capital funds. In such a case, the prior approval of the CBC is required. The CBC grants its approval only if it is satisfied that the bank has sufficient capital funds to support the expansion abroad.
Assessment	Compliant.
Comments	None.
Principle 7.	Credit Policies An essential part of any supervisory system is the independent evaluation of a bank’s policies, practices, and procedures related to the granting of loans and making of investments and the ongoing management of the loan and investment portfolios.
Description	Both domestic and international banks operating in Cyprus are subject to the same responsibilities and oversight regarding their credit and investment risk-related policies, procedures, and systems. Pursuant to its authority under the BL, through a series of directives and circulars and direct communication with the banks, the CBC has established and implemented its requirements that banks have established and well-documented credit and investment policies, practices, and procedures, approved by their Board of Directors and implemented by bank management. Such requirements include the establishment of internal risk management and control systems and asset classification and provisioning requirements by the banks and their establishment of effective internal communications systems to transmit those processes to bank management and staff involved in the credit granting and control process. Section 11(1) of the BL prescribes limitations on large exposures and aggregate large exposures, as well as on credit facilities to directors and their interests. The CBC reviews and evaluates compliance with all legal and prudential requirements through both off-site monitoring and on-site examination. The CBC requirements include policies on ongoing organization-wide credit and investment risk assessment, management, control, and reporting systems, asset quality classification, large exposures, establishment and monitoring of limitations, connected lending, assurance that the credit approval process is free of inappropriate external pressure and conflict of interest, and other related matters. Section 26 (2) of the BL requires that banks provide all necessary information to the CBC, which facilitates both the off-site supervision and on-site monitoring processes. Off-site monitoring is effected by the regular collection of a variety of information through the collection of detailed periodic returns on all aspects of credit and investment risks in the banks. Such reporting includes, inter alia, a monthly balance sheet with detailed asset and liabilities breakdown; information on asset quality, non-performing loans, and provisioning; large exposures; and, investments. Returns are reviewed and analyzed and the results are provided to appropriate examination staff and senior CBC management for necessary action. The scope of the on-site examination process includes an assessment of all aspects of credit administration, credit control, and credit risk evaluation. Appropriate asset quality classification and provisioning, including the adequacy of credit loss reserves, is addressed, as is the bank’s ongoing credit authorization, information, and documentation systems and senior management oversight. Information systems must include information on customer outstandings, delinquencies and other problems, sectoral exposures, and corrective action. On-site examinations also evaluate the understanding of the credit risk system by bank management and staff. The results of on-site examinations are reviewed with bank senior management and corrective action is required.
Assessment	Compliant.
Comments	None.
Principle 8.	Loan Evaluation and Loan-Loss Provisioning Banking supervisors must be satisfied that banks establish and adhere to adequate policies, practices, and procedures for evaluating the quality of assets and the adequacy of loan-loss provisions and reserves.
Description	All licensed banks are subject to regular on-site examinations. One of the prime objectives of these examinations is to assess the quality of the assets of the banks. In the course of an on-site examination, the CBC examiners review extensively the bank’s lending practices, its credit granting standards, and the level and adequacy of provisions. Banks themselves are required to review individual credits, asset classifications, and provisioning, including those for both on-and off-balance sheet exposures, at least annually. In addition, the external auditors of banks, when conducting the audit of each bank’s financial statements, review their provisioning policies and adequacy. During the course of on-site examinations, the CBC examiners assess the quality of assets individually, especially major loan accounts, and the level and adequacy of provisions and compare their results with those of the bank. In view of the small number of banks, CBC examiners are able to review a sample of more than 50 percent of the balance sheet value of bank credit exposures; the sample selected is biased towards large or problematic loans and includes both on- and off-balance sheet exposures. Each borrower selected is individually assessed by account, collateral held, financial condition, and other pertinent factors. Then, according to the risk entailed, each account is classified on the basis of CBC’s established asset quality classification criteria. These classifications are Pass, Special Mention, Substandard, and Doubtful; the definition of the characteristics of each of these classifications is very comparable to the definitions of similar classifications that are used by other competent supervisory authorities worldwide. In the course of on-site examinations, the CBC inspectors review the bank’s provisioning policies, as approved by the Board of Directors, together with the guidelines that are set for considering specific credits for provision. Since CBC examiners are able to review more than 50 percent of the balance sheet value of credit exposure, they can more adequately assess the level and adequacy of each bank’s provisioning policies, as well as their implementation in practice. The CBC requires banks to have appropriate procedures and the necessary organizational resources for the ongoing oversight of problem credits and for identifying and collecting past due loans. The CBC meets twice yearly with each bank’s management to review the bank’s provisioning policy and practices and the progress made in the collection of past due loans. The banks provide the CBC with quarterly reports on provisioning, non-performing assets, and assets where interest has been suspended. In January 2004, the CBC established more stringent criteria for the suspension of the recognition of interest on problem-credit facilities. The time period beyond which interest will be suspended for such credit facilities that are in arrears or where limits are in excess, provided that there is no adequate tangible security, was reduced from nine months to six months. In December 2004, the time period was further reduced from six months to ninety days, to be effective from January 1, 2006. The CBC plans to further modify its policy in the near future to require the suspension of interest in such cases, irrespective of the existence of tangible security, in line with international practice and the provisions of the proposed Capital Adequacy Directive of the EU.4 Section 30(1) of the BL empowers the CBC, when a bank fails to comply with any provision of law or regulations or the conditions of its license, or the liquidity or character of its assets have been impaired, to, inter alia, require the bank to forthwith take such action as the CBC may consider to rectify the matter. Consequently, the CBC is empowered to require a bank to strengthen its lending practices, credit-granting standards, level of provisions and reserves, and overall financial strength if it deems the level of problem assets to be of concern. Section 20 of the Banking Act empowers the CBC to increase the capital requirement of a bank in order to deal with shortfalls in provisions. The CBC collects information from the banks quarterly on provisioning, non-performing loans, and assets where interest is suspended. Further information on provisioning is obtained at semiannual meetings with the banks and annual tri-lateral meetings with the banks and their external auditors. In the course of on-site examinations, the CBC examiners require details on the bank’s classification of assets and provisioning. In keeping with the basic principles and standards for risk control contained in its “Framework for the Evaluation of Internal Control Systems,” the CBC would expect the banks to have processes in place for continually identifying, measuring, analyzing, and controlling risk in its credit portfolio, including mechanisms for continually assessing the strength of guarantees and appraising the worth of collateral and identifying and classifying problem credits as impaired. The CBC has issued specific guidelines on determining the value of collateral held by banks, which specify that the valuation of collateral is required to reflect its net realizable value. The CBC directives also provide that the refinancing of loans that would otherwise fall into arrears does not lead to improved classification. The CBC requires that the valuation, classification, and provisioning for large credit exposures be conducted on an individual item basis.
Assessment	Largely Compliant.
Comments	Pending the full completion of the ongoing implementation of the more stringent criteria for the suspension of the recognition of interest on problem facilities on January 1, 2006, Cyprus remains largely compliant with this Principle.5
Principle 9.	Large Exposure Limits Banking supervisors must be satisfied that banks have management information systems that enable management to identify concentrations within the portfolio, and supervisors must set prudential limits to restrict bank exposures to single borrowers or groups of related borrowers.
Description	Sections 11(1) and (2) of the BL establish limitations on exposures extended to individual borrowers and their interests (i.e., a closely related group) generally to 25 percent of the bank’s capital base. However, the CBC has discretionary power to grant very limited exceptions to this limitation in cases involving the public interest or exceptionally low risk arising from the exposures concerned, provided that such exemptions are not in conflict with EU acts in force in Cyprus. The aggregate of large exposures (i.e., exposures in excess of 10 percent of the bank’s capital base) is limited to 800 percent of the bank’s capital base. The law empowers the CBC to establish lower limits, as it deems necessary. Section 11(3) establishes the criteria for determining what constitutes a closely related group (“connected persons”) and section 11(4) defines a credit exposure, which includes both on-and off-balance sheet exposures. Section 43 of the BL provides for monetary penalties for non-compliance with these requirements. In June 2004, the CBC re-issued its Directive 7, Monitoring and Control of Credit Facilities to Individual Borrowers or Bank Directors and their Connected Persons, which, inter alia, describes the determination of a connected person, the definition of the bank’s capital base, and the credit exposures to be included. It also includes the requirements for monitoring exposures on both a consolidated and non-consolidated basis, as appropriate. It requires the maintenance of accounting, administrative, and internal control systems to monitor these exposures and prescribes periodic reporting of the exposures to the CBC. Banks are required to submit semi-annual reporting on concentrations of lending. The scope of on-site examinations includes a review of concentrations of lending and compliance with the requirements of the law as well as the management systems that monitor such exposures on both a solo and consolidated basis, as appropriate. It also determines the accuracy of management information systems and reporting to the CBC.
Assessment	Compliant.
Comments	The CBC may wish to consider establishing a centralized registry of information on large credit exposures as would be defined by them to be regularly collected from banks and other credit providers in Cyprus, aggregated by the CBC for each borrower and then made available to the banks and other credit providers for their use in evaluating their credit risk exposures.
Principle 10.	Connected Lending In order to prevent abuses arising from connected lending, banking supervisors must have in place requirements that banks lend to related companies and individuals on an arm’s-length basis, that such extensions of credit are effectively monitored, and that other appropriate steps are taken to control or mitigate the risks.
Description	In addition to the general large exposure limitations on exposures to individual borrowers and their closely related groups prescribed in Section 11(1)(a), section 11(1)(d) of the BL, as amended, establishes limitations on credit facilities extended to all of the bank’s directors together to 40 percent of the bank’s capital base. Section 11(1)(e) limits the unsecured credit exposure of each individual director to 5 percent of the bank’s capital base. Section 11(c) requires that the approval of all credit exposures to directors be approved by a resolution of a minimum of two-thirds of the directors with the effected director not present for the discussion and voting, and that such credit exposures be granted on the same commercial conditions as would apply to any customer in the ordinary course of business. Section 11(3) establishes the criteria for determining what constitutes a closely related group (“connected persons”) and Section 11(4) defines a credit exposure, which includes both on- and off-balance sheet exposures. Section 22 would permit the CBC to deduct credit exposures to directors and their interest in the computation of the bank’s capital base; although, this has not been done. Section 42 provides the CBC with authority to impose administrative fines for non-compliance with these requirements. In addition, Section 43 of the BL provides for the imposition of administrative fines and imprisonment in situations where a case of criminal prosecution by the Attorney General is involved. In June 2004, the CBC re-issued its Directive 7, Monitoring and Control of Credit Facilities to Individual Borrowers or Bank Directors and their Connected Persons, which, inter alia, describes the determination of a connected person, the definition of the bank’s capital base, and the credit exposures to be included. It also includes the requirements for monitoring exposures on both a consolidated and non-consolidated basis, as appropriate. It requires the maintenance of accounting, administrative, and internal control systems to monitor these exposures and prescribes periodic reporting of the exposures to the CBC. Banks are required to submit semi-annual reporting on all concentrations of lending, including exposures to their directors and their interests. The scope of on-site examinations includes a review of concentrations of lending and compliance with the requirements of the law as well as the management systems that monitor such exposures, on both a solo and consolidated basis, as appropriate. It also determines the accuracy of management information systems and reporting to the CBC.
Assessment	Compliant.
Comments	None.
Principle 11.	Country Risk Banking supervisors must be satisfied that banks have adequate policies and procedures for identifying, monitoring, and controlling country risk and transfer risk in their international lending and investment activities, and for maintaining appropriate reserves against such risks.
Description	The CBC has not prescribed specific, formal country risk limitations for banks; however, country risk exposures are monitored through a monthly return that is filed by all internationally active banks. Exposures that are of concern are addressed through direct communication with the bank. Banks with material country risk exposure would be expected to establish, monitor, and control their own internal country risk limitations, pursuant to the nature of their business as part of an overall risk management system. In addition, Cyprus-incorporated banks have a physical presence in only three foreign developed countries, and the CBC insures that the activities/exposures in these countries are adequately supported by each bank’s capital base. Likewise, the CBC has not mandated overall, formal transfer risk limitations but would expect that each internationally-active bank include transfer risk-related limitations in its overall risk management process and appropriately monitor, review, and control any such exposures. In addition, the CBC expects that banks maintain correspondent accounts only with prime banks and has established a limit for maximum allowable placements with each foreign bank of 20 percent of the depositing bank’s capital base. The bank’s compliance with this limitation and any internally-imposed limitations is reviewed by the CBC during each on-site examination. The bank’s systems to identify, monitor, and control country/transfer risk are reviewed during each on-site examination. These matters are discussed with bank management during the examination and concerns are communicated to the bank.
Assessment	Largely Compliant.
Comments	The CBC should consider establishing formal guidance on a framework for country risk and transfer risk management, which could be used by all banks located in Cyprus to formulate their own specific internal limitations, as appropriate, to the nature of their business and their ability to identify, monitor, and control such risks.
Principle 12.	Market Risks Banking supervisors must be satisfied that banks have in place systems that accurately measure, monitor, and adequately control market risks; supervisors should have powers to impose specific limits and/or a specific capital charge on market risk exposure, if warranted.
Description	In the course of the periodical on-site examinations, the CBC verifies that banks have information systems, risk management systems, and internal controls that enable them to measure, monitor and control market risk. During these on-site examinations, the CBC also ensures that there are appropriate limits, including stop-loss limits, for various risks. Moreover, open positions in foreign currency are subject to limits imposed by the CBC. These limits are currently 6 percent of capital base for the overall open position (coming down from 15 percent) and 3 percent of capital base for the open position in each currency (coming down from 10 percent). In addition, there are intra day limits in place. The overall open foreign currency position is the sum of all the net short positions or the net long positions, whichever is greater. During on-site examinations, the CBC reviews the banks’ systems and assesses compliance with internal limits. The limits imposed by the CBC on open positions in foreign currency are monitored through monthly prudential returns submitted to the CBC. The CBC has adopted as from January 1, 2003, the provisions of the EU Capital Adequacy Directive (CAD) (Council Directive 93/6/EEC dated March 15, 1993 as subsequently amended by Council Directives 98/31/EC and 98/31/33/EC dated June 22, 1998), thereby requiring a capital charge for market risk, including commodity derivatives position risk. Section 20 of the BL enables the CBC to increase the capital requirements of banks if it deems necessary. The presence of adequate systems and controls, ensuring that all transactions are captured on a timely basis and that the banks’ positions are revalued frequently, using reliable and prudent market data, is not directly assumed by the CBC. In this area the CBC relies on the work carried out by the banks’ internal as well as external auditors. At present, there are no formal supervisory requirements with respect to scenario analysis, stress testing, and contingency planning. However, the presence of market risk in bank operations has up to now been minimal. In the case of those banks which are relatively active in market operations and which are subsidiaries of EU banks, there is a close cooperation with the consolidating/lead supervisory authority. As to the required expertise needed to monitor the actual level of complexity in the market activities of banks, it is to be noted that with the exception of perhaps one or two banks, the level of market activities of banks is low and, therefore, until now, there has been no practical need for specialization in monitoring market risk in the Banking Supervision and Regulation Division. As a result, non-specialized bank supervisors can easily review the market operations of banks during on-site examinations. However, the CBC realizes that market sophistication of banks is imminent so the mission has been informed of the plans to develop the required expertise among its supervisors through the attendance of specialized training courses offered by the FSI and other organizations. In the case of those banks which are relatively active in market operations and which are subsidiaries of EU banks, there is a close cooperation with the consolidating/lead supervisory authority, thus mitigating the lack of expertise at the local level. The CBC holds meetings with senior management to discuss findings of on-site inspections. During these meetings, the CBC determines that the senior management understands the market risks undertaken and the risk management information that they receive. With the exception of one bank which is relatively active in market operations and which is a subsidiary of an EU bank permitting a close cooperation with the consolidating/lead supervisory authority, the CBC has not so far allowed any other banks to use sophisticated models to calculate their regulatory capital requirements.
Assessment	Largely Compliant.
Comments	The CBC has to be commended for the adoption of CAD. However, while acknowledging that activities generating market risk in this market are limited, in order to be fully compliant and to prepare for future expansion of such activities, the CBC should: satisfiy itself that there are systems and controls in place to ensure that all transactions are captured on a timely basis, and that the banks’ positions are revalued frequently, using reliable and prudent market data; determine that banks perform scenario analysis, stress testing, and contingency planning, as appropriate, and periodic validation or testing of the systems used to measure market risk; build up the expertise needed to monitor the actual level of complexity in the market activities of banks and acquire the expertise in order to validate itself the internal model of the foreign subsidiaries for which the CBC is the home regulator.
Principle 13.	Other Risks Banking supervisors must be satisfied that banks have in place a comprehensive risk management process (including appropriate board and senior management oversight) to identify, measure, monitor, and control all other material risks and, where appropriate, to hold capital against these risks.
Description	Section 23(1) of the BL empowers the CBC to establish a minimum ratio of liquefiable assets to be held by banks. In November 2001, the CBC issued its Directive #11 on the Computation of Prudential Liquidity, which sets out its requirements for maintaining bank liquidity. Pursuant to the directive, banks are required to manage their liquidity through the use of time-band analysis for assets and liabilities and maintaining maximum allowable maturity mismatches (excess liabilities over assets) within limitations prescribed in Directive #11. The directive requires consideration of both on- and off-balance sheet assets and liabilities. Liquidity is monitored by the banks on a daily basis, and a quarterly liquidity return is required by the CBC. Information on foreign currency liquidity is collected monthly. During on-site examinations, compliance with the prescribed requirements and limitations is verified. Banks are permitted to set their own internal interest rate risk-related limitations, with respect to both Cyprus pounds and foreign currencies, which are to be monitored using their own models. These limitations and compliance with them is reviewed during on-site examinations. The CBC reports that the banks’ current self-imposed limitations are conservative and below the level that it would find acceptable. Banks submit quarterly returns on interest rate risk exposure. The CBC requires that banks maintain adequate systems of measuring and monitoring their interest-rate risk exposures on a daily basis. Banks currently assess their interest-rate risk exposures using the “gap-analysis” method with simple maturity/repricing schedules. Banks are also required to have in place a system of interest rate risk limits, maintaining banks’ interest rate risk exposures within self-imposed parameters. The CBC has the right to request the revision of a bank’s upper operating limit for interest-rate risk exposures if it considers that this limit has been set at an excessively high level. In addition, the adequacy and effectiveness of banks’ interest-rate risk measurement and management processes is assessed by the CBC during on-site examinations. To facilitate the monitoring of interest-rate risk exposures by the CBC across institutions, banks are required to perform stress tests and provide to the CBC, on a quarterly basis, the results of their internal measurement systems, expressed in terms of a change in net-interest income, using a standardized interest rate shock of 1 percent in the base interest rate. The CBC requires that banks limit their overnight foreign exchange net-open positions in any one currency to the equivalent of 3 percent of their capital base; the intra-day maximum limit is 5 percent. The overall aggregate net-position limit for all currencies together is the equivalent of 6 percent of their capital base, measured as the sum of the absolute values of the individual net-currency positions; the intra-day maximum is 8 percent. Also, banks must establish stop-loss limits on both a daily and cumulative basis. Monthly returns on foreign currency positions are filed with the CBC. The CBC’s Directive on the “Framework for the Evaluation of Internal Control Systems” requires banks to have contingency plans to enable the continuation of services and operations and provide for the restoration of controls. Included in these requirements are the basic requirements and criteria for the ongoing maintenance of and contingency planning for the recovery of the bank’s information systems and other operational risk-related matters. Banks are required to have appropriate management systems and systems to measure, monitor, and control these risks as well as internal management reporting systems to provide for oversight by senior management. Also, a required task for the internal auditor is to evaluate compliance with, and the efficiency of, risk control/management procedures and to estimate any potential loss that the bank might incur as a result of its exposure to risks. The directive requires that banks have a structure appropriate to the scope and complexity of its activities and that tasks and responsibilities for each activity and operational unit be clearly stated in the bank’s operational manuals. During on-site examinations, the CBC reviews the adequacy and effectiveness of all of the bank’s systems to identify, analyze, monitor, and control risks and compliance with limitations imposed by the CBC as well as verification of periodic reporting. Off-site monitoring of returns also identifies issues of concern and compliance with limitations. Section 20 of the BL empowers the CBC to increase the banks’ minimum capital requirement to include consideration of other risks. In its Directive #10, Monitoring of Foreign Currency Exposures, for banks whose business is carried out primarily in Cyprus pounds, the CBC has imposed a minimum liquidity ratio for liabilities in foreign currencies, currently set at 75 percent, and specifies the types of assets that may be treated as liquid. The CBC does not currently require that banks include a statement on their risk management policies and procedures in their published accounts. However, these accounts are prepared according to International Accounting Standards, which require certain disclosures on risk management.
Assessment	Compliant.
Comments	Beginning on January 1, 2007, the CBC will require banks to comply with the requirements the EU Capital Requirements Directive, which includes disclosures on risk management.
Principle 14.	Internal Control and Audit Banking supervisors must determine that banks have in place internal controls that are adequate for the nature and scale of their business. These should include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding its assets; and appropriate independent internal or external audit and compliance functions to test adherence to these controls, as well as applicable laws and regulations.
Description	The CBC issues Directives pursuant its authority under Section 41 of the BL. In April 2004, the CBC updated its previously-issued Directive #8 on the Framework for the Evaluation of Internal Control Systems, which establishes general principles and standards for ensuring adequate internal control systems and recommends the tasks and responsibilities that should be given to internal audit units of banks. The directive sets out the objectives of the internal control system; the basic principles and standards for the overall system and for the organizational structure and operational procedures of the bank; basic principles and standards for risk control and accounting and information systems; the responsibilities of the Board of Directors and senior bank management (with regard to all aspects of risk management), including the establishment of an audit committee and the establishment, tasks, and operational principles of the internal audit department. The directive requires the Board of Directors and senior management to develop and implement a risk control system appropriate to the specifics of the bank and the complexity of its operations. In addition, various general provisions in the BL and the Companies Law include duties and responsibilities of directors. Section 19 of the BL requires that at least two individuals participate and concur in the effective direction and management of the business of the bank (the “four-eyes” principle) and the Companies Law provides that the business of the company will be managed by the directors and that the duties of directors are the fiduciary duties of loyalty and good faith and the statutory duty of disclosure. Section 18(2) of the BL empowers the CBC to assess the fitness and propriety of the directors, the chief executive officer, and managers of banks and, if they are found to be not fit and proper, to direct that they not be a director, chief executive officer, or manager. Prospective directors and senior management that are not known to the CBC provide detailed background information to the CBC prior to their appointment, and the CBC conducts investigations on those individuals to determine whether they have the necessary skills to assume their proposed position. Section 30(1)(a)(v) of the BL empowers the CBC to require the removal of any director, controller, or manager of a bank. Competence and skills of bank management are assessed during on-site examinations and in direct contacts between CBC officers and bank management. On-site examination procedures include review and assessment of internal audit, credit review, control, and administration, treasury management, management information systems, organizational structure, recruitment policies, and other internal control functions to evaluate the adequacy and effectiveness of back office and operational functions, relative to the bank’s business. The on-site examination also includes a comprehensive review of the adequacy and effectiveness of the internal audit function to ensure complete access to all aspects of and records on the bank’s business, staff adequacy, independence, and reporting lines to the Audit Committee of the Board of Directors, and senior management attention to the issues and exceptions raised by the internal audit function. Section 26(2) of the BL provides the CBC with access to all records and other information of the bank, including all reports of the internal and external audit functions. The off-site supervision and on-site examination functions include contact with bank’s internal audit and internal control and compliance staff. The Directive on the Framework for Evaluation of Internal Control Systems requires that the Audit Committee of the Board of Directors be composed of non-executive directors, thus ensuring that there are non-executive directors on the Board. It also requires that the internal audit function report directly to the Audit Committee of the Board.
Assessment	Compliant.
Comments	None.
Principle 15.	Money Laundering Banking supervisors must determine that banks have adequate policies, practices, and procedures in place, including strict “know-your-customer” rules, that promote high ethical and professional standards in the financial sector and prevent the bank being used, intentionally or unintentionally, by criminal elements.
Description	The Prevention and Suppression of Money Laundering Activities Laws of 1996 to 2004, (hereafter referred to as the “PSMLAL”), establish a solid framework that covers the various aspects of money laundering and the role of the financial system in this regard. The salient features of the PSMLAL are as follows: It defines and criminalizes laundering of proceeds from all criminal offenses punishable with imprisonment in excess of one year. It provides for the confiscation of proceeds from all serious crime. It empowers courts to issue freezing and restraint orders in respect of such. It requires suspicion of money laundering to be reported to the Unit for Combating Money Laundering (MOKAS) without this being treated as a breach of confidentiality. It empowers the courts to order the disclosure and production of information held by natural or legal persons, including banks, related to money laundering investigations. It requires all persons carrying on relevant financial or other business, as defined by the law, to maintain procedures in relation to customer identification, record keeping, internal control, and communication and staff training in the recognition and handling of suspicious transactions. It enables the registration and enforcement of foreign orders for the freezing and confiscation of proceeds. In November 2004, the CBC issued a Guidance Note to banks which consolidates in one single document all the previous Guidance Notes and Supplements/Amendments. The revised Guidance Note takes into account: i) the harmonization of Cyprus’s legislation with the EU Directive 2001/97EC; ii) the revised recommendations for combating money laundering issued by the Financial Action Task Force (FATF) on money in June 2003 and the nine special recommendations against terrorist financing; iii) the recommendations included in the paper on “Customer Due Diligence for Banks” issued in October 2001, by the Basel Committee on Banking Supervision. The revised Guidance Note requires banks to implement measures to prevent money laundering and contains requirements in respect of the following: Customer identification and due diligence procedures; Record keeping procedures; Cash deposits in foreign currency notes; The role of the Money Laundering Compliance Officer; Recognition and reporting of suspicious transactions to the financial intelligence unit (“MOKAS”); Prudential reporting to the CBC; Internal control procedures and risk management; Education and training of employees. CBC’s supervision in this area entails, besides the issuance of Guidance Notes for the implementation of preventive measures, off-site monitoring and on-site examinations which aim at assessing bank’s compliance with their anti-money laundering obligations. The PSMLAL, the Banking Law, and CBC’s Guidance Note prohibit banks from opening and maintaining secret, anonymous, or numbered accounts, or accounts in fictitious names, or accounts not in the full name (s) of the holder (s) as per the identification documents. Additionally, the Guidance Note requires banks to identify, in the case of private and non-listed public companies, the identity of the principal ultimate beneficial owners. The latter are defined to be persons with direct or indirect interest of 5 percent or more in a company’s share capital. Apart from beneficial owners, banks must also establish the identity of any person (s) who have control over a company’s business and assets, even if that person has an interest of less than five percent in a company’s share capital. The CBC’s Guidance Note requires that records maintained by banks in respect of any customer account should contain the following minimum information: the identity of the account holder (s); the identity of the beneficial owner (s) of the account; the identity of the authorized signatory (ies) to the account; the volume of funds or level of transactions flowing through the account; connected accounts; for selected transactions: the origin of the funds; the type and amount of the currency involved; the form in which the funds were placed or withdrawn; i.e., cash, cheques, wire transfers, etc.; the identity of the person undertaking the transaction; the destination of the funds; the form of instructions and authority; the type and identifying number of any account involved in the transaction. In accordance with the CBC Guidance Note, when opening accounts for trusts and nominees of third persons, banks should ascertain, without any exception, the identity of all the settlors and the true benificaries of the said accounts. The PSMLAL requires banks, when forming a business relationship or carrying out a one-off transaction with or for another, to apply appropriate procedures of internal control, communication, and detailed examination of any transaction, which, by its nature, may be considered to be associated with money laundering for the purpose of preventing or forestalling money laundering. As a means of assisting persons employed by banks in recognizing the most basic ways through which money laundering may occur, the CBC’s Guidance Note contains an extensive list of examples of suspicious transactions and activities. In the period from June 1998 to June 2004, banks reported a total of 375 suspicious transactions to the FIU (75 in 2002, 99 in 2003 and 77 in 2004). The CBC’s Guidance Note also requires that banks put in place by June 30, 2005, the latest, adequate management information systems for the on-going monitoring of accounts and transactions. In the course of developing these systems, banks should give particular attention to the effective monitoring of higher-risk customer accounts and transactions, which, by their nature, may be associated with money laundering. Furthermore, banks should not accept cash deposits in foreign currency notes in excess of $100.000 (one hundred thousand U.S. Dollars) or the equivalent in other foreign currency per calendar year from any person (resident or nonresident) or a group of connected persons. Such cash deposits should be accepted only with the prior written approval of the CBC. The PSMLAL requires that banks institute internal reporting procedures and that they identify a person (known as “the Money Laundering Compliance Officer”) to whom the bank’s employees should report their knowledge or suspicion of transactions/activities involving money laundering. The CBC’s Guidance Notes requires that the person so appointed should be sufficiently senior to command the necessary authority. The CBC’s Guidance Note requires that the banks’ Board of Directors and Senior Management establish an anti-money laundering program through the implementation of appropriate internal control procedures. In the course of an on-site examination for the evaluation of security and internal control systems, CBC examiners ensure that banks have established lines of communication both to management and to an internal security function for reporting problems. Banks are required to inform the CBC if they have any indication that they may face serious difficulties or become unable to meet their obligations; or if they are about to suspend payment or become aware of any material adverse change in their condition (Section 40 of the BL). Section 27 of the PSMLAL requires that any knowledge or suspicion of money laundering should be promptly reported to a police officer or MOKAS. The law also provides, under Section 26, that such a disclosure cannot be treated as a breach of the duty of confidentiality owed by banks to their customers by virtue of the contractual relationship existing between them. In case of bank employees, the PSMLAL recognizes, under Section 26, that internal reporting to the Money Laundering Compliance Officer will satisfy the reporting requirement imposed by virtue of Section 27, i.e., once a bank employee has reported his/her suspicion to the Money Laundering Compliance Officer, he or she is considered to have fully satisfied his/her statutory requirements under Section 27. The CBC is carrying out off-site monitoring and on-site examinations which aim at assessing banks’ compliance with their anti-money laundering obligations as set out in the law and the CBC’s Guidance Note. The CBC developed a special “examinations manual” for checking and evaluating banks’ internal control arrangements for money laundering prevention. As a result of the on-site examination, the CBC may issue to the bank concerned a letter with recommendations for corrective action in order to rectify weaknesses and strengthening controls in anti-money laundering procedures. Section 58(2)(a) of the PSMLAL authorizes the CBC to impose an administrative fine of up to £C3,000 to any person under their supervision who allegedly fails to take the preventive measures against money laundering prescribed in the law. The PSMLAL provides that the allegedly non-compliant person should first be given the opportunity to be heard before a Supervisory Authority determines the imposition of the administrative fine. Section 27(1) of the BL provides that the CBC may cooperate and exchange information with domestic and foreign banking, insurance, and securities market supervisory authorities in order to assist the discharge of its own or the other supervisory authorities’ functions and responsibilities. The said exchange of information and cooperation covers anti-money laundering matters as well. The CBC’s directive entitled “Framework for the Evaluation of Internal Control Systems” provides for putting in place mechanisms ensuring that all policies of a bank are enforced. Although not directly specified in this directive, some aspects related to ethics and professional behavior are indirectly addressed. Currently, the CBC is in the process of preparing and issuing a Directive on Corporate Governance, whereby the issue of having a policy statement on ethics and professional behavior will be explicitly addressed. The Council of the Institute of Certified Public Accountants of Cyprus also issued a number of guidance notes, the latest of which is a consolidated version dated November 2004. These notes are addressed to all accountants, auditors, and their staff. The Council of the Institute has been appointed by the Cyprus Government’s Council of Ministers in March 2000 as the supervisory authority for accountants and auditors in accordance with Section 59 of the Prevention and Supression of Money Laundering Activities Laws of 1966 to 2004.
Assessment	Compliant.
Comments	The CBC is commended for the efforts undertaken in order to strenghten the regulatory AML regime by issuing a number of Guidance Notes and by training efforts to increase the awareness and professionalism of the financial community for the prevention of money laundering. The mission has also noted the increase of the supervisory resources by two staff members and the increase of the number of on-site examinations during which the AML-procedures have been tested.
Principle 16.	On-Site and Off-Site Supervision An effective banking supervisory system should consist of some form of both on-site and off-site supervision.
Description	Section 26(2) of the BL requires that banks provide access to the CBC to all of their books, records, documentation, and other reports as necessary to carry out the supervision authority that is granted to it in Section 26(1). Section 25 requires the bank to provide a monthly statement of assets and liabilities to the CBC and empowers the CBC to require banks to periodically or at its request submit other reporting as it may specify. Complete access to such information, including information and reports generated by the bank’s internal and external auditors, provides the CBC with the ability to perform its supervisory function. Section 26 of the BL provides that any information received as part of the supervisory process must be kept confidential. Section 29 defines under what circumstances such information may be disclosed. The CBC exercises supervision in a twofold manner: on-site examination and off-site monitoring. The two modes of supervision complement one another. There are no material differences between the CBC’s supervision of domestic banks and its supervision of international banks. The specific scope of off-site monitoring and on-site examination for each bank is determined by each bank’s particular conditions and circumstances. The quality of internal audit work is assessed in order to determine the reliance that might be placed on it during the on-site examination. Both off-site monitoring and on-site supervision are performed by the same division, within the CBC, thereby integrating the framework of the two functions. The purpose of an on-site examination is to evaluate the condition of a bank and its future prospects at a given time, including providing verification that adequate risk management and controls are in place. In this respect, the following main areas are covered: a) the quality of the management of the bank by the directors and senior management, including internal controls and procedures, including internal audit; b) the bank’s loan portfolio, with emphasis on credit risk management, evaluation, and controls; the quality of the loan portfolio; and the adequacy of the provisions for bad and doubtful debts; c) the bank’s treasury operations with emphasis on risk management; d) the profitability of the bank, including the analysis of its income generation and costs and the assessment of the returns achieved; e) the compliance with the law, the conditions of the bank’s license, and the CBC Directives; regulations and instructions on capital adequacy; large exposures, etc.; and f) adherence to the requirements of the anti-money laundering legislation and guidance notes. CBC policy requires that on-site examinations be conducted annually for the domestic banks, annually for the subsidiaries of foreign banks, and every two years for the branches of foreign banks. However, due to the resource requirements necessary for the implementing of the EU Directives as part of the assession of Cyprus to the EU, the originally-planned examination schedule has been delayed. Now that this work is well underway, the CBC is confident that it can properly fully resume its planned on-site examination program. Special examinations may also be conducted, as necessary. The on-site examination findings are communicated to the bank’s management and discussed with the bank’s senior management in a meeting especially convened for this purpose. A management letter containing the on-site examination findings and conclusions is transmitted to bank senior management, and a response detailing corrective measures is required. Off-site monitoring involves the submission of various periodic prudential returns such as monthly balance sheet, profit and loss account, capital adequacy, prudential liquidity, large exposures and facilities to directors, foreign currency exposure, interest rate risk, anti-money laundering procedures, etc. Findings emerging in periodic prudential returns submitted by banks are analyzed, trended, and compared with other banks. This process enables the CBC to monitor the condition of banks as well as their compliance with the BL and other relevant prudential legislation and directives on an on-going basis. The accuracy of these returns is independently verified during the on-site examinations. The CBC supervisors, in the course of on-site examinations, assess the risk profile of each bank and, based on this assessment, on-site and off-site work is prioritized. For its international banks, the CBC has decided to adopt a risk-based approach in carrying out its supervisory activities. The main objectives are to allow the supervisors to focus on the banks that are confronted with higher risk and to allocate staff more efficiently. In the model adopted, risk elements are grouped into two major categories: Business Risks and the Control Risks. Based on this framework, the total Business and Control risks of each bank are assessed and a Total Business Risk Score/Total Control Risk Score map is created, indicating the position of each bank. In order to improve the model, the CBC has decided to review it once a year. In preparing its on-site examination program, the CBC considers three main factors: the positioning of each bank on the map, an ageing factor setting the maximum interval between two consecutive on-site examinations, and its knowledge of the bank based on the returns submitted; its ongoing contact with bank management; and the results of previous examinations. The CBC is in the process of designing and implementing a risk-based supervision methodology for the domestic banks. Bank examination report findings and conclusions as well as the analysis of periodic returns are reported to the governor of the CBC.
Assessment	Compliant.
Comments	Since no formal procedure is in place to assess the effectiveness of supervisory functions, the CBC may wish to consider establishing an internal quality control function within the Banking Supervision and Regulation Division to assess the effectiveness of its off-site and on-site supervisory activities and address any weaknesses identified.
Principle 17.	Bank Management Contact Banking supervisors must have regular contact with bank management and a thorough understanding of the institution’s operations.
Description	Section 28 of the BL requires that the CBC conduct a tri-lateral meeting with senior bank management and the bank’s external auditor at least annually to discuss matters of supervisory relevance that might arise in the audit, including relevant aspects of the bank’s business, its accounting and control systems, and its financial statements. Senior CBC officers conduct at least semi-annual meetings with senior bank management on matters of interest, including provisioning and financial performance results, and at the conclusion of on-site examinations, to discuss results and plans to correct identified deficiencies. Meetings with senior bank management are conducted during and subsequent to on-site examinations, and regarding matters that arise as a result of ongoing off-site monitoring. Off-site monitoring and on-site examination provides the CBC with frequent contact with and a thorough understanding of the bank and its management and operations. Visits of parent/head office senior management and internal auditors of foreign banks operating subsidiaries/branches in Cyprus offer further opportunity to understand the bank’s activities and operations. These and other meetings provide the CBC with the opportunity to evaluate management’s abilities and its performance. The evaluation of prospective management is also included in the CBC’s licensing process (see CP-3, above). in practice, the governor of the CBC also meets with all banks as a group at least semi-annually to discuss matters of general interest and changes in supervisory policy and practice. Section 40 of the BL requires banks to inform the CBC when it has any indication that it may face serious difficulties or if it is about to suspend payment on its obligations. Banks are also required by law to report any material changes in their circumstances. Information on changes in circumstances and other relevant information is also provided through the wide range of periodic prudential returns that are required.
Assessment	Compliant.
Comments	None.
Principle 18.	Off-Site Supervision Banking supervisors must have a means of collecting, reviewing, and analyzing prudential reports and statistical returns from banks on a solo and consolidated basis.
Description	Section 26(2) of the BL empowers the CBC to obtain from banks any information and with whatever frequency that it deems necessary. As a result, the CBC periodically obtains a wide range of information on banks’ financial condition and performance at regular intervals from both domestic and international banks. There are no restrictions to the CBC’s access to information about any aspect of the bank’s business and their related companies. Both domestic banks and international banks provide virtually the same information, as appropriate to their operations and activities, with the same frequency. The information is provided through a series of standardized returns supported by comprehensive instructions. The information provided through bank returns is verified during on-site examinations to determine if it’s accurate, properly classified, and in conformity with CBC instructions. Prudential returns include detailed information regarding on- and off-balance sheet assets and liabilities, profit and loss, capital adequacy, liquidity, large exposures, loan loss provisioning, market risk, and deposit-related matters at a frequency commensurate with the nature of the information. Specific details about the loan classifications performed by the banks themselves are not disclosed in the standardized reports; this information is collected, assessed, and analyzed during the on-site examinations carried out by the examiners of the CBC. The CBC also requires submission of copies of the management letter from the bank’s external auditor and the minutes of the Audit Committee of its Board of Directors. Section 42 of the BL provides for a range of monetary penalties for failure to provide requested information within specified time limits, knowingly or negligently providing inaccurate or misleading information, or knowingly or negligently providing incomplete information. The internal auditors of banks are required to submit reports to the CBC every 18 months on the results of their activities. The external auditors of international banks must submit reports on the bank’s compliance with any conditions of their license; a reconciliation of any differences between the information provided on returns to the CBC and audited financial statements; the adequacy of internal controls; the correctness/adequacy of information that the local operations provide to their parent/head office, and the adequacy of provisioning. International banks must also provide the CBC with copies of internal audit reports prepared on local operations by their parent/head office. Section 24 of the BL requires that banks produce annual audited financial statements and also allows the CBC to prescribe the manner and form in which accounts must be prepared. The CBC has issued directives specifying the content of financial statements and the manner in which they must be presented. The CBC in its directives has adopted International Accounting Standards. With regard to the audit of bank annual financial statements, Section 24 of the BL also requires that the audit of banks be carried out in accordance with International Auditing Standards and any additional requirements specified by the CBC. International Accounting Standards have been used in Cyprus since 1981 through the action of the Institute of Certified Public Accountants of Cyprus (the regulatory body for accountants/auditors) to require auditors to state in their audit report that the financial statements of the audited company have been prepared in accordance with the International Accounting Standards. Furthermore, through an amendment to the Companies Law in 2003, legal backing has been given to the International Accounting Standards implementation, which is compulsory for all companies, including banks, incorporated in Cyprus. The auditors’ report is required to state that the audit has been carried out in accordance with International Auditing Standards. All statistical and prudential reports filed with the CBC, are processed and analyzed. The conclusion of this analysis forms part of various internal reports that identify compliance or not with rules and regulations, and highlight intra-market comparisons and trends, with a view to prompting further action by the CBC. This information is readily available to all supervisors who are required to utilize it for planning future on-site visits to the banks. This reporting forms part of the CBC’s comprehensive information system. This analysis, along with the results of on-site examinations and information acquired through meetings with bank officials, provides the basis for the CBC’s early identification of potential problems, difficulties, and trends in banks, although there is, as yet, no formal early warning system in place.
Assessment	Compliant.
Comments	The CBC may wish to consider developing and implementing a more formal, comprehensive early warning system to provide timely alerts to prospective issues affecting individual banks, groups of banks, or the system as a whole. Such a system may permit the CBC to more easily set supervisory priorities and to react more timely and adquately to identified issues.
Principle 19.	Validation of Supervisory Information Banking supervisors must have a means of independent validation of supervisory information either through on-site examinations or use of external auditors.
Description	On-site examinations are conducted annually for the domestic banks, annually for the Cyprus subsidiaries of foreign banks, and every two years for the Cyprus branches of foreign banks. Examinations of foreign subsidiaries and branches of Cyprus banks are conducted annually for operations in Greece and every two years for operations in other countries when they are material (i.e., more than 5 percent of the total balance sheet assets of the entity of which it is a part). Special examinations may also be conducted. Pursuant to Section 26 of the BL, the CBC has the legal right of full access to all bank records for the furtherance of supervisory work. The information provided through bank returns is verified during on-site examinations to determine if its accurate, properly classified, and in conformity with CBC instructions. The CBC maintains a coherent process for planning and executing these on-site examinations. The same process is applied to the on-site examinations of all banks, both domestic and international. The criteria used by the CBC for the planning and executing of on-site examinations are: (a) the relative size of the banking operation; (b) the annual growth rate of the operation; (c) the relative contribution of the operation to the group as a whole; (d) the results of off-site review monitoring and analysis; (e) any special issues; and (f) the availability of resources. Section 26 of the BL provides that the CBC examiners may be assisted in the course of their work by a duly qualified person nominated for this purpose by the CBC provided that this person shall be bound by the same requirements regarding confidentiality as those applicable to the CBC officials. This would permit external auditors to assist, as necessary, in on-site examinations and to be commissioned by the CBC to perform special work for it in the banks. The auditing and accounting profession in Cyprus is well developed and professionally independent and operates within the international auditing and accounting standards framework. Section 28 of the BL provides that the CBC will arrange, at least once a year, tri-lateral meetings with each bank and its auditors to discuss matters relevant to the CBC’s supervisory responsibilities that arise in the course of the audit of all banks. The CBC is also entitled to hold bi-lateral meetings with external auditors, to the exclusion of the bank concerned, if the CBC considers such a meeting necessary for the protection of the bank’s depositors. Under the same section of the BL, the external auditors may freely report to the CBC any information that is relevant to its supervisory responsibilities. The BL protects the auditor from the consequences of any breach in his duty of confidentiality by providing that no duty of confidentiality to which an auditor of a bank may be subject will be regarded as contravened by reason of his communication in good faith to the CBC, whether or not it is responding to a request made by the CBC, any information or opinion which is relevant to the CBC’s functions and responsibilities under the BL. The CBC has issued a notice to the banks on the relation between the CBC and the external auditors of banks. The purpose of this notice is to provide the guidelines for the arrangements of tri-partite meetings between the CBC, the banks, and their external auditors and give a general description of the situations and conditions under which the CBC may invite the auditors of banks to bi-lateral meetings in accordance with Section 28(2) of the BL. Section 24 of the BL requires that each bank, at the end of its business year, provide the CBC with a copy of its consolidated balance sheet and profit and loss account for that year, duly certified by an approved external auditor. Section 2 of the BL requires that the external auditors of banks be approved by the CBC; in practice, banks are audited by local offices of the big four accounting/auditing firms. In addition to the tri-lateral meetings between the CBC, the banks, and their external auditors, the CBC regularly holds meetings with the banks’ management and/or board of directors to discuss all matters pertaining to the operations of the bank and, particularly, all issues identified during the on-site examinations and off-site surveillance conducted by the CBC.
Assessment	Compliant.
Comments	None.
Principle 20.	Consolidated Supervision An essential element of banking supervision is the ability of the supervisors to supervise the banking group on a consolidated basis.
Description	Section 39 of the BL permits the CBC to determine that the holding company and any of the subsidiaries of the bank and of its holding company will be deemed to be a bank for the purposes of the BL, as may be specified by the CBC, whereupon the relevant provision or provisions will apply to any such company either singly or on a consolidated basis. The CBC practices consolidated supervision. In this regard, the CBC has exercised its power under Section 39 of the BL and has extended its supervision to all bank subsidiaries carrying out banking-related activities, as defined in Section 13 of the BL. Thus, the CBC requires bank subsidiaries that carry out banking-related activities to be consolidated on a worldwide basis. Within the scope of consolidated supervision, the CBC obtains information on the nature of activities of non-banking related subsidiaries as well as the level of their assets, liabilities, and profitability. The CBC may require the holding company to take any action relating to non-bank subsidiaries, as it may deem necessary. Moreover, the investment in non-banking related subsidiaries, including lending of a capital nature to such subsidiaries, is deducted from the consolidated capital base of the group. There are no obstacles to direct or indirect supervision of bank subsidiaries or affiliates that carry out banking-related activities as defined in section 13 of the BL. The CBC conducts on-site examinations of material subsidiaries carrying on banking or banking-related activities. The condition of non-material subsidiaries is monitored and assessed through the submission of periodic returns. The CBC is empowered to impose any prudential standards on a consolidated basis. In this respect, the CBC Directives on capital adequacy, large exposures, and foreign currency exposure apply on a consolidated basis. The CBC requires that each bank submit audited consolidated financial statements annually. Pursuant to Section 27 of the BL, the CBC may co-operate and exchange information with the competent banking and/or insurance and/or securities markets supervisory authorities whether in Cyprus or elsewhere. To this end, the CBC has signed an MOU with local securities, insurance, and cooperatives societies supervisory authorities and MOUs with foreign supervisory authorities in the financial sector. In this context, the CBC receives and shares information on the financial condition and risk management of such companies. Section 7 of the BL provides that banks must obtain the prior approval of the CBC to establish business outside of Cyprus. The CBC may impose conditions on such establishments. Moreover, Section 13 of the BL imposes limits on the investments of banks in the capital of other companies. The CBC exercises this power to limit the expansion of banks overseas so as to ensure that banks possess adequate financial resources to conduct such operations. Periodic on-site examinations are conducted at the bank’s overseas locations. Section 39 of the BL provides that the holding company and any of the subsidiaries of a bank shall be deemed to be a bank for the purpose of any of the provisions of the BL. Thus, the CBC is empowered to impose standards and measures, including remedial action, on the non-banking subsidiaries and/or holding company of a bank. Also under Section 39 of the BL, the holding company of a bank may be deemed by CBC to be a bank and, consequently, the provisions of Sections 17 and 18 of the BL regarding the fitness and propriety of owners and senior management of a bank holding company apply to these persons.
Assessment	Compliant.
Comments	None.
Principle 21.	Accounting Standards Banking supervisors must be satisfied that each bank maintains adequate records drawn up in accordance with consistent accounting policies and practices that enable the supervisor to obtain a true and fair view of the financial condition of the bank and the profitability of its business, and that the bank publishes on a regular basis financial statements that fairly reflect its condition.
Description	Any bank that fails to provide requested financial information within specified time limits, knowingly or negligently provided inaccurate data or misleading information, knowingly or negligently made available in an incomplete form, records, books, accounts, or other information is subject to an administrative fine (Section 42 of the BL). The BL provides that where an offense is committed as a result of an infringement of the provisions of this law, by a bank or by an organisation of persons incorporated or unincorporated, then any director, chief executive, manager, partner or other officer or employee of the bank or of the organization, who authorizes or knowingly permits such infringement shall be guilty of an offense and in case of conviction shall be liable to penalties provided in the BL, depending on the provisions infringed. Every bank should, within four months from the end of each financial year, submit to the CBC a copy of the balance sheet and profit and loss account for that year in the form prescribed by the CBC, duly certified by an approved auditor, together with a signed copy of his report in the form prescribed by the CBC. Branches of foreign incorporated banks are not required to publish their financial statements. The CBC Directive on the framework for the evaluation of internal control systems requires banks to maintain comprehensive and reliable financial reporting to ensure the accurate and timely disclosure of the bank’s financial position and the production of reliable financial statements. In this respect, information from bank records, such as prudential returns submitted to the CBC, is verified periodically in the course of on-site examination. The CBC has issued a notice on the relationship between the CBC and the external auditors of banks. The purpose of the above notice is to: a) Provide the guidelines for the arrangements of tripartite meetings between the CBC, the banks and their external auditors; and b) Give a general description of the situations, and the conditions under which the CBC may invite the auditors of banks to bilateral meetings in accordance with Section 28(2) of the BL. The CBC aims at the creation of a constructive relationship with the external auditors of banks, through the medium of which there will be such an exchange of information so as to facilitate the supervisory activity of the CBC, as this arises from the provisions of the BL. This relationship consists of: a) Tri-partite meetings with the external auditors of each bank during which the following will be discussed: (i) the balance sheet and the profit and loss account for each year, copies of which each bank is obligated [under Section 24(1) of the BL] to submit to the CBC, in a form to be determined by the CBC, within four months from the end of the financial year; (ii) the report of the external auditor that has to be submitted with (i) above, in a form to be determined by the CBC; (iii) matters arising from the audit work of the external auditors in relation to (i) and (ii) above. (b) bilateral meetings with the external auditors of a bank, either with the knowledge of the bank concerned or not, whenever this is considered desirable or necessary by the CBC, in the interests of depositors, in accordance with Section 28(2) of the BL. The CBC is authorized to set accounting standards for banks provided that the CBC is guided in this respect by international practice and the EU directives. To this effect, the CBC has issued a directive on the layout and content of annual accounts of banks, which requires compliance with international accounting standards modified as necessary to comply with EU directives. Chapter 4 of the CBC’s Directive on the layout and content of annual accounts, entitled valuation rules, describes in detail the supervisory requirements for banks to utilize valuation rules that are consistent, realistic, and prudent, taking into account values where relevant. Moreover, International Accounting Standards that have been adopted in Cyprus since 1981 through the action of the Institute of Certified Public Accountants of Cyprus (the regulatory body for accountants/auditors) require auditors to state in their audit report that the financial statements of the audited company have been prepared in accordance with the International Accounting Standards. Furthermore, through an amendment to the Companies Law in 2003, legal backing has been given to the International Accounting Standards implementation, which is compulsory for all companies, including banks, incorporated in Cyprus. The confidential character of the financial information gathered by the CBC is legaly enforced by the BL [Sections 17(4) and 18]. The external auditors of banks, prior to their appointment, are required to be expressly authorized by the CBC (Sections 2 and 24 of the BL). In practice, most banks are audited by the big four international firms of accountants/auditors. The CBC relies on its own experienced bank supervisory staff for the conduct of on-site examination and does not generally need to employ the services of external auditors at the present time, although section 26(2) of the BL would permit the CBC to use duly qualified persons, as necessary. There are no supervisory requirements in respect of the scope and conduct of audit programs as the CBC is not legally empowered to set standards for external audit review. However, as mentioned above, external auditors are required to conduct their audits in accordance with the International Auditing Standards. Section 28 of the BL provides that auditors may freely report to the CBC any information which is relevant to the latter’s supervisory responsibilities. The BL protects the auditor from the consequences of any breach in his duty of confidentiality, by providing that no duty of confidentiality to which an auditor of a bank may be subject shall be regarded as contravened by reason of his communication in good faith to the CBC, whether or not to a request made by the CBC, any information or opinion which is relevant to the CBC’s functions and responsibilities under the BL. The CBC has issued a notice on the relationship between the CBC and the external auditors of banks. This notice provides, inter alia, that the external auditors are expected to report to the CBC matters of material significance or matters which may be of material significance to the latter’s supervisory functions or responsibilities.
Assessment	Compliant.
Comments	It must be noted that external auditors do not have a legal duty to report to the CBC on matters of material significance. But, the tri-partite and bi-partite meetings described above, as well as mandatory transmission by the external auditors to the CBC of their written communciations with the banks on matters of material significance, do seem to provide a valuable communication system. However, Cyprus may consider amending the BL to introduce a mandatory duty for auditors to report matters of material significance to the supervisor, as provided for in the pertinent EU Directive.
Principle 22.	Remedial Measures Banking supervisors must have at their disposal adequate supervisory measures to bring about timely corrective action when banks fail to meet prudential requirements (such as minimum capital adequacy ratios), when there are regulatory violations, or where depositors are threatened in any other way. In extreme circumstances, this should include the ability to revoke the banking license or recommend its revocation.
Description	Section 30 of the BL provides the CBC with extensive remedial powers where a bank fails to comply with any of the provisions of the BL, including power to require the bank to take such action as the CBC may consider necessary to rectify the matter, the power to prohibit the acceptance of deposits or the granting of credit facilities by the bank, or both; both assume control of the business of a bank and revoke the bank’s license. Section 42 of the BL empowers the CBC to impose administrative fines if a bank fails to provide information to the bank within specified time limits. Other offenses and penalties are covered in detail in Sections 42 and 44. Administrative penalties have been imposed on numerous occasions. Where an offense is committed as a result of an infringement of the provisions of the BL, by a bank or by an organization of persons incorporated or unincorporated, then any director, chief executive, manager, partner or other officer or employee of the bank or of the organization, who authorizes or knowingly permits such infringement shall be guilty of an offense and, in case of conviction, shall be liable to the penalties provided in subsections 43(1) or 43(2) of the Banking Law depending on the provisions infringed. Pursuant to Section 30(2) of the BL the CBC shall, before taking any remedial measure, furnish a report to the bank inviting its comments thereon within a specified period, which should not be less than three days from the date of delivery of the report.
Assessment	Compliant.
Comments	None.
Principle 23.	Globally Consolidated Supervision Banking supervisors must practice global consolidated supervision over their internationally active banking organizations, adequately monitoring and applying appropriate prudential norms to all aspects of the business conducted by these banking organizations worldwide, primarily at their foreign branches, joint ventures, and subsidiaries.
Description	Pursuant to Section 13 of the BL, banks are not allowed to extend their direct or indirect operations outside Cyprus without obtaining the prior written approval of the CBC. The CBC makes its approval conditional upon the on-going availability of information from the overseas operation, including the ability to carry out on-site examinations and to exercise consolidated supervision. On-site and off-site supervision of overseas operations of Cyprus-incorporated banks has been routinely carried out for many years. In the course of an on-site examination, the CBC inspectors determine that the bank maintains proper oversight of its foreign operations by examining the following: (a) the centralization of credit control and internal audit; (b) the identification, measurement, control, and monitoring of risks on a global consolidated basis at head office level; (c) the monitoring of the overseas operations through the regular submission of returns to head office; (d) the credit review by head office of foreign operations; and (e), the involvement of head office management in strategic decision-making. In the course of on-site examinations, the CBC inspectors establish that bank management’s oversight includes: a) information reporting on its overseas operations that is adequate in scope and frequency and is periodically verified; (b) assessing in an appropriate manner compliance with internal controls; and (c) ensuring effective local oversight of foreign operations. The CBC places special emphasis on the foreign operations of domestic banks by requiring senior management to closely monitor and control risks undertaken on a global basis. Pursuant to its authority under Section 7 of the BL, if the CBC is not satisfied that the bank maintains proper oversight of its foreign operations, it may amend or impose additional conditions on the foreign operation’s license. In extreme cases, if the need arises, the CBC may revoke the approval. Section 30 of the BL confers upon the CBC a range of powers to take measures to address prudential and compliance issues arising from the supervision of foreign operations of Cyprus banks. On-site examinations of overseas subsidiaries/branches of Cyprus-incorporated banks are planned and executed by the CBC as follows: annually for banks with operations in Greece and every two years for banks with operations in the United Kingdom and Australia. The CBC may also conduct ad hoc on-site examinations if and when the need arises in relation to special issues. Meetings with local supervisors are arranged during the on-site examinations for overseas subsidiaries/branches of Cyprus-incorporated banks. The assessment of host country supervision is carried out in the spirit and letter of the MOUs signed and in the course of on-site examinations, the findings of which are discussed with host supervisors.
Assessment	Compliant.
Comments	None.
Principle 24.	Host Country Supervision A key component of consolidated supervision is establishing contact and information exchange with the various other supervisors involved, primarily host country supervisory authorities.
Description	Section 27(1) of the BL permits the CBC to cooperate and exchange information with competent banking and/or insurance and/or securities markets supervisory authorities, whether in Cyprus or elsewhere, including member states of the EU, in order to assist these supervisory authorities in the discharge of their functions and responsibilities or to enable the effective exercise of their functions, including consolidated supervision. Section 27(4) prescribes that any exchange of information will only take place when the CBC is satisfied that the information provided is subject to the same confidentiality rules in the hands of the receiving competent supervisory authority as apply to the CBC. Section 27(5) prescribes that where the information received by the CBC originates in another member state of the EU, it may not be disclosed without the express agreement of the competent authorities that have disclosed it and, where appropriate, solely for the purposes for which those authorities gave their agreement. MOUs have already been signed or are in process of negotiation with a number of overseas supervisors, including the United Kingdom, Lebanon, and Ireland, where Cyprus-incorporated banks have overseas operations. The MOUs include statements on the scope of information to be exchanged and stipulate details on the cooperation regarding on-site examinations in the host country, and the confidentiality of the information received from the other supervisory authority. Consequently, the MOUs facilitate the close cooperation and exchange of information between the CBC and other overseas banking supervisory and regulatory authorities in the discharge of their functions and responsibilities, including the overall framework of supervision in which a banking group operates, and, to the extent appropriate, concerning significant problems arising in the head office or in the group as a whole. In practice, there is close and frequent contact with host country supervisors. The CBC cooperates and exchanges information with all foreign supervisory authorities in jurisdictions in which Cyprus-incorporated banks operate subsidiaries and branches, regardless of their significance. Pursuant to Section 13 of the BL, banks are not allowed to extend their direct or indirect operations outside Cyprus without obtaining the prior written approval of the CBC. In this regard, the CBC is empowered to prohibit banks or their affiliates from establishing operations in countries with secrecy laws or other regulations prohibiting flows of information deemed necessary for adequate supervision. The CBC makes its approval 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. On-site examination and off-site supervision of overseas operations of Cyprus-incorporated banks has been routinely carried out for many years by the CBC.
Assessment	Compliant.
Comments	None.
Principle 25.	Supervision Over Foreign Banks’ Establishments Banking supervisors must require the local operations of foreign banks to be conducted with the same high standards as are required of domestic institutions and must have powers to share information needed by the home country supervisors of those banks for the purpose of carrying out consolidated supervision.
Description	Cyprus branches and subsidiaries of foreign-incorporated banks are subject to the same prudential inspection and regulatory reporting requirements as Cyprus-incorporated banks. No differences exist in the regulatory regime for Cyprus-incorporated banks and Cyprus branches/subsidiaries of foreign-incorporated banks. However, branches of foreign banks are exempted from own capital and capital adequacy requirements; consequently, capital-based restrictions (e.g., large exposures limitations) are not applicable and are left to the home country supervisory authority to monitor. With regard to the licensing process as well as for ongoing supervision, applicant banks are required to submit to the CBC a “Letter of Authorization,” which enables the CBC to approach and exchange information with the home supervisory or regulatory authority of the applicant’s parent institution. In this respect, the CBC approaches the home country licensing and supervisory/regulatory authority of the applicant bank’s parent institution directly and obtains, inter alia, its written consent authorizing the proposed establishment, as well as an undertaking that, in circumstances under which that authority is warranted to act as the group’s consolidating supervisor/regulator, it will exercise consolidated supervision equivalent to that provided in the EU over the global activities of the parent institution, including the operations proposed to be carried out by the prospective subsidiary/branch in Cyprus. Section 27(1) of the BL permits the CBC to cooperate and exchange information with competent banking and/or insurance and/or securities markets supervisory authorities, whether in Cyprus or elsewhere, including member states of the EU, in order to assist these supervisory authorities in the discharge of their functions and responsibilities or to enable the effective exercise of their functions, including consolidated supervision. Section 27(4) prescribes that any exchange of information will only take place when the CBC is satisfied that the information provided is subject to the same confidentiality rules in the hands of the receiving competent supervisory authority as apply to the CBC. Section 27(5) prescribes that where the information received by the CBC originates in another member state of the EU, it may not be disclosed without the express agreement of the competent authorities that have disclosed it and, where appropriate, solely for the purposes for which those authorities gave their agreement. MOUs have already been signed or are in process of negotiation with a number of overseas supervisors. The MOUs include statements on the scope of information to be exchanged and stipulate details on the cooperation regarding on-site examinations in the host country and the confidentiality of the information received from the other supervisory authority. Consequently, the MOUs facilitate the close cooperation and exchange of information between the CBC and other overseas banking supervisory and regulatory authorities in the discharge of their functions and responsibilities, including the overall framework of supervision in which a banking group operates, and, to the extent appropriate, concerning significant problems arising in the head office or in the group as a whole. In practice, there is close and frequent contact with home country supervisors. The CBC cooperates and exchanges information with all foreign supervisory authorities from jurisdictions whose banks operate subsidiaries and branches in Cyprus, regardless of their significance. The CBC permits home country supervisors of banks operating subsidiaries and branches in Cyprus to conduct on-site examinations and meets with the foreign supervisory authorities to discuss the examination results. Over the years, many home supervisory authorities have conducted on-site examinations of branches and subsidiaries in Cyprus pursuant to their primary or consolidated supervisory responsibility.
Assessment	Compliant.
Comments	None.

View Table

Table 1.

Detailed Assessment of Compliance of the Basel Core Principles (CBC)

Principle 1.	Objectives, Autonomy, Powers, and Resources An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks. Each such agency should possess operational independence and adequate resources. A suitable legal framework for banking supervision is also necessary, including provisions relating to the authorization of banking establishments and their ongoing supervision; powers to address compliance with laws, as well as safety and soundness concerns; and legal protection for supervisors. Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Principle 1(1)	An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks.
Description	The Banking Law N°66(1) of 1997 (the BL) provides in Section 26 that the Central Bank of Cyprus (the CBC) is responsible for the supervision of banks in order to ensure the orderly functioning of the banking system. The original law setting up the Central Bank of Cyprus came into effect in 1963. The new Central Bank of Cyprus Law of 2002 (N. 138(1) 2002 (the CBC Law) defines the main tasks of the Bank as follows: The definition and implementation of monetary policy; The conduct of the exchange-rate policy and the management of the official foreign reserves of the Republic; The supervision of banks in the Republic; The promotion, regulation, and oversight of the smooth operation of payments and settlements systems; To act as banker and financial agent of the Government of the Republic. All responsibilities for banking supervision rest solely and entirely with the CBC. According to Section 30(1) of the BL, the CBC may take the necessary measures when a bank fails to comply with any provision of the BL or with any regulations made under the BL. The minimum prudential standards that banks should meet are the following: Limitation of credit exposures; Limitation on holdings of immovable property; Limitation of shareholdings; Prohibition of commercial trading; Prohibition of dealing in own shares; Prior approval for amalgamation; Limitations on large shareholdings; Persons disqualified to act as directors in banks; Direction and management by at least two individuals (Four-eyes principle); Minimum capital; Capital adequacy ratio; Computation of capital; Minimum liquidity; Compensation of depositors (Deposit Protection Scheme). The CBC is empowered to issue directives for the purpose of implementing the objectives and provisions of the BL. Banks are required to comply with both the provisions of the BL and the directives of the CBC. To this effect, the CBC has issued directives on the following: Computation of prudential liquidity; Computation of the capital base of banks; Computation of banks’ capital adequacy ratio; Capital adequacy; Layout and contents of banks’ annual accounts; Monitoring and control of credit facilities (large exposures); Framework for the evaluation of internal control systems; Foreign currency positions and exposures; Employment of funds derived from foreign currency deposit liabilities; Cross-border credit transfers; Establishment and operation of the Deposit Protection Scheme; Freedom of establishment and freedom to provide banking related activities by European Union authorized credit institutions. The above directives issued by the CBC are based on respective European Union (“EU”) Directives and the recommendations of the Basel Committee on Banking Supervision (“BCBS”). The CBC has also issued a notice on the following: Relationship between the CBC and the external auditors of banks. Regulations have also been issued on the following: Establishment and Operation of an Investor Compensation Fund for Clients of Banks. Cyprus’s accession to the EU has triggered a number of fundamental amendments to the regulatory framework in view of the necessary and timely harmonization of supervision with the acquis communautaire. In April 2004, the Banking Amendment No. 2 Law was enacted in order to harmonize Cyprus’s legislation with Directive 2001/24/EC, which introduces the principle of mutual recognition by the EU member states with regard to the reorganization measures or winding up proceedings adopted by the home country of credit institution, in case these run into difficulties. The CBC decides when and how to effect the orderly resolution of a problem bank situation. The CBC publishes an Annual Report of its activities in each financial year, which covers its banking regulatory and supervisory activities. The CBC Annual Report also includes a short description of the developments in the banking industry in Cyprus as well as a brief assessment of the performance of the above sector for the year under review. In addition, the CBC publishes current and historical statistics on the banking industry. Moreover, all Cyprus incorporated banks are required to publish, within six months from the end of each financial year, the balance sheet and profit and loss account for that year together with the auditor’s report.
Assessment	Compliant.
Comments	None.
Principle 1(2)	Each such agency should possess operational independence and adequate resources.
Description	Section 7 of the CBC Law states that when carrying out the tasks conferred upon them under this, neither the Bank nor any member of its decision-making bodies shall seek or take instructions from the government or any other body. The CBC is therefore an independent organization, separate from the government or governmental agencies. There is, in practice, no evidence of government or industry interference in the operational independence of the CBC and in its ability to obtain and deploy the resources needed to carry out its mandate. The management of the CBC is in the hands of the board of directors consisting of the governor, the deputy governor, and five directors. The governor and the deputy governor are appointed by the president and the vice resident of the Republic, respectively. The independence of the CBC is secured by the Cyprus Constitution. The supervision of banks is carried out by the Banking Supervision and Regulation Division, which consists of two departments. The total number of staff in each department is as follows: a) Domestic Banks Supervision Department: 32 staff members. b) Supervision of International Banks, Regulation and Financial Stability Department: 19 staff members. The senior manager of the Banking Supervision and Regulation Division as well as the managers of the two departments mentioned above, in addition to their academic/professional qualifications, have had a long experience in their respective positions having been promoted from the ranks. Supervisory staff are also well educated being in possession of academic/professional qualifications and have had considerable hands-on experience in the supervision of banks. Salary levels of the supervisory staff within the CBC (officers, administrative, and clerical staff) are comparable to the salary levels in the private banking industry. Salary levels of senior managers within the CBC remain, however, below the salary levels of general managers in the private banking sector. Training programs for bank supervisory staff cover a variety of areas related to banking supervision and regulation. Staff members regularly attend courses organized by the Financial Stability Institute of the Bank for International Settlements, the Bank of England, the Deutsche Bundesbank, the Banque de France, the Nederlandsche Bank, the United States (U.S.) Federal Deposit Insurance Corporation, the U.S. Federal Reserve System, and other central banks/banking supervisory authorities, as well as private institutions. Staff also visit other domestic regulators when that is deemed appropriate within the scope of the MOU between the CBC and the securities, insurance, and cooperative credit institutions supervisory authorities, as well as overseas supervisory authorities in accordance with MOUs signed with them. In addition, the CBC is a subscriber to the “FSI Connect” service provided by the Financial Stability Institute of the Bank for International Settlements, which is an online information resource and training tool for bank supervisors worldwide. Emphasis is also placed on developing and maintaining a modern information technology infrastructure to support the key activities of the Banking Supervision and Regulation Division. The budget of the CBC’s supervisory function (covering recruitment, hiring outside experts, training, information technology (IT) expenditure, travel etc.) forms part of the CBC’s overall budget. The CBC is also authorized to charge fees in connection with expenses incurred for the supervision and inspection of banks. The Governor of the CBC is appointed for a renewable term of office of five years. He may be relieved from office only if, in the opinion of the Council of Ministers, he no longer fulfills the conditions required for the performance of his duties or in the event of serious misconduct. This provision which is in accordance with the Statute of the European System of Central Banks has also been incorporated in the Cyprus constitution. Although the CBC Law does not specify that the reason for the Governor’s removal from office must be publicly disclosed, it is expected that, in such an event, the reasoning behind the decision will be made public in accordance with the established principles of administrative law.
Assessment	Largely Compliant.
Comments	The increasing demands on the Banking Supervision and Regulation Division’s officers and staff emanating from the substantial requirements relating to the accession of Cyprus to the EU, as well as other developments in the financial supervisory and regulatory sector, have interfered with the execution of a number of supervisory tasks and slowed the fulfillment of the regular on-and off-site supervisory programs. Since this problem is one of a permanent structural nature, the authorities should take action to ensure that properly trained and experienced staff are provided for in numbers that will assure timely and adequate fulfillment of the CBC’s supervisory reponsibilities.
Principle 1(3)	A suitable legal framework for banking supervision is also necessary, including provisions relating to authorization of banking establishments and their ongoing supervision.
Description	The CBC is the banking supervisory authority responsible for granting and withdrawing banking business licenses. The Cooperative Societies’ Supervision and Development Authority (CSSDA) is the supervisory and licensing authority of cooperative credit institutions in Cyprus (a separate assessment addresses the implementation of the Basel Core Principles for Effective Banking Supervision regarding the cooperative credit institutions). Section 3(3) of the BL authorizes the CBC to: grant a license without any condition or subject to such conditions as the CBC may consider proper to impose; or refuse to grant a license. The CBC may amend or cancel whenever, either permanently or temporarily, any condition imposed on a license, or impose any new conditions thereto [Section 3(4) of the BL]. The CBC shall not take into consideration the economic need criterion for purposes of granting a bank license [Section 4(5)]. The CBC is empowered to set prudential rules administratively for the following: Bank capital base (definition of the constituent parts; BL Section 22); Capital adequacy ratio [BL Section 21(1)]; Liquidity [BL Section 23(1)]. The CBC may, for the purpose of implementing the objectives of the BL and subject to the provisions of the BL, issue general or specific directives which are communicated in any manner that the CBC may determine [BL Section 41(1)]. In exercising its discretionary power under the Banking Law, the CBC is required to act after taking into consideration, by way of guidance, the international practice and the directives and regulations of the European Union. Sections 24 and 25 of the BL require licensed banks to submit prudential returns. The CBC is authorized to determine their contents and frequency.
Assessment	Compliant.
Comments	None.
Principle 1(4)	A suitable legal framework for banking supervision is also necessary, including powers to address compliance with laws, as well as safety and soundness concerns.
Description	The BL [Section 30(1)] enables the CBC to address compliance with laws and the safety and soundness of the banks under its supervision. The CBC is authorized to exercise qualitative judgment in applying these measures. Section 26 of the BL gives the CBC unfettered access to all of the institutions records and books. Section 30(1) of the BL determines the powers of the CBC where a bank fails to comply with laws and regulations or is likely to be engaged in unsafe or unsound practices. According to this section, the CBC requires the bank to take such action as deemed necessary to rectify the situation and is authorized to impose a range of sanctions, including the revocation of the license.
Assessment	Compliant.
Comments	None.
Principle 1(5)	A suitable legal framework for banking supervision is also necessary, including legal protection for supervisors.
Description	Neither, the CBC nor any person who is a director or an officer of the CBC, is liable in any action suit or other legal proceedings for damages for anything done or omitted in the discharge or purported discharge of the functions and responsibilities of the CBC under the BL, unless it is shown that the act or omission was not in good faith or was the result of gross negligence. The defense of CBC staff against lawsuits rests with the Office of the Attorney General and all legal expenses incurred are covered by the Cyprus government.
Assessment	Compliant.
Comments	None.
Principle 1(6)	Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Description	A memorandum of understanding (MOU) has been signed between the CBC, the Cyprus Securities and Exchange Commission, the Insurance Companies’ Control Service, and the Cooperatives Societies Supervision and Development Authority (CSSDA). The MOU came into effect on January 1, 2003. The four parties to this MOU meet at least quarterly to discuss matters of mutual interest. Also, at the technical level, supervisors meet at least on a monthly basis and communicate, if need be, on an ongoing basis. This MOU is based on the application of Section 27(1) which allows the competent supervisory authorities of the financial sector to cooperate and exchange information between them and/or with other supervisory authorities, whether in Cyprus or elsewhere, with a view of discharging their functions and responsibilities in a more effective manner. Any exchange of information will only take place when the CBC is satisfied that the information provided is subject to the same confidentiality rules in the hands of the receiving competent supervisory authority as apply to the CBC. Section 27(1) of the BL enables the CBC to provide to home country supervisory authorities information, which in the opinion of the CBC enables the home country supervisory authority to exercise consolidated supervision. Information on individual deposit accounts is excluded. However, in practice, such information can be passed by the affected subsidiary or branch to its parent or head office or the foreign regulator may choose to visit Cyprus to conduct an on-site review of the operations. The information exchange between the competent supervisory authorities is exclusively used in the discharge of their functions and responsibilities and is subject to confidentiality rules in the hands of the receiving supervisory authority as applied to the supervisory authority which provides the information on the basis of legislation in force from time to time. Confidential information exchanged between the competent supervisory authorities on the basis of the legislation in force may not be disclosed without the express agreement of the competent supervisory authority which disclosed it and, where appropriate, solely for the purposes for which this authority gave its agreement. Memoranda of Understanding (“MOUs”) have been signed, largely on the initiative of the CBC, with the following overseas banking supervisory authorities: Central Bank of the Russian Federation; Bulgarian National Bank; National Bank of the Republic of Belarus; National Bank of Ukraine; National Bank of Yugoslavia; National Bank of Romania; Financial and Capital Market Commission of the Republic of Latvia; National Bank of Slovakia; Bank of Tanzania; Central Bank of Jordan; Bank of Greece; Central Bank of the Lebanon. In addition, MOUs are under negotiation with a number of overseas banking regulatory and supervisory authorities, including authorities in the United Kingdom and Ireland. MOUs have been signed with the following overseas regulators in the field of international financial services: Greek Capital Markets Commission; Federal Commission for the Securities Market of Russia; Czech Securities Commission; Lithuanian Securities Commission. With regard to the securities and investment business, a member of the CBC’s staff, appointed by the Governor of the CBC, participates on the Board of the Cyprus Securities and Exchange Commission. The above person does not have the right to vote but has the right to raise issues, participate in discussions, and convey the opinion of the CBC during Board meetings. The CBC also has on-going contact and cooperation with the Official Receiver and Registrar of Companies as well as with the Head of the Unit for Combating Money Laundering. The above unit is the investigative and law enforcement authority in regards to money laundering, whereas the CBC is the supervisory authority of the banking system in regard to anti-money laundering compliance. Every director, officer, or employee of the CBC is bound to secrecy. The CBC’s governor, directors, officers, and employees take the oath of fidelity and secrecy before assuming their duties.
Assessment	Compliant.
Comments	None.
Principle 2.	Permissible Activities The permissible activities of institutions that are licensed and subject to supervision as banks must be clearly defined, and the use of the word “bank” in names should be controlled as far as possible.
Description	The term “bank” is defined in the BL as a body corporate licensed to carry on banking business under the provisions of the BL. “Banking business” is defined as business carried on in Cyprus or abroad from within Cyprus consisting of lending of funds acquired from the assumption of obligations to the public, whether in the form of deposits, securities or other evidence of debt. Licensed banks are authorized to carry on banking business as defined in Section 2 of the BL. In addition, licensed banks are authorized to carry out, directly or through subsidiaries, the following activities which are integral or closely related to banking business (Section 13 of the BL): a) financial leasing, including hire purchase financing; b) money transmission services; c) issuing and administering means of payment including credit cards, travellers cheques and bankers drafts; d) guarantees and commitments; e) trading for own account or for account of customers in: (i) money market instruments including cheques, bills, CDs; (ii) foreign exchange; (iii) financial futures and options; (iv) exchange and interest rate instruments; (v) securities; f) participation in securities issues and the provision of services related to such issues; g) advice to undertakings on capital structure, industrial strategy and related questions and advice and services relating to mergers and the purchase of undertakings; h) money broking; i) portfolio management and advice; j) safekeeping and management of securities; k) credit reference services; l) safe custody services; m) data processing services; n) nsurance brokerage services; o) any other activity which may be specified by the CBC. No person, other than a bank, shall use in any language on use of the word “bank” or any grammatical variation thereof of the word “bank” in connection with any trade or business carried on by him unless the CBC has granted its prior written approval and subject to any conditions which the CBC may consider proper to impose.
Assessment	Compliant.
Comments	None.
Principle 3.	Licensing Criteria The licensing authority must have the right to set criteria and reject applications for establishments that do not meet the standards set. The licensing process, at a minimum, should consist of an assessment of the banking organization’s ownership structure, directors and senior management, its operating plan and internal controls, and its projected financial condition, including its capital base; where the proposed owner or parent organization is a foreign bank, the prior consent of its home country supervisor should be obtained.
Description	The statutory criteria for the licensing of a bank are contained in Sections 3 and 4 of the BL. The CBC is both the licensing and supervisory authority for banks. The CBC supervises domestic banks, International Banking Units (IBUs) (formerly “offshore banks”), as well as representative offices of foreign banks. At present, 14 domestic banks, 26 IBUs, and 1 representative office of a foreign bank operate in Cyprus. It should be clarified that the term International Banking Unit (IBU) is not a legal term but a purely descriptive term denoting banks licensed to operate in and from within Cyprus, which are owned by nonresidents of Cyprus and which by the conditions attached to their banking licenses deal in currencies other than the Cyprus Pound and primarily with other nonresidents. The above-mentioned category of banks is officially coming to an end when the transitional period allowed under the provisions of the Income Tax Law of 2002 expire on December 31, 2005. The BL provides for one type of license. The CBC may, with an adequately reasoned decision, grant a license without any condition or impose conditions on the license or refuse to grant a license (Section 4 of the BL). Due to a condition attached to all IBUs’ banking-business licenses, IBUs have in the past been prohibited from raising funds in the form of any deposits, extending credits facilities, or offering any banking services whatsoever to both residents and nonresidents in Cyprus pounds. However, upon accession of Cyprus to the EU on May 1, 2004, all exchange control restrictions have been abolished, and residents of Cyprus are now allowed to transfer funds operate payments, and deal in foreign currencies without any limitations or restrictions. As a result of all these changes, the CBC’s Circular Letter of May 25, 2004 has amended the range of permissible operations of the IBUs which operate in Cyprus today. Those IBUs, already subject to the ten percent tax rate, that was generally applicable to the domestic banks, either because they had been licensed after December 31, 2001 or have, subsequent to the 2002 tax reform, elected to be taxable at ten percent, were free to offer all types of banking services to permanent residents of Cyprus, the only restriction being, for the moment, the acceptance of deposits in Cyprus pounds. This restriction, which is the only one that distinguishes the operations of domestic banks from those of of IBUs, will be abolished on Cyprus’ entry into the Euro zone. Until that time, individual IBUs that may wish to engage in banking business in Cyprus pounds must request the CBC to delete the relevant condition attached to their banking business license. Those IBUs, which were licensed prior to December 31, 2001 and which have elected to continue generating their income exclusively outside Cyprus, thus paying a reduced rate of tax of 4.25 percent, are obliged to continue restricting their activities to transactions with nonresidents and in currencies other than the Cyprus pound, despite the repeal of the exchange control laws, until December 31, 2005. The licensing criteria applied by the CBC encompass compliance of the applicant with the requirements stipulated in the BL as well as a judgmental evaluation of the applicant by the CBC. Thus, the principal licensing criteria are the following: At least two directors are required to participate and concur in the effective direction and management of the bank (Section 19 of the BL). A bank incorporated in the Republic must have at all times a minimum capital of not less than £C 3 million or such other higher amount that the CBC might determine (Section 20 of the BL). Directors, chief executives, and managers of the proposed bank must satisfy the CBC that they are fit-and-proper persons (Section 18.2). Short history and business objectives of the applicant bank, including the reasons for wishing to establish a presence in Cyprus. Detailed description of the proposed banking operations, including details of the banking services proposed to be offered and the proposed management structure of the applicant bank. Feasibility study of the bank’s proposed banking operations incorporating projected financial statements for the first five years of its operation. In the case of foreign banking organizations the CBC, in addition to the licensing criteria above, approaches directly the applicant bank’s home supervisory authority and obtains its consent as well as undertaking that it will exercise consolidated supervision over the global activities of the applicant bank, including the operations proposed to be carried out in Cyprus. In the case of foreign banking organizations, the CBC also obtains Letters of Comfort or Letters of Guarantee from the principal shareholders. Upon accession of Cyprus to the EU on May 1, 2004, the provisions of the BL allowing freedom of establishment and cross-border provision of banking services by banks authorized in other member states of the EU entered into force and the BL has been amended to that effect (Banking Amendment Law of 2003). Conversely, banks incorporated in Cyprus are free to establish branches in another member state and/or provide cross-border provision of services in member states of the EU. Following these fundamental changes, the CBC has issued in July 2004 a “Policy statement and Guidelines on the establishment and cross-border provision of services in the Republic of Cyprus by a credit institution incorporated in another member state of the EU,” which includes the terms and conditions for the conduct of banking business in accordance with the above as well as details with regard to the procedure that must be followed. There is no time limit on banking licenses issued by the CBC. However, the CBC may, under Section 30 of the Banking Law, revoke a banking license in circumstances where a bank’s condition is irretrievably impaired. As part of the review process, information/references are also obtained from third parties, such as the applicant bank’s home supervisory authority, correspondent banks, etc. The information received from the applicant is reviewed and judgmentally assessed by the CBC. If all the above criteria are satisfied and the judgmental evaluation is positive, a banking license is issued by the CBC. Directors, chief executives and managers of licensed banks have to satisfy the CBC that they are”fit-and-proper persons” to be involved in the provision of banking services. The”fitness and propriety” of the above persons is determined, to the extent possible, by means of detailed questionnaires which are required to be completed by the persons concerned. In certain circumstances, applicants are currently required to submit a police clearance certificate from their country of origin. All licensees are required to establish a real presence in Cyprus and actually carry out real business. All licensees must, therefore, operate as fully staffed units as required by the scale of operations in each case. The scale of operations and, therefore, the size of staff varies considerably. There is at least one IBU with almost 100 persons and, on the other hand, one unit is considered fully staffed with three persons. In one of the cases (application for the establishment of a domestic bank), the CBC rejected the application as one of the major prospective shareholders was a company whose background and activities rendered it unsuitable. Two of the applications were successful, whereas two remaining cases were unable to satisfy the eligibility criteria. Notwithstanding the above, it should be noted that in the case of IBUs, the policy of the CBC is to discourage the submission of formal applications under the Banking Law by banks which do not meet the eligibility criteria as set out in the bank’s “Policy Statement and Guidelines for the establishment and operation of IBUs.” The CBC also requires prospective applicant banks to obtain the prior approval and support of their home banking regulatory/supervisory authority before submitting a formal application to the CBC for a banking license. In this way, besides the cases referred to in the preceding sentence, a number of prospective applicant banks have been discouraged in the last two years from actually submitting an application. With respect to the transparency of the ownership structure and the source of capital, the CBC indicated that its policy is to license only branches or subsidiaries of existing international banks. The CBC has in place a process of ongoing supervision and monitoring to determine whether the licensing criteria continue to be met and that the institution is meeting its business goals. The CBC is home supervisor for 16 banks (10 domestic and 6 IBUs). Three of the domestic banks maintain branches/subsidiaries in foreign jurisdictions. The CBC is empowered to revoke the licence of the bank if it is revealed that the decision to grant the licence of the bank was knowingly based on false information [Section 30(1)]. The applicant bank is required to submit to the CBC a list of the prospective shareholders with their proposed percentage shareholding in the bank. Major and/or controlling shareholders who are natural persons must submit a brief outline of their financial standing and complete a “Personal Questionnaire,” while corporate bodies must submit their full particulars and latest audited accounts. The CBC reserves the right to enquire into the individuals who control such corporate bodies. In this regard, the shareholders of the applicant bank must be able to supply additional financial support, if needed. Major and/or controlling shareholders are required to provide the CBC with appropriate “Letters of Comfort” or “Letters of Guarantee.” The CBC requires that the directors of the applicant bank must have substantial experience and sound knowledge of all types of financial activities the bank intends to pursue. Once licensed and following the commencement of its operations, the banking subsidiary or branch is subject to the supervision of the CBC through regular off-site monitoring and on-site examinations. The aim of on-site examinations is to assess the quality of the bank’s assets, its financial soundness, the adequacy of liquidity, its earning capacity, the adequacy and quality of management, the adequacy of internal control systems, the implementation of prudent policies, and its compliance with the conditions that may be attached to its banking licence.
Assessment	Compliant.
Comments	None.
Principle 4.	Ownership Banking supervisors must have the authority to review and reject any proposals to transfer significant ownership or controlling interests in existing banks to other parties.
Description	Section 17(1) of the BL stipulates that no person shall, without the prior written approval of the CBC, either alone or with an associate or associates, acquire or have control over any bank incorporated in Cyprus or its holding company. “Control” is defined in Section 2 of the BL as: a) beneficial ownership by a person of its share capital or of its holding company which carries ten percent or more of the voting power at any general meeting of the company or its holding company; or b) ability by a person to determine in any manner the election of a majority of the directors of the company or of its holding company. Regarding foreign banks’ ownership, the CBC considers applications only from banks licensed in jurisdictions, which, in its judgment, exercise proper licensing and banking supervision. In addition, applicant banks should be institutions enjoying a good reputation internationally and having an established record of growth and profitable operation. In addition, it must be noted that the CBC does not grant licenses to “de novo” banks or banks which are ultimately beneficially owned and/or controlled by a non-established, non-financial institution. Notwithstanding the provisions of any other law, section 16 of the BL stipulates that: a) a bank incorporated in Cyprus shall not sell or dispose the whole or part of its business in Cyprus by amalgamation or otherwise, except with the prior written approval of the CBC; and b) a bank other than a bank incorporated in Cyprus shall not sell or dispose the whole or part of its business in Cyprus, except with the prior written approval of the CBC. Moreover, no person shall, without the prior written approval of the CBC, either alone or with any associate or associates acquire or have control over any bank incorporated in Cyprus or its holding company. Any intention to increase the holding in a bank or its holding company above the level that has initially been approved by the CBC requires the prior approval of the CBC. Any intention to decrease a holding in a bank or its holding company will also require notification to the CBC [Section 17 (1)]. Notwithstanding any provisions of the Companies Law or any other law in force in Cyprus from time to time, if a holding in a bank or its holding company is acquired despite the opposition of the CBC, it shall, regardless of any other sanctions to be adopted, provide either for exercise of the corresponding voting rights to be suspended, or for the nullity of votes cast or for the possibility of their annulment [Section 17(2)]. The CBC, in deciding whether to grant a license approval, will ensure that persons of dubious reputation or persons who may pose a threat to the interest of depositors and integrity of the bank are excluded. In the course of on-site examinations, the CBC obtains the names and holdings of all significant shareholders.
Assessment	Compliant.
Comments	None.
Principle 5.	Investment Criteria Banking supervisors must have the authority to establish criteria for reviewing major acquisitions or investments by a bank and ensuring that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision.
Description	Section 13 of the BL regulates investments by banks and sets limits on the acquisition of shares by banks in other companies. Specifically, the BL [Section 13(1)] provides that a bank shall not acquire or hold directly or indirectly more than ten percent of the share capital of any other company, and, in the case of a bank incorporated in Cyprus, the value of any share capital held in any other company shall not exceed ten percent and for all companies in aggregate 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 which are integral to or closely related to banking business provided that such companies are incorporated in Cyprus. Any bank investments exceeding the limits mentioned above require the prior written approval of the CBC. Before granting its approval for any new acquisition by a bank, the CBC requires that any new acquisitions and investments do not expose the bank to undue risks or hinder effective supervision. The bank must demonstrate that it has, from the outset, adequate financial and organizational resources to handle the acquisition/investment. Investments in non-consolidated subsidiaries are deducted from the bank’s capital base for purposes of consolidated supervision. In the course of on-site examinations, the CBC inspectors ensure that investments in banking and non-banking companies do not expose the bank to undue risks. In addition, Section 12 of the BL prohibits the acquisition or purchase of immovable property by banks, except in certain cases as provided in Section 12 of the BL. Notification after the acquisition or investment is sufficient in the case of activities closely related to banking and where the investment is small relative to the bank’s capital. EU Directive 2000/12/EC, which is to be transposed, limits individual participation to 15 percent of capital and aggregate participation to 60 percent.
Assessment	Compliant.
Comments	None.
Principle 6.	Capital Adequacy Banking supervisors must set minimum capital adequacy requirements for banks that reflect the risks that the bank undertakes, and must define the components of capital, bearing in mind its ability to absorb losses. For internationally active banks, these requirements must not be less than those established in the Basel Capital Accord.
Description	Cyprus incorporated banks, including subsidiaries of foreign banks, are required to have a minimum capital and to maintain capital adequacy ratios. These requirements do not apply to branches of foreign incorporated banks. A bank incorporated in Cyprus should have at all times a minimum capital base of not less than £C 3 million (€5 million) or such other higher amount that the CBC might determine in line with EU requirements (Section 20). Banks incorporated in Cyprus are also required to maintain a capital adequacy ratio at such minimum level as may be determined by the CBC from time to time for each bank individually having regard to its circumstances provided that such ratio shall be uniform for all banks within the same class [Section 21(1)]. The capital adequacy ratio is in the form of mandatory maintenance of a capital base in relation to total assets including off-balance sheet exposures or to categories of assets specified by the CBC from time to time at such minimum ratio or ratios as is prescribed by the CBC [Section 21(2)]. At present, the required capital adequacy ratio stands at 10 percent. All banks comply with the ratio and the average ratio for the sector exceeds 14 percent. The CBC has issued two directives (January 1999) to all banks incorporated in Cyprus: Directive on the computation of the capital adequacy ratio in relation to credit risk (excluding risks arising from the trading book); and Capital adequacy directive in relation to a bank’s trading book business and in respect of the foreign exchange and commodity derivatives risks resulting from all of its business activities. These directives conform to the Basel recommendations and make use of the Basel risk weights and components of capital. The capital adequacy ratios of banks are calculated on both a consolidated and solo basis. Banks are required to report capital adequacy ratios and their components to the CBC on a semi-annual basis. The above ratios are verified in the course of on-site examinations. Off-balance sheet risks, subordinated debt, revaluation gains, and unrealized losses are treated in accordance with Basel recommendations for purposes of determining capital adequacy. Off-balance sheet items are grouped into four categories depending on the risk that they entail, and each category carries out a different risk conversion factor. Then the values of these items, as adjusted by the conversion factor, are multiplied by the risk weightings attributable to the relevant counterparties. Subordinated debt is included in tier two capital and cannot exceed 50 percent of tier one capital. Moreover, the total of tier two capital cannot exceed the total of tier one capital. Revaluation gains are credited to a revaluation reserve, and the balance of this reserve is included in tier two capital. Unrealized losses are debited to the revaluation reserve to the extent that these are covered by revaluation gains individually for each item concerned. Any shortfall is debited to the Profit and Loss Account, which is included in tier one capital. Under Section 30(1)of the BL, the CBC has broad powers to take remedial measures. This would no doubt include requiring institutions to take corrective action where their capital ratios fell below a certain limit. Branches of foreign incorporated banks are not required to have capital and, therefore, they do not maintain a capital adequacy ratio. Banks are required to have an internal process for assessing their overall capital adequacy in relation to their risk profile. Banks are required to provide the CBC with all the information necessary for the assessment of their compliance with the requirements of the Capital Adequacy Directive. The banks’ internal control mechanisms and administrative and accounting procedures should be such as to permit the CBC to verify the banks’ compliance with these requirements at all times. The adequacy of the internal process of banks for assessing their overall capital adequacy in relation to their risk profile is evaluated in the course of on-site examinations. In addition, the expansion of banks abroad, especially in Greece, requires additional capital funds. In such a case, the prior approval of the CBC is required. The CBC grants its approval only if it is satisfied that the bank has sufficient capital funds to support the expansion abroad.
Assessment	Compliant.
Comments	None.
Principle 7.	Credit Policies An essential part of any supervisory system is the independent evaluation of a bank’s policies, practices, and procedures related to the granting of loans and making of investments and the ongoing management of the loan and investment portfolios.
Description	Both domestic and international banks operating in Cyprus are subject to the same responsibilities and oversight regarding their credit and investment risk-related policies, procedures, and systems. Pursuant to its authority under the BL, through a series of directives and circulars and direct communication with the banks, the CBC has established and implemented its requirements that banks have established and well-documented credit and investment policies, practices, and procedures, approved by their Board of Directors and implemented by bank management. Such requirements include the establishment of internal risk management and control systems and asset classification and provisioning requirements by the banks and their establishment of effective internal communications systems to transmit those processes to bank management and staff involved in the credit granting and control process. Section 11(1) of the BL prescribes limitations on large exposures and aggregate large exposures, as well as on credit facilities to directors and their interests. The CBC reviews and evaluates compliance with all legal and prudential requirements through both off-site monitoring and on-site examination. The CBC requirements include policies on ongoing organization-wide credit and investment risk assessment, management, control, and reporting systems, asset quality classification, large exposures, establishment and monitoring of limitations, connected lending, assurance that the credit approval process is free of inappropriate external pressure and conflict of interest, and other related matters. Section 26 (2) of the BL requires that banks provide all necessary information to the CBC, which facilitates both the off-site supervision and on-site monitoring processes. Off-site monitoring is effected by the regular collection of a variety of information through the collection of detailed periodic returns on all aspects of credit and investment risks in the banks. Such reporting includes, inter alia, a monthly balance sheet with detailed asset and liabilities breakdown; information on asset quality, non-performing loans, and provisioning; large exposures; and, investments. Returns are reviewed and analyzed and the results are provided to appropriate examination staff and senior CBC management for necessary action. The scope of the on-site examination process includes an assessment of all aspects of credit administration, credit control, and credit risk evaluation. Appropriate asset quality classification and provisioning, including the adequacy of credit loss reserves, is addressed, as is the bank’s ongoing credit authorization, information, and documentation systems and senior management oversight. Information systems must include information on customer outstandings, delinquencies and other problems, sectoral exposures, and corrective action. On-site examinations also evaluate the understanding of the credit risk system by bank management and staff. The results of on-site examinations are reviewed with bank senior management and corrective action is required.
Assessment	Compliant.
Comments	None.
Principle 8.	Loan Evaluation and Loan-Loss Provisioning Banking supervisors must be satisfied that banks establish and adhere to adequate policies, practices, and procedures for evaluating the quality of assets and the adequacy of loan-loss provisions and reserves.
Description	All licensed banks are subject to regular on-site examinations. One of the prime objectives of these examinations is to assess the quality of the assets of the banks. In the course of an on-site examination, the CBC examiners review extensively the bank’s lending practices, its credit granting standards, and the level and adequacy of provisions. Banks themselves are required to review individual credits, asset classifications, and provisioning, including those for both on-and off-balance sheet exposures, at least annually. In addition, the external auditors of banks, when conducting the audit of each bank’s financial statements, review their provisioning policies and adequacy. During the course of on-site examinations, the CBC examiners assess the quality of assets individually, especially major loan accounts, and the level and adequacy of provisions and compare their results with those of the bank. In view of the small number of banks, CBC examiners are able to review a sample of more than 50 percent of the balance sheet value of bank credit exposures; the sample selected is biased towards large or problematic loans and includes both on- and off-balance sheet exposures. Each borrower selected is individually assessed by account, collateral held, financial condition, and other pertinent factors. Then, according to the risk entailed, each account is classified on the basis of CBC’s established asset quality classification criteria. These classifications are Pass, Special Mention, Substandard, and Doubtful; the definition of the characteristics of each of these classifications is very comparable to the definitions of similar classifications that are used by other competent supervisory authorities worldwide. In the course of on-site examinations, the CBC inspectors review the bank’s provisioning policies, as approved by the Board of Directors, together with the guidelines that are set for considering specific credits for provision. Since CBC examiners are able to review more than 50 percent of the balance sheet value of credit exposure, they can more adequately assess the level and adequacy of each bank’s provisioning policies, as well as their implementation in practice. The CBC requires banks to have appropriate procedures and the necessary organizational resources for the ongoing oversight of problem credits and for identifying and collecting past due loans. The CBC meets twice yearly with each bank’s management to review the bank’s provisioning policy and practices and the progress made in the collection of past due loans. The banks provide the CBC with quarterly reports on provisioning, non-performing assets, and assets where interest has been suspended. In January 2004, the CBC established more stringent criteria for the suspension of the recognition of interest on problem-credit facilities. The time period beyond which interest will be suspended for such credit facilities that are in arrears or where limits are in excess, provided that there is no adequate tangible security, was reduced from nine months to six months. In December 2004, the time period was further reduced from six months to ninety days, to be effective from January 1, 2006. The CBC plans to further modify its policy in the near future to require the suspension of interest in such cases, irrespective of the existence of tangible security, in line with international practice and the provisions of the proposed Capital Adequacy Directive of the EU.4 Section 30(1) of the BL empowers the CBC, when a bank fails to comply with any provision of law or regulations or the conditions of its license, or the liquidity or character of its assets have been impaired, to, inter alia, require the bank to forthwith take such action as the CBC may consider to rectify the matter. Consequently, the CBC is empowered to require a bank to strengthen its lending practices, credit-granting standards, level of provisions and reserves, and overall financial strength if it deems the level of problem assets to be of concern. Section 20 of the Banking Act empowers the CBC to increase the capital requirement of a bank in order to deal with shortfalls in provisions. The CBC collects information from the banks quarterly on provisioning, non-performing loans, and assets where interest is suspended. Further information on provisioning is obtained at semiannual meetings with the banks and annual tri-lateral meetings with the banks and their external auditors. In the course of on-site examinations, the CBC examiners require details on the bank’s classification of assets and provisioning. In keeping with the basic principles and standards for risk control contained in its “Framework for the Evaluation of Internal Control Systems,” the CBC would expect the banks to have processes in place for continually identifying, measuring, analyzing, and controlling risk in its credit portfolio, including mechanisms for continually assessing the strength of guarantees and appraising the worth of collateral and identifying and classifying problem credits as impaired. The CBC has issued specific guidelines on determining the value of collateral held by banks, which specify that the valuation of collateral is required to reflect its net realizable value. The CBC directives also provide that the refinancing of loans that would otherwise fall into arrears does not lead to improved classification. The CBC requires that the valuation, classification, and provisioning for large credit exposures be conducted on an individual item basis.
Assessment	Largely Compliant.
Comments	Pending the full completion of the ongoing implementation of the more stringent criteria for the suspension of the recognition of interest on problem facilities on January 1, 2006, Cyprus remains largely compliant with this Principle.5
Principle 9.	Large Exposure Limits Banking supervisors must be satisfied that banks have management information systems that enable management to identify concentrations within the portfolio, and supervisors must set prudential limits to restrict bank exposures to single borrowers or groups of related borrowers.
Description	Sections 11(1) and (2) of the BL establish limitations on exposures extended to individual borrowers and their interests (i.e., a closely related group) generally to 25 percent of the bank’s capital base. However, the CBC has discretionary power to grant very limited exceptions to this limitation in cases involving the public interest or exceptionally low risk arising from the exposures concerned, provided that such exemptions are not in conflict with EU acts in force in Cyprus. The aggregate of large exposures (i.e., exposures in excess of 10 percent of the bank’s capital base) is limited to 800 percent of the bank’s capital base. The law empowers the CBC to establish lower limits, as it deems necessary. Section 11(3) establishes the criteria for determining what constitutes a closely related group (“connected persons”) and section 11(4) defines a credit exposure, which includes both on-and off-balance sheet exposures. Section 43 of the BL provides for monetary penalties for non-compliance with these requirements. In June 2004, the CBC re-issued its Directive 7, Monitoring and Control of Credit Facilities to Individual Borrowers or Bank Directors and their Connected Persons, which, inter alia, describes the determination of a connected person, the definition of the bank’s capital base, and the credit exposures to be included. It also includes the requirements for monitoring exposures on both a consolidated and non-consolidated basis, as appropriate. It requires the maintenance of accounting, administrative, and internal control systems to monitor these exposures and prescribes periodic reporting of the exposures to the CBC. Banks are required to submit semi-annual reporting on concentrations of lending. The scope of on-site examinations includes a review of concentrations of lending and compliance with the requirements of the law as well as the management systems that monitor such exposures on both a solo and consolidated basis, as appropriate. It also determines the accuracy of management information systems and reporting to the CBC.
Assessment	Compliant.
Comments	The CBC may wish to consider establishing a centralized registry of information on large credit exposures as would be defined by them to be regularly collected from banks and other credit providers in Cyprus, aggregated by the CBC for each borrower and then made available to the banks and other credit providers for their use in evaluating their credit risk exposures.
Principle 10.	Connected Lending In order to prevent abuses arising from connected lending, banking supervisors must have in place requirements that banks lend to related companies and individuals on an arm’s-length basis, that such extensions of credit are effectively monitored, and that other appropriate steps are taken to control or mitigate the risks.
Description	In addition to the general large exposure limitations on exposures to individual borrowers and their closely related groups prescribed in Section 11(1)(a), section 11(1)(d) of the BL, as amended, establishes limitations on credit facilities extended to all of the bank’s directors together to 40 percent of the bank’s capital base. Section 11(1)(e) limits the unsecured credit exposure of each individual director to 5 percent of the bank’s capital base. Section 11(c) requires that the approval of all credit exposures to directors be approved by a resolution of a minimum of two-thirds of the directors with the effected director not present for the discussion and voting, and that such credit exposures be granted on the same commercial conditions as would apply to any customer in the ordinary course of business. Section 11(3) establishes the criteria for determining what constitutes a closely related group (“connected persons”) and Section 11(4) defines a credit exposure, which includes both on- and off-balance sheet exposures. Section 22 would permit the CBC to deduct credit exposures to directors and their interest in the computation of the bank’s capital base; although, this has not been done. Section 42 provides the CBC with authority to impose administrative fines for non-compliance with these requirements. In addition, Section 43 of the BL provides for the imposition of administrative fines and imprisonment in situations where a case of criminal prosecution by the Attorney General is involved. In June 2004, the CBC re-issued its Directive 7, Monitoring and Control of Credit Facilities to Individual Borrowers or Bank Directors and their Connected Persons, which, inter alia, describes the determination of a connected person, the definition of the bank’s capital base, and the credit exposures to be included. It also includes the requirements for monitoring exposures on both a consolidated and non-consolidated basis, as appropriate. It requires the maintenance of accounting, administrative, and internal control systems to monitor these exposures and prescribes periodic reporting of the exposures to the CBC. Banks are required to submit semi-annual reporting on all concentrations of lending, including exposures to their directors and their interests. The scope of on-site examinations includes a review of concentrations of lending and compliance with the requirements of the law as well as the management systems that monitor such exposures, on both a solo and consolidated basis, as appropriate. It also determines the accuracy of management information systems and reporting to the CBC.
Assessment	Compliant.
Comments	None.
Principle 11.	Country Risk Banking supervisors must be satisfied that banks have adequate policies and procedures for identifying, monitoring, and controlling country risk and transfer risk in their international lending and investment activities, and for maintaining appropriate reserves against such risks.
Description	The CBC has not prescribed specific, formal country risk limitations for banks; however, country risk exposures are monitored through a monthly return that is filed by all internationally active banks. Exposures that are of concern are addressed through direct communication with the bank. Banks with material country risk exposure would be expected to establish, monitor, and control their own internal country risk limitations, pursuant to the nature of their business as part of an overall risk management system. In addition, Cyprus-incorporated banks have a physical presence in only three foreign developed countries, and the CBC insures that the activities/exposures in these countries are adequately supported by each bank’s capital base. Likewise, the CBC has not mandated overall, formal transfer risk limitations but would expect that each internationally-active bank include transfer risk-related limitations in its overall risk management process and appropriately monitor, review, and control any such exposures. In addition, the CBC expects that banks maintain correspondent accounts only with prime banks and has established a limit for maximum allowable placements with each foreign bank of 20 percent of the depositing bank’s capital base. The bank’s compliance with this limitation and any internally-imposed limitations is reviewed by the CBC during each on-site examination. The bank’s systems to identify, monitor, and control country/transfer risk are reviewed during each on-site examination. These matters are discussed with bank management during the examination and concerns are communicated to the bank.
Assessment	Largely Compliant.
Comments	The CBC should consider establishing formal guidance on a framework for country risk and transfer risk management, which could be used by all banks located in Cyprus to formulate their own specific internal limitations, as appropriate, to the nature of their business and their ability to identify, monitor, and control such risks.
Principle 12.	Market Risks Banking supervisors must be satisfied that banks have in place systems that accurately measure, monitor, and adequately control market risks; supervisors should have powers to impose specific limits and/or a specific capital charge on market risk exposure, if warranted.
Description	In the course of the periodical on-site examinations, the CBC verifies that banks have information systems, risk management systems, and internal controls that enable them to measure, monitor and control market risk. During these on-site examinations, the CBC also ensures that there are appropriate limits, including stop-loss limits, for various risks. Moreover, open positions in foreign currency are subject to limits imposed by the CBC. These limits are currently 6 percent of capital base for the overall open position (coming down from 15 percent) and 3 percent of capital base for the open position in each currency (coming down from 10 percent). In addition, there are intra day limits in place. The overall open foreign currency position is the sum of all the net short positions or the net long positions, whichever is greater. During on-site examinations, the CBC reviews the banks’ systems and assesses compliance with internal limits. The limits imposed by the CBC on open positions in foreign currency are monitored through monthly prudential returns submitted to the CBC. The CBC has adopted as from January 1, 2003, the provisions of the EU Capital Adequacy Directive (CAD) (Council Directive 93/6/EEC dated March 15, 1993 as subsequently amended by Council Directives 98/31/EC and 98/31/33/EC dated June 22, 1998), thereby requiring a capital charge for market risk, including commodity derivatives position risk. Section 20 of the BL enables the CBC to increase the capital requirements of banks if it deems necessary. The presence of adequate systems and controls, ensuring that all transactions are captured on a timely basis and that the banks’ positions are revalued frequently, using reliable and prudent market data, is not directly assumed by the CBC. In this area the CBC relies on the work carried out by the banks’ internal as well as external auditors. At present, there are no formal supervisory requirements with respect to scenario analysis, stress testing, and contingency planning. However, the presence of market risk in bank operations has up to now been minimal. In the case of those banks which are relatively active in market operations and which are subsidiaries of EU banks, there is a close cooperation with the consolidating/lead supervisory authority. As to the required expertise needed to monitor the actual level of complexity in the market activities of banks, it is to be noted that with the exception of perhaps one or two banks, the level of market activities of banks is low and, therefore, until now, there has been no practical need for specialization in monitoring market risk in the Banking Supervision and Regulation Division. As a result, non-specialized bank supervisors can easily review the market operations of banks during on-site examinations. However, the CBC realizes that market sophistication of banks is imminent so the mission has been informed of the plans to develop the required expertise among its supervisors through the attendance of specialized training courses offered by the FSI and other organizations. In the case of those banks which are relatively active in market operations and which are subsidiaries of EU banks, there is a close cooperation with the consolidating/lead supervisory authority, thus mitigating the lack of expertise at the local level. The CBC holds meetings with senior management to discuss findings of on-site inspections. During these meetings, the CBC determines that the senior management understands the market risks undertaken and the risk management information that they receive. With the exception of one bank which is relatively active in market operations and which is a subsidiary of an EU bank permitting a close cooperation with the consolidating/lead supervisory authority, the CBC has not so far allowed any other banks to use sophisticated models to calculate their regulatory capital requirements.
Assessment	Largely Compliant.
Comments	The CBC has to be commended for the adoption of CAD. However, while acknowledging that activities generating market risk in this market are limited, in order to be fully compliant and to prepare for future expansion of such activities, the CBC should: satisfiy itself that there are systems and controls in place to ensure that all transactions are captured on a timely basis, and that the banks’ positions are revalued frequently, using reliable and prudent market data; determine that banks perform scenario analysis, stress testing, and contingency planning, as appropriate, and periodic validation or testing of the systems used to measure market risk; build up the expertise needed to monitor the actual level of complexity in the market activities of banks and acquire the expertise in order to validate itself the internal model of the foreign subsidiaries for which the CBC is the home regulator.
Principle 13.	Other Risks Banking supervisors must be satisfied that banks have in place a comprehensive risk management process (including appropriate board and senior management oversight) to identify, measure, monitor, and control all other material risks and, where appropriate, to hold capital against these risks.
Description	Section 23(1) of the BL empowers the CBC to establish a minimum ratio of liquefiable assets to be held by banks. In November 2001, the CBC issued its Directive #11 on the Computation of Prudential Liquidity, which sets out its requirements for maintaining bank liquidity. Pursuant to the directive, banks are required to manage their liquidity through the use of time-band analysis for assets and liabilities and maintaining maximum allowable maturity mismatches (excess liabilities over assets) within limitations prescribed in Directive #11. The directive requires consideration of both on- and off-balance sheet assets and liabilities. Liquidity is monitored by the banks on a daily basis, and a quarterly liquidity return is required by the CBC. Information on foreign currency liquidity is collected monthly. During on-site examinations, compliance with the prescribed requirements and limitations is verified. Banks are permitted to set their own internal interest rate risk-related limitations, with respect to both Cyprus pounds and foreign currencies, which are to be monitored using their own models. These limitations and compliance with them is reviewed during on-site examinations. The CBC reports that the banks’ current self-imposed limitations are conservative and below the level that it would find acceptable. Banks submit quarterly returns on interest rate risk exposure. The CBC requires that banks maintain adequate systems of measuring and monitoring their interest-rate risk exposures on a daily basis. Banks currently assess their interest-rate risk exposures using the “gap-analysis” method with simple maturity/repricing schedules. Banks are also required to have in place a system of interest rate risk limits, maintaining banks’ interest rate risk exposures within self-imposed parameters. The CBC has the right to request the revision of a bank’s upper operating limit for interest-rate risk exposures if it considers that this limit has been set at an excessively high level. In addition, the adequacy and effectiveness of banks’ interest-rate risk measurement and management processes is assessed by the CBC during on-site examinations. To facilitate the monitoring of interest-rate risk exposures by the CBC across institutions, banks are required to perform stress tests and provide to the CBC, on a quarterly basis, the results of their internal measurement systems, expressed in terms of a change in net-interest income, using a standardized interest rate shock of 1 percent in the base interest rate. The CBC requires that banks limit their overnight foreign exchange net-open positions in any one currency to the equivalent of 3 percent of their capital base; the intra-day maximum limit is 5 percent. The overall aggregate net-position limit for all currencies together is the equivalent of 6 percent of their capital base, measured as the sum of the absolute values of the individual net-currency positions; the intra-day maximum is 8 percent. Also, banks must establish stop-loss limits on both a daily and cumulative basis. Monthly returns on foreign currency positions are filed with the CBC. The CBC’s Directive on the “Framework for the Evaluation of Internal Control Systems” requires banks to have contingency plans to enable the continuation of services and operations and provide for the restoration of controls. Included in these requirements are the basic requirements and criteria for the ongoing maintenance of and contingency planning for the recovery of the bank’s information systems and other operational risk-related matters. Banks are required to have appropriate management systems and systems to measure, monitor, and control these risks as well as internal management reporting systems to provide for oversight by senior management. Also, a required task for the internal auditor is to evaluate compliance with, and the efficiency of, risk control/management procedures and to estimate any potential loss that the bank might incur as a result of its exposure to risks. The directive requires that banks have a structure appropriate to the scope and complexity of its activities and that tasks and responsibilities for each activity and operational unit be clearly stated in the bank’s operational manuals. During on-site examinations, the CBC reviews the adequacy and effectiveness of all of the bank’s systems to identify, analyze, monitor, and control risks and compliance with limitations imposed by the CBC as well as verification of periodic reporting. Off-site monitoring of returns also identifies issues of concern and compliance with limitations. Section 20 of the BL empowers the CBC to increase the banks’ minimum capital requirement to include consideration of other risks. In its Directive #10, Monitoring of Foreign Currency Exposures, for banks whose business is carried out primarily in Cyprus pounds, the CBC has imposed a minimum liquidity ratio for liabilities in foreign currencies, currently set at 75 percent, and specifies the types of assets that may be treated as liquid. The CBC does not currently require that banks include a statement on their risk management policies and procedures in their published accounts. However, these accounts are prepared according to International Accounting Standards, which require certain disclosures on risk management.
Assessment	Compliant.
Comments	Beginning on January 1, 2007, the CBC will require banks to comply with the requirements the EU Capital Requirements Directive, which includes disclosures on risk management.
Principle 14.	Internal Control and Audit Banking supervisors must determine that banks have in place internal controls that are adequate for the nature and scale of their business. These should include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding its assets; and appropriate independent internal or external audit and compliance functions to test adherence to these controls, as well as applicable laws and regulations.
Description	The CBC issues Directives pursuant its authority under Section 41 of the BL. In April 2004, the CBC updated its previously-issued Directive #8 on the Framework for the Evaluation of Internal Control Systems, which establishes general principles and standards for ensuring adequate internal control systems and recommends the tasks and responsibilities that should be given to internal audit units of banks. The directive sets out the objectives of the internal control system; the basic principles and standards for the overall system and for the organizational structure and operational procedures of the bank; basic principles and standards for risk control and accounting and information systems; the responsibilities of the Board of Directors and senior bank management (with regard to all aspects of risk management), including the establishment of an audit committee and the establishment, tasks, and operational principles of the internal audit department. The directive requires the Board of Directors and senior management to develop and implement a risk control system appropriate to the specifics of the bank and the complexity of its operations. In addition, various general provisions in the BL and the Companies Law include duties and responsibilities of directors. Section 19 of the BL requires that at least two individuals participate and concur in the effective direction and management of the business of the bank (the “four-eyes” principle) and the Companies Law provides that the business of the company will be managed by the directors and that the duties of directors are the fiduciary duties of loyalty and good faith and the statutory duty of disclosure. Section 18(2) of the BL empowers the CBC to assess the fitness and propriety of the directors, the chief executive officer, and managers of banks and, if they are found to be not fit and proper, to direct that they not be a director, chief executive officer, or manager. Prospective directors and senior management that are not known to the CBC provide detailed background information to the CBC prior to their appointment, and the CBC conducts investigations on those individuals to determine whether they have the necessary skills to assume their proposed position. Section 30(1)(a)(v) of the BL empowers the CBC to require the removal of any director, controller, or manager of a bank. Competence and skills of bank management are assessed during on-site examinations and in direct contacts between CBC officers and bank management. On-site examination procedures include review and assessment of internal audit, credit review, control, and administration, treasury management, management information systems, organizational structure, recruitment policies, and other internal control functions to evaluate the adequacy and effectiveness of back office and operational functions, relative to the bank’s business. The on-site examination also includes a comprehensive review of the adequacy and effectiveness of the internal audit function to ensure complete access to all aspects of and records on the bank’s business, staff adequacy, independence, and reporting lines to the Audit Committee of the Board of Directors, and senior management attention to the issues and exceptions raised by the internal audit function. Section 26(2) of the BL provides the CBC with access to all records and other information of the bank, including all reports of the internal and external audit functions. The off-site supervision and on-site examination functions include contact with bank’s internal audit and internal control and compliance staff. The Directive on the Framework for Evaluation of Internal Control Systems requires that the Audit Committee of the Board of Directors be composed of non-executive directors, thus ensuring that there are non-executive directors on the Board. It also requires that the internal audit function report directly to the Audit Committee of the Board.
Assessment	Compliant.
Comments	None.
Principle 15.	Money Laundering Banking supervisors must determine that banks have adequate policies, practices, and procedures in place, including strict “know-your-customer” rules, that promote high ethical and professional standards in the financial sector and prevent the bank being used, intentionally or unintentionally, by criminal elements.
Description	The Prevention and Suppression of Money Laundering Activities Laws of 1996 to 2004, (hereafter referred to as the “PSMLAL”), establish a solid framework that covers the various aspects of money laundering and the role of the financial system in this regard. The salient features of the PSMLAL are as follows: It defines and criminalizes laundering of proceeds from all criminal offenses punishable with imprisonment in excess of one year. It provides for the confiscation of proceeds from all serious crime. It empowers courts to issue freezing and restraint orders in respect of such. It requires suspicion of money laundering to be reported to the Unit for Combating Money Laundering (MOKAS) without this being treated as a breach of confidentiality. It empowers the courts to order the disclosure and production of information held by natural or legal persons, including banks, related to money laundering investigations. It requires all persons carrying on relevant financial or other business, as defined by the law, to maintain procedures in relation to customer identification, record keeping, internal control, and communication and staff training in the recognition and handling of suspicious transactions. It enables the registration and enforcement of foreign orders for the freezing and confiscation of proceeds. In November 2004, the CBC issued a Guidance Note to banks which consolidates in one single document all the previous Guidance Notes and Supplements/Amendments. The revised Guidance Note takes into account: i) the harmonization of Cyprus’s legislation with the EU Directive 2001/97EC; ii) the revised recommendations for combating money laundering issued by the Financial Action Task Force (FATF) on money in June 2003 and the nine special recommendations against terrorist financing; iii) the recommendations included in the paper on “Customer Due Diligence for Banks” issued in October 2001, by the Basel Committee on Banking Supervision. The revised Guidance Note requires banks to implement measures to prevent money laundering and contains requirements in respect of the following: Customer identification and due diligence procedures; Record keeping procedures; Cash deposits in foreign currency notes; The role of the Money Laundering Compliance Officer; Recognition and reporting of suspicious transactions to the financial intelligence unit (“MOKAS”); Prudential reporting to the CBC; Internal control procedures and risk management; Education and training of employees. CBC’s supervision in this area entails, besides the issuance of Guidance Notes for the implementation of preventive measures, off-site monitoring and on-site examinations which aim at assessing bank’s compliance with their anti-money laundering obligations. The PSMLAL, the Banking Law, and CBC’s Guidance Note prohibit banks from opening and maintaining secret, anonymous, or numbered accounts, or accounts in fictitious names, or accounts not in the full name (s) of the holder (s) as per the identification documents. Additionally, the Guidance Note requires banks to identify, in the case of private and non-listed public companies, the identity of the principal ultimate beneficial owners. The latter are defined to be persons with direct or indirect interest of 5 percent or more in a company’s share capital. Apart from beneficial owners, banks must also establish the identity of any person (s) who have control over a company’s business and assets, even if that person has an interest of less than five percent in a company’s share capital. The CBC’s Guidance Note requires that records maintained by banks in respect of any customer account should contain the following minimum information: the identity of the account holder (s); the identity of the beneficial owner (s) of the account; the identity of the authorized signatory (ies) to the account; the volume of funds or level of transactions flowing through the account; connected accounts; for selected transactions: the origin of the funds; the type and amount of the currency involved; the form in which the funds were placed or withdrawn; i.e., cash, cheques, wire transfers, etc.; the identity of the person undertaking the transaction; the destination of the funds; the form of instructions and authority; the type and identifying number of any account involved in the transaction. In accordance with the CBC Guidance Note, when opening accounts for trusts and nominees of third persons, banks should ascertain, without any exception, the identity of all the settlors and the true benificaries of the said accounts. The PSMLAL requires banks, when forming a business relationship or carrying out a one-off transaction with or for another, to apply appropriate procedures of internal control, communication, and detailed examination of any transaction, which, by its nature, may be considered to be associated with money laundering for the purpose of preventing or forestalling money laundering. As a means of assisting persons employed by banks in recognizing the most basic ways through which money laundering may occur, the CBC’s Guidance Note contains an extensive list of examples of suspicious transactions and activities. In the period from June 1998 to June 2004, banks reported a total of 375 suspicious transactions to the FIU (75 in 2002, 99 in 2003 and 77 in 2004). The CBC’s Guidance Note also requires that banks put in place by June 30, 2005, the latest, adequate management information systems for the on-going monitoring of accounts and transactions. In the course of developing these systems, banks should give particular attention to the effective monitoring of higher-risk customer accounts and transactions, which, by their nature, may be associated with money laundering. Furthermore, banks should not accept cash deposits in foreign currency notes in excess of $100.000 (one hundred thousand U.S. Dollars) or the equivalent in other foreign currency per calendar year from any person (resident or nonresident) or a group of connected persons. Such cash deposits should be accepted only with the prior written approval of the CBC. The PSMLAL requires that banks institute internal reporting procedures and that they identify a person (known as “the Money Laundering Compliance Officer”) to whom the bank’s employees should report their knowledge or suspicion of transactions/activities involving money laundering. The CBC’s Guidance Notes requires that the person so appointed should be sufficiently senior to command the necessary authority. The CBC’s Guidance Note requires that the banks’ Board of Directors and Senior Management establish an anti-money laundering program through the implementation of appropriate internal control procedures. In the course of an on-site examination for the evaluation of security and internal control systems, CBC examiners ensure that banks have established lines of communication both to management and to an internal security function for reporting problems. Banks are required to inform the CBC if they have any indication that they may face serious difficulties or become unable to meet their obligations; or if they are about to suspend payment or become aware of any material adverse change in their condition (Section 40 of the BL). Section 27 of the PSMLAL requires that any knowledge or suspicion of money laundering should be promptly reported to a police officer or MOKAS. The law also provides, under Section 26, that such a disclosure cannot be treated as a breach of the duty of confidentiality owed by banks to their customers by virtue of the contractual relationship existing between them. In case of bank employees, the PSMLAL recognizes, under Section 26, that internal reporting to the Money Laundering Compliance Officer will satisfy the reporting requirement imposed by virtue of Section 27, i.e., once a bank employee has reported his/her suspicion to the Money Laundering Compliance Officer, he or she is considered to have fully satisfied his/her statutory requirements under Section 27. The CBC is carrying out off-site monitoring and on-site examinations which aim at assessing banks’ compliance with their anti-money laundering obligations as set out in the law and the CBC’s Guidance Note. The CBC developed a special “examinations manual” for checking and evaluating banks’ internal control arrangements for money laundering prevention. As a result of the on-site examination, the CBC may issue to the bank concerned a letter with recommendations for corrective action in order to rectify weaknesses and strengthening controls in anti-money laundering procedures. Section 58(2)(a) of the PSMLAL authorizes the CBC to impose an administrative fine of up to £C3,000 to any person under their supervision who allegedly fails to take the preventive measures against money laundering prescribed in the law. The PSMLAL provides that the allegedly non-compliant person should first be given the opportunity to be heard before a Supervisory Authority determines the imposition of the administrative fine. Section 27(1) of the BL provides that the CBC may cooperate and exchange information with domestic and foreign banking, insurance, and securities market supervisory authorities in order to assist the discharge of its own or the other supervisory authorities’ functions and responsibilities. The said exchange of information and cooperation covers anti-money laundering matters as well. The CBC’s directive entitled “Framework for the Evaluation of Internal Control Systems” provides for putting in place mechanisms ensuring that all policies of a bank are enforced. Although not directly specified in this directive, some aspects related to ethics and professional behavior are indirectly addressed. Currently, the CBC is in the process of preparing and issuing a Directive on Corporate Governance, whereby the issue of having a policy statement on ethics and professional behavior will be explicitly addressed. The Council of the Institute of Certified Public Accountants of Cyprus also issued a number of guidance notes, the latest of which is a consolidated version dated November 2004. These notes are addressed to all accountants, auditors, and their staff. The Council of the Institute has been appointed by the Cyprus Government’s Council of Ministers in March 2000 as the supervisory authority for accountants and auditors in accordance with Section 59 of the Prevention and Supression of Money Laundering Activities Laws of 1966 to 2004.
Assessment	Compliant.
Comments	The CBC is commended for the efforts undertaken in order to strenghten the regulatory AML regime by issuing a number of Guidance Notes and by training efforts to increase the awareness and professionalism of the financial community for the prevention of money laundering. The mission has also noted the increase of the supervisory resources by two staff members and the increase of the number of on-site examinations during which the AML-procedures have been tested.
Principle 16.	On-Site and Off-Site Supervision An effective banking supervisory system should consist of some form of both on-site and off-site supervision.
Description	Section 26(2) of the BL requires that banks provide access to the CBC to all of their books, records, documentation, and other reports as necessary to carry out the supervision authority that is granted to it in Section 26(1). Section 25 requires the bank to provide a monthly statement of assets and liabilities to the CBC and empowers the CBC to require banks to periodically or at its request submit other reporting as it may specify. Complete access to such information, including information and reports generated by the bank’s internal and external auditors, provides the CBC with the ability to perform its supervisory function. Section 26 of the BL provides that any information received as part of the supervisory process must be kept confidential. Section 29 defines under what circumstances such information may be disclosed. The CBC exercises supervision in a twofold manner: on-site examination and off-site monitoring. The two modes of supervision complement one another. There are no material differences between the CBC’s supervision of domestic banks and its supervision of international banks. The specific scope of off-site monitoring and on-site examination for each bank is determined by each bank’s particular conditions and circumstances. The quality of internal audit work is assessed in order to determine the reliance that might be placed on it during the on-site examination. Both off-site monitoring and on-site supervision are performed by the same division, within the CBC, thereby integrating the framework of the two functions. The purpose of an on-site examination is to evaluate the condition of a bank and its future prospects at a given time, including providing verification that adequate risk management and controls are in place. In this respect, the following main areas are covered: a) the quality of the management of the bank by the directors and senior management, including internal controls and procedures, including internal audit; b) the bank’s loan portfolio, with emphasis on credit risk management, evaluation, and controls; the quality of the loan portfolio; and the adequacy of the provisions for bad and doubtful debts; c) the bank’s treasury operations with emphasis on risk management; d) the profitability of the bank, including the analysis of its income generation and costs and the assessment of the returns achieved; e) the compliance with the law, the conditions of the bank’s license, and the CBC Directives; regulations and instructions on capital adequacy; large exposures, etc.; and f) adherence to the requirements of the anti-money laundering legislation and guidance notes. CBC policy requires that on-site examinations be conducted annually for the domestic banks, annually for the subsidiaries of foreign banks, and every two years for the branches of foreign banks. However, due to the resource requirements necessary for the implementing of the EU Directives as part of the assession of Cyprus to the EU, the originally-planned examination schedule has been delayed. Now that this work is well underway, the CBC is confident that it can properly fully resume its planned on-site examination program. Special examinations may also be conducted, as necessary. The on-site examination findings are communicated to the bank’s management and discussed with the bank’s senior management in a meeting especially convened for this purpose. A management letter containing the on-site examination findings and conclusions is transmitted to bank senior management, and a response detailing corrective measures is required. Off-site monitoring involves the submission of various periodic prudential returns such as monthly balance sheet, profit and loss account, capital adequacy, prudential liquidity, large exposures and facilities to directors, foreign currency exposure, interest rate risk, anti-money laundering procedures, etc. Findings emerging in periodic prudential returns submitted by banks are analyzed, trended, and compared with other banks. This process enables the CBC to monitor the condition of banks as well as their compliance with the BL and other relevant prudential legislation and directives on an on-going basis. The accuracy of these returns is independently verified during the on-site examinations. The CBC supervisors, in the course of on-site examinations, assess the risk profile of each bank and, based on this assessment, on-site and off-site work is prioritized. For its international banks, the CBC has decided to adopt a risk-based approach in carrying out its supervisory activities. The main objectives are to allow the supervisors to focus on the banks that are confronted with higher risk and to allocate staff more efficiently. In the model adopted, risk elements are grouped into two major categories: Business Risks and the Control Risks. Based on this framework, the total Business and Control risks of each bank are assessed and a Total Business Risk Score/Total Control Risk Score map is created, indicating the position of each bank. In order to improve the model, the CBC has decided to review it once a year. In preparing its on-site examination program, the CBC considers three main factors: the positioning of each bank on the map, an ageing factor setting the maximum interval between two consecutive on-site examinations, and its knowledge of the bank based on the returns submitted; its ongoing contact with bank management; and the results of previous examinations. The CBC is in the process of designing and implementing a risk-based supervision methodology for the domestic banks. Bank examination report findings and conclusions as well as the analysis of periodic returns are reported to the governor of the CBC.
Assessment	Compliant.
Comments	Since no formal procedure is in place to assess the effectiveness of supervisory functions, the CBC may wish to consider establishing an internal quality control function within the Banking Supervision and Regulation Division to assess the effectiveness of its off-site and on-site supervisory activities and address any weaknesses identified.
Principle 17.	Bank Management Contact Banking supervisors must have regular contact with bank management and a thorough understanding of the institution’s operations.
Description	Section 28 of the BL requires that the CBC conduct a tri-lateral meeting with senior bank management and the bank’s external auditor at least annually to discuss matters of supervisory relevance that might arise in the audit, including relevant aspects of the bank’s business, its accounting and control systems, and its financial statements. Senior CBC officers conduct at least semi-annual meetings with senior bank management on matters of interest, including provisioning and financial performance results, and at the conclusion of on-site examinations, to discuss results and plans to correct identified deficiencies. Meetings with senior bank management are conducted during and subsequent to on-site examinations, and regarding matters that arise as a result of ongoing off-site monitoring. Off-site monitoring and on-site examination provides the CBC with frequent contact with and a thorough understanding of the bank and its management and operations. Visits of parent/head office senior management and internal auditors of foreign banks operating subsidiaries/branches in Cyprus offer further opportunity to understand the bank’s activities and operations. These and other meetings provide the CBC with the opportunity to evaluate management’s abilities and its performance. The evaluation of prospective management is also included in the CBC’s licensing process (see CP-3, above). in practice, the governor of the CBC also meets with all banks as a group at least semi-annually to discuss matters of general interest and changes in supervisory policy and practice. Section 40 of the BL requires banks to inform the CBC when it has any indication that it may face serious difficulties or if it is about to suspend payment on its obligations. Banks are also required by law to report any material changes in their circumstances. Information on changes in circumstances and other relevant information is also provided through the wide range of periodic prudential returns that are required.
Assessment	Compliant.
Comments	None.
Principle 18.	Off-Site Supervision Banking supervisors must have a means of collecting, reviewing, and analyzing prudential reports and statistical returns from banks on a solo and consolidated basis.
Description	Section 26(2) of the BL empowers the CBC to obtain from banks any information and with whatever frequency that it deems necessary. As a result, the CBC periodically obtains a wide range of information on banks’ financial condition and performance at regular intervals from both domestic and international banks. There are no restrictions to the CBC’s access to information about any aspect of the bank’s business and their related companies. Both domestic banks and international banks provide virtually the same information, as appropriate to their operations and activities, with the same frequency. The information is provided through a series of standardized returns supported by comprehensive instructions. The information provided through bank returns is verified during on-site examinations to determine if it’s accurate, properly classified, and in conformity with CBC instructions. Prudential returns include detailed information regarding on- and off-balance sheet assets and liabilities, profit and loss, capital adequacy, liquidity, large exposures, loan loss provisioning, market risk, and deposit-related matters at a frequency commensurate with the nature of the information. Specific details about the loan classifications performed by the banks themselves are not disclosed in the standardized reports; this information is collected, assessed, and analyzed during the on-site examinations carried out by the examiners of the CBC. The CBC also requires submission of copies of the management letter from the bank’s external auditor and the minutes of the Audit Committee of its Board of Directors. Section 42 of the BL provides for a range of monetary penalties for failure to provide requested information within specified time limits, knowingly or negligently providing inaccurate or misleading information, or knowingly or negligently providing incomplete information. The internal auditors of banks are required to submit reports to the CBC every 18 months on the results of their activities. The external auditors of international banks must submit reports on the bank’s compliance with any conditions of their license; a reconciliation of any differences between the information provided on returns to the CBC and audited financial statements; the adequacy of internal controls; the correctness/adequacy of information that the local operations provide to their parent/head office, and the adequacy of provisioning. International banks must also provide the CBC with copies of internal audit reports prepared on local operations by their parent/head office. Section 24 of the BL requires that banks produce annual audited financial statements and also allows the CBC to prescribe the manner and form in which accounts must be prepared. The CBC has issued directives specifying the content of financial statements and the manner in which they must be presented. The CBC in its directives has adopted International Accounting Standards. With regard to the audit of bank annual financial statements, Section 24 of the BL also requires that the audit of banks be carried out in accordance with International Auditing Standards and any additional requirements specified by the CBC. International Accounting Standards have been used in Cyprus since 1981 through the action of the Institute of Certified Public Accountants of Cyprus (the regulatory body for accountants/auditors) to require auditors to state in their audit report that the financial statements of the audited company have been prepared in accordance with the International Accounting Standards. Furthermore, through an amendment to the Companies Law in 2003, legal backing has been given to the International Accounting Standards implementation, which is compulsory for all companies, including banks, incorporated in Cyprus. The auditors’ report is required to state that the audit has been carried out in accordance with International Auditing Standards. All statistical and prudential reports filed with the CBC, are processed and analyzed. The conclusion of this analysis forms part of various internal reports that identify compliance or not with rules and regulations, and highlight intra-market comparisons and trends, with a view to prompting further action by the CBC. This information is readily available to all supervisors who are required to utilize it for planning future on-site visits to the banks. This reporting forms part of the CBC’s comprehensive information system. This analysis, along with the results of on-site examinations and information acquired through meetings with bank officials, provides the basis for the CBC’s early identification of potential problems, difficulties, and trends in banks, although there is, as yet, no formal early warning system in place.
Assessment	Compliant.
Comments	The CBC may wish to consider developing and implementing a more formal, comprehensive early warning system to provide timely alerts to prospective issues affecting individual banks, groups of banks, or the system as a whole. Such a system may permit the CBC to more easily set supervisory priorities and to react more timely and adquately to identified issues.
Principle 19.	Validation of Supervisory Information Banking supervisors must have a means of independent validation of supervisory information either through on-site examinations or use of external auditors.
Description	On-site examinations are conducted annually for the domestic banks, annually for the Cyprus subsidiaries of foreign banks, and every two years for the Cyprus branches of foreign banks. Examinations of foreign subsidiaries and branches of Cyprus banks are conducted annually for operations in Greece and every two years for operations in other countries when they are material (i.e., more than 5 percent of the total balance sheet assets of the entity of which it is a part). Special examinations may also be conducted. Pursuant to Section 26 of the BL, the CBC has the legal right of full access to all bank records for the furtherance of supervisory work. The information provided through bank returns is verified during on-site examinations to determine if its accurate, properly classified, and in conformity with CBC instructions. The CBC maintains a coherent process for planning and executing these on-site examinations. The same process is applied to the on-site examinations of all banks, both domestic and international. The criteria used by the CBC for the planning and executing of on-site examinations are: (a) the relative size of the banking operation; (b) the annual growth rate of the operation; (c) the relative contribution of the operation to the group as a whole; (d) the results of off-site review monitoring and analysis; (e) any special issues; and (f) the availability of resources. Section 26 of the BL provides that the CBC examiners may be assisted in the course of their work by a duly qualified person nominated for this purpose by the CBC provided that this person shall be bound by the same requirements regarding confidentiality as those applicable to the CBC officials. This would permit external auditors to assist, as necessary, in on-site examinations and to be commissioned by the CBC to perform special work for it in the banks. The auditing and accounting profession in Cyprus is well developed and professionally independent and operates within the international auditing and accounting standards framework. Section 28 of the BL provides that the CBC will arrange, at least once a year, tri-lateral meetings with each bank and its auditors to discuss matters relevant to the CBC’s supervisory responsibilities that arise in the course of the audit of all banks. The CBC is also entitled to hold bi-lateral meetings with external auditors, to the exclusion of the bank concerned, if the CBC considers such a meeting necessary for the protection of the bank’s depositors. Under the same section of the BL, the external auditors may freely report to the CBC any information that is relevant to its supervisory responsibilities. The BL protects the auditor from the consequences of any breach in his duty of confidentiality by providing that no duty of confidentiality to which an auditor of a bank may be subject will be regarded as contravened by reason of his communication in good faith to the CBC, whether or not it is responding to a request made by the CBC, any information or opinion which is relevant to the CBC’s functions and responsibilities under the BL. The CBC has issued a notice to the banks on the relation between the CBC and the external auditors of banks. The purpose of this notice is to provide the guidelines for the arrangements of tri-partite meetings between the CBC, the banks, and their external auditors and give a general description of the situations and conditions under which the CBC may invite the auditors of banks to bi-lateral meetings in accordance with Section 28(2) of the BL. Section 24 of the BL requires that each bank, at the end of its business year, provide the CBC with a copy of its consolidated balance sheet and profit and loss account for that year, duly certified by an approved external auditor. Section 2 of the BL requires that the external auditors of banks be approved by the CBC; in practice, banks are audited by local offices of the big four accounting/auditing firms. In addition to the tri-lateral meetings between the CBC, the banks, and their external auditors, the CBC regularly holds meetings with the banks’ management and/or board of directors to discuss all matters pertaining to the operations of the bank and, particularly, all issues identified during the on-site examinations and off-site surveillance conducted by the CBC.
Assessment	Compliant.
Comments	None.
Principle 20.	Consolidated Supervision An essential element of banking supervision is the ability of the supervisors to supervise the banking group on a consolidated basis.
Description	Section 39 of the BL permits the CBC to determine that the holding company and any of the subsidiaries of the bank and of its holding company will be deemed to be a bank for the purposes of the BL, as may be specified by the CBC, whereupon the relevant provision or provisions will apply to any such company either singly or on a consolidated basis. The CBC practices consolidated supervision. In this regard, the CBC has exercised its power under Section 39 of the BL and has extended its supervision to all bank subsidiaries carrying out banking-related activities, as defined in Section 13 of the BL. Thus, the CBC requires bank subsidiaries that carry out banking-related activities to be consolidated on a worldwide basis. Within the scope of consolidated supervision, the CBC obtains information on the nature of activities of non-banking related subsidiaries as well as the level of their assets, liabilities, and profitability. The CBC may require the holding company to take any action relating to non-bank subsidiaries, as it may deem necessary. Moreover, the investment in non-banking related subsidiaries, including lending of a capital nature to such subsidiaries, is deducted from the consolidated capital base of the group. There are no obstacles to direct or indirect supervision of bank subsidiaries or affiliates that carry out banking-related activities as defined in section 13 of the BL. The CBC conducts on-site examinations of material subsidiaries carrying on banking or banking-related activities. The condition of non-material subsidiaries is monitored and assessed through the submission of periodic returns. The CBC is empowered to impose any prudential standards on a consolidated basis. In this respect, the CBC Directives on capital adequacy, large exposures, and foreign currency exposure apply on a consolidated basis. The CBC requires that each bank submit audited consolidated financial statements annually. Pursuant to Section 27 of the BL, the CBC may co-operate and exchange information with the competent banking and/or insurance and/or securities markets supervisory authorities whether in Cyprus or elsewhere. To this end, the CBC has signed an MOU with local securities, insurance, and cooperatives societies supervisory authorities and MOUs with foreign supervisory authorities in the financial sector. In this context, the CBC receives and shares information on the financial condition and risk management of such companies. Section 7 of the BL provides that banks must obtain the prior approval of the CBC to establish business outside of Cyprus. The CBC may impose conditions on such establishments. Moreover, Section 13 of the BL imposes limits on the investments of banks in the capital of other companies. The CBC exercises this power to limit the expansion of banks overseas so as to ensure that banks possess adequate financial resources to conduct such operations. Periodic on-site examinations are conducted at the bank’s overseas locations. Section 39 of the BL provides that the holding company and any of the subsidiaries of a bank shall be deemed to be a bank for the purpose of any of the provisions of the BL. Thus, the CBC is empowered to impose standards and measures, including remedial action, on the non-banking subsidiaries and/or holding company of a bank. Also under Section 39 of the BL, the holding company of a bank may be deemed by CBC to be a bank and, consequently, the provisions of Sections 17 and 18 of the BL regarding the fitness and propriety of owners and senior management of a bank holding company apply to these persons.
Assessment	Compliant.
Comments	None.
Principle 21.	Accounting Standards Banking supervisors must be satisfied that each bank maintains adequate records drawn up in accordance with consistent accounting policies and practices that enable the supervisor to obtain a true and fair view of the financial condition of the bank and the profitability of its business, and that the bank publishes on a regular basis financial statements that fairly reflect its condition.
Description	Any bank that fails to provide requested financial information within specified time limits, knowingly or negligently provided inaccurate data or misleading information, knowingly or negligently made available in an incomplete form, records, books, accounts, or other information is subject to an administrative fine (Section 42 of the BL). The BL provides that where an offense is committed as a result of an infringement of the provisions of this law, by a bank or by an organisation of persons incorporated or unincorporated, then any director, chief executive, manager, partner or other officer or employee of the bank or of the organization, who authorizes or knowingly permits such infringement shall be guilty of an offense and in case of conviction shall be liable to penalties provided in the BL, depending on the provisions infringed. Every bank should, within four months from the end of each financial year, submit to the CBC a copy of the balance sheet and profit and loss account for that year in the form prescribed by the CBC, duly certified by an approved auditor, together with a signed copy of his report in the form prescribed by the CBC. Branches of foreign incorporated banks are not required to publish their financial statements. The CBC Directive on the framework for the evaluation of internal control systems requires banks to maintain comprehensive and reliable financial reporting to ensure the accurate and timely disclosure of the bank’s financial position and the production of reliable financial statements. In this respect, information from bank records, such as prudential returns submitted to the CBC, is verified periodically in the course of on-site examination. The CBC has issued a notice on the relationship between the CBC and the external auditors of banks. The purpose of the above notice is to: a) Provide the guidelines for the arrangements of tripartite meetings between the CBC, the banks and their external auditors; and b) Give a general description of the situations, and the conditions under which the CBC may invite the auditors of banks to bilateral meetings in accordance with Section 28(2) of the BL. The CBC aims at the creation of a constructive relationship with the external auditors of banks, through the medium of which there will be such an exchange of information so as to facilitate the supervisory activity of the CBC, as this arises from the provisions of the BL. This relationship consists of: a) Tri-partite meetings with the external auditors of each bank during which the following will be discussed: (i) the balance sheet and the profit and loss account for each year, copies of which each bank is obligated [under Section 24(1) of the BL] to submit to the CBC, in a form to be determined by the CBC, within four months from the end of the financial year; (ii) the report of the external auditor that has to be submitted with (i) above, in a form to be determined by the CBC; (iii) matters arising from the audit work of the external auditors in relation to (i) and (ii) above. (b) bilateral meetings with the external auditors of a bank, either with the knowledge of the bank concerned or not, whenever this is considered desirable or necessary by the CBC, in the interests of depositors, in accordance with Section 28(2) of the BL. The CBC is authorized to set accounting standards for banks provided that the CBC is guided in this respect by international practice and the EU directives. To this effect, the CBC has issued a directive on the layout and content of annual accounts of banks, which requires compliance with international accounting standards modified as necessary to comply with EU directives. Chapter 4 of the CBC’s Directive on the layout and content of annual accounts, entitled valuation rules, describes in detail the supervisory requirements for banks to utilize valuation rules that are consistent, realistic, and prudent, taking into account values where relevant. Moreover, International Accounting Standards that have been adopted in Cyprus since 1981 through the action of the Institute of Certified Public Accountants of Cyprus (the regulatory body for accountants/auditors) require auditors to state in their audit report that the financial statements of the audited company have been prepared in accordance with the International Accounting Standards. Furthermore, through an amendment to the Companies Law in 2003, legal backing has been given to the International Accounting Standards implementation, which is compulsory for all companies, including banks, incorporated in Cyprus. The confidential character of the financial information gathered by the CBC is legaly enforced by the BL [Sections 17(4) and 18]. The external auditors of banks, prior to their appointment, are required to be expressly authorized by the CBC (Sections 2 and 24 of the BL). In practice, most banks are audited by the big four international firms of accountants/auditors. The CBC relies on its own experienced bank supervisory staff for the conduct of on-site examination and does not generally need to employ the services of external auditors at the present time, although section 26(2) of the BL would permit the CBC to use duly qualified persons, as necessary. There are no supervisory requirements in respect of the scope and conduct of audit programs as the CBC is not legally empowered to set standards for external audit review. However, as mentioned above, external auditors are required to conduct their audits in accordance with the International Auditing Standards. Section 28 of the BL provides that auditors may freely report to the CBC any information which is relevant to the latter’s supervisory responsibilities. The BL protects the auditor from the consequences of any breach in his duty of confidentiality, by providing that no duty of confidentiality to which an auditor of a bank may be subject shall be regarded as contravened by reason of his communication in good faith to the CBC, whether or not to a request made by the CBC, any information or opinion which is relevant to the CBC’s functions and responsibilities under the BL. The CBC has issued a notice on the relationship between the CBC and the external auditors of banks. This notice provides, inter alia, that the external auditors are expected to report to the CBC matters of material significance or matters which may be of material significance to the latter’s supervisory functions or responsibilities.
Assessment	Compliant.
Comments	It must be noted that external auditors do not have a legal duty to report to the CBC on matters of material significance. But, the tri-partite and bi-partite meetings described above, as well as mandatory transmission by the external auditors to the CBC of their written communciations with the banks on matters of material significance, do seem to provide a valuable communication system. However, Cyprus may consider amending the BL to introduce a mandatory duty for auditors to report matters of material significance to the supervisor, as provided for in the pertinent EU Directive.
Principle 22.	Remedial Measures Banking supervisors must have at their disposal adequate supervisory measures to bring about timely corrective action when banks fail to meet prudential requirements (such as minimum capital adequacy ratios), when there are regulatory violations, or where depositors are threatened in any other way. In extreme circumstances, this should include the ability to revoke the banking license or recommend its revocation.
Description	Section 30 of the BL provides the CBC with extensive remedial powers where a bank fails to comply with any of the provisions of the BL, including power to require the bank to take such action as the CBC may consider necessary to rectify the matter, the power to prohibit the acceptance of deposits or the granting of credit facilities by the bank, or both; both assume control of the business of a bank and revoke the bank’s license. Section 42 of the BL empowers the CBC to impose administrative fines if a bank fails to provide information to the bank within specified time limits. Other offenses and penalties are covered in detail in Sections 42 and 44. Administrative penalties have been imposed on numerous occasions. Where an offense is committed as a result of an infringement of the provisions of the BL, by a bank or by an organization of persons incorporated or unincorporated, then any director, chief executive, manager, partner or other officer or employee of the bank or of the organization, who authorizes or knowingly permits such infringement shall be guilty of an offense and, in case of conviction, shall be liable to the penalties provided in subsections 43(1) or 43(2) of the Banking Law depending on the provisions infringed. Pursuant to Section 30(2) of the BL the CBC shall, before taking any remedial measure, furnish a report to the bank inviting its comments thereon within a specified period, which should not be less than three days from the date of delivery of the report.
Assessment	Compliant.
Comments	None.
Principle 23.	Globally Consolidated Supervision Banking supervisors must practice global consolidated supervision over their internationally active banking organizations, adequately monitoring and applying appropriate prudential norms to all aspects of the business conducted by these banking organizations worldwide, primarily at their foreign branches, joint ventures, and subsidiaries.
Description	Pursuant to Section 13 of the BL, banks are not allowed to extend their direct or indirect operations outside Cyprus without obtaining the prior written approval of the CBC. The CBC makes its approval conditional upon the on-going availability of information from the overseas operation, including the ability to carry out on-site examinations and to exercise consolidated supervision. On-site and off-site supervision of overseas operations of Cyprus-incorporated banks has been routinely carried out for many years. In the course of an on-site examination, the CBC inspectors determine that the bank maintains proper oversight of its foreign operations by examining the following: (a) the centralization of credit control and internal audit; (b) the identification, measurement, control, and monitoring of risks on a global consolidated basis at head office level; (c) the monitoring of the overseas operations through the regular submission of returns to head office; (d) the credit review by head office of foreign operations; and (e), the involvement of head office management in strategic decision-making. In the course of on-site examinations, the CBC inspectors establish that bank management’s oversight includes: a) information reporting on its overseas operations that is adequate in scope and frequency and is periodically verified; (b) assessing in an appropriate manner compliance with internal controls; and (c) ensuring effective local oversight of foreign operations. The CBC places special emphasis on the foreign operations of domestic banks by requiring senior management to closely monitor and control risks undertaken on a global basis. Pursuant to its authority under Section 7 of the BL, if the CBC is not satisfied that the bank maintains proper oversight of its foreign operations, it may amend or impose additional conditions on the foreign operation’s license. In extreme cases, if the need arises, the CBC may revoke the approval. Section 30 of the BL confers upon the CBC a range of powers to take measures to address prudential and compliance issues arising from the supervision of foreign operations of Cyprus banks. On-site examinations of overseas subsidiaries/branches of Cyprus-incorporated banks are planned and executed by the CBC as follows: annually for banks with operations in Greece and every two years for banks with operations in the United Kingdom and Australia. The CBC may also conduct ad hoc on-site examinations if and when the need arises in relation to special issues. Meetings with local supervisors are arranged during the on-site examinations for overseas subsidiaries/branches of Cyprus-incorporated banks. The assessment of host country supervision is carried out in the spirit and letter of the MOUs signed and in the course of on-site examinations, the findings of which are discussed with host supervisors.
Assessment	Compliant.
Comments	None.
Principle 24.	Host Country Supervision A key component of consolidated supervision is establishing contact and information exchange with the various other supervisors involved, primarily host country supervisory authorities.
Description	Section 27(1) of the BL permits the CBC to cooperate and exchange information with competent banking and/or insurance and/or securities markets supervisory authorities, whether in Cyprus or elsewhere, including member states of the EU, in order to assist these supervisory authorities in the discharge of their functions and responsibilities or to enable the effective exercise of their functions, including consolidated supervision. Section 27(4) prescribes that any exchange of information will only take place when the CBC is satisfied that the information provided is subject to the same confidentiality rules in the hands of the receiving competent supervisory authority as apply to the CBC. Section 27(5) prescribes that where the information received by the CBC originates in another member state of the EU, it may not be disclosed without the express agreement of the competent authorities that have disclosed it and, where appropriate, solely for the purposes for which those authorities gave their agreement. MOUs have already been signed or are in process of negotiation with a number of overseas supervisors, including the United Kingdom, Lebanon, and Ireland, where Cyprus-incorporated banks have overseas operations. The MOUs include statements on the scope of information to be exchanged and stipulate details on the cooperation regarding on-site examinations in the host country, and the confidentiality of the information received from the other supervisory authority. Consequently, the MOUs facilitate the close cooperation and exchange of information between the CBC and other overseas banking supervisory and regulatory authorities in the discharge of their functions and responsibilities, including the overall framework of supervision in which a banking group operates, and, to the extent appropriate, concerning significant problems arising in the head office or in the group as a whole. In practice, there is close and frequent contact with host country supervisors. The CBC cooperates and exchanges information with all foreign supervisory authorities in jurisdictions in which Cyprus-incorporated banks operate subsidiaries and branches, regardless of their significance. Pursuant to Section 13 of the BL, banks are not allowed to extend their direct or indirect operations outside Cyprus without obtaining the prior written approval of the CBC. In this regard, the CBC is empowered to prohibit banks or their affiliates from establishing operations in countries with secrecy laws or other regulations prohibiting flows of information deemed necessary for adequate supervision. The CBC makes its approval 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. On-site examination and off-site supervision of overseas operations of Cyprus-incorporated banks has been routinely carried out for many years by the CBC.
Assessment	Compliant.
Comments	None.
Principle 25.	Supervision Over Foreign Banks’ Establishments Banking supervisors must require the local operations of foreign banks to be conducted with the same high standards as are required of domestic institutions and must have powers to share information needed by the home country supervisors of those banks for the purpose of carrying out consolidated supervision.
Description	Cyprus branches and subsidiaries of foreign-incorporated banks are subject to the same prudential inspection and regulatory reporting requirements as Cyprus-incorporated banks. No differences exist in the regulatory regime for Cyprus-incorporated banks and Cyprus branches/subsidiaries of foreign-incorporated banks. However, branches of foreign banks are exempted from own capital and capital adequacy requirements; consequently, capital-based restrictions (e.g., large exposures limitations) are not applicable and are left to the home country supervisory authority to monitor. With regard to the licensing process as well as for ongoing supervision, applicant banks are required to submit to the CBC a “Letter of Authorization,” which enables the CBC to approach and exchange information with the home supervisory or regulatory authority of the applicant’s parent institution. In this respect, the CBC approaches the home country licensing and supervisory/regulatory authority of the applicant bank’s parent institution directly and obtains, inter alia, its written consent authorizing the proposed establishment, as well as an undertaking that, in circumstances under which that authority is warranted to act as the group’s consolidating supervisor/regulator, it will exercise consolidated supervision equivalent to that provided in the EU over the global activities of the parent institution, including the operations proposed to be carried out by the prospective subsidiary/branch in Cyprus. Section 27(1) of the BL permits the CBC to cooperate and exchange information with competent banking and/or insurance and/or securities markets supervisory authorities, whether in Cyprus or elsewhere, including member states of the EU, in order to assist these supervisory authorities in the discharge of their functions and responsibilities or to enable the effective exercise of their functions, including consolidated supervision. Section 27(4) prescribes that any exchange of information will only take place when the CBC is satisfied that the information provided is subject to the same confidentiality rules in the hands of the receiving competent supervisory authority as apply to the CBC. Section 27(5) prescribes that where the information received by the CBC originates in another member state of the EU, it may not be disclosed without the express agreement of the competent authorities that have disclosed it and, where appropriate, solely for the purposes for which those authorities gave their agreement. MOUs have already been signed or are in process of negotiation with a number of overseas supervisors. The MOUs include statements on the scope of information to be exchanged and stipulate details on the cooperation regarding on-site examinations in the host country and the confidentiality of the information received from the other supervisory authority. Consequently, the MOUs facilitate the close cooperation and exchange of information between the CBC and other overseas banking supervisory and regulatory authorities in the discharge of their functions and responsibilities, including the overall framework of supervision in which a banking group operates, and, to the extent appropriate, concerning significant problems arising in the head office or in the group as a whole. In practice, there is close and frequent contact with home country supervisors. The CBC cooperates and exchanges information with all foreign supervisory authorities from jurisdictions whose banks operate subsidiaries and branches in Cyprus, regardless of their significance. The CBC permits home country supervisors of banks operating subsidiaries and branches in Cyprus to conduct on-site examinations and meets with the foreign supervisory authorities to discuss the examination results. Over the years, many home supervisory authorities have conducted on-site examinations of branches and subsidiaries in Cyprus pursuant to their primary or consolidated supervisory responsibility.
Assessment	Compliant.
Comments	None.

Table 2.

Summary Compliance of the Basel Core Principles (CBC)

^1/C: Compliant.

^2/LC: Largely compliant.

^3/MNC: Materially non-compliant.

^4/NC: Non-compliant.

^5/NA: Not applicable.

Table 2.

Summary Compliance of the Basel Core Principles (CBC)

Core Principle	C1/	LC2/	MNC3/	NC4/	NA5/
1. Objectives, Autonomy, Powers, and Resources
1.1 Objectives	X
1.2 Independence		X
1.3 Legal framework	X
1.4 Enforcement Powers	X
1.5 Legal Protection	X
1.6 Information Sharing	X
2. Permissible Activities	X
3. Licensing Criteria	X
4. Ownership	X
5. Investment Criteria	X
6. Capital Adequacy	X
7. Credit Policies	X
8. Loan Evaluation and Loan-Loss Provisioning		X
9. Large Exposure Limits	X
10. Connected Lending	X
11. Country Risk		X
12. Market Risks		X
13. Other Risks	X
14. Internal Control and Audit	X
15. Money Laundering	X
16. On-Site and Off-Site Supervision	X
17. Bank Management Contact	X
18. Off-Site Supervision	X
19. Validation of Supervisory Information	X
20. Consolidated Supervision	X
21. Accounting Standards	X
22. Remedial Measures	X
23. Globally Consolidated Supervision	X
24. Host Country Supervision	X
25. Supervision Over Foreign Banks’ Establishments	X

^1/C: Compliant.

^2/LC: Largely compliant.

^3/MNC: Materially non-compliant.

^4/NC: Non-compliant.

^5/NA: Not applicable.

View Table

Table 2.

Summary Compliance of the Basel Core Principles (CBC)

Core Principle	C1/	LC2/	MNC3/	NC4/	NA5/
1. Objectives, Autonomy, Powers, and Resources
1.1 Objectives	X
1.2 Independence		X
1.3 Legal framework	X
1.4 Enforcement Powers	X
1.5 Legal Protection	X
1.6 Information Sharing	X
2. Permissible Activities	X
3. Licensing Criteria	X
4. Ownership	X
5. Investment Criteria	X
6. Capital Adequacy	X
7. Credit Policies	X
8. Loan Evaluation and Loan-Loss Provisioning		X
9. Large Exposure Limits	X
10. Connected Lending	X
11. Country Risk		X
12. Market Risks		X
13. Other Risks	X
14. Internal Control and Audit	X
15. Money Laundering	X
16. On-Site and Off-Site Supervision	X
17. Bank Management Contact	X
18. Off-Site Supervision	X
19. Validation of Supervisory Information	X
20. Consolidated Supervision	X
21. Accounting Standards	X
22. Remedial Measures	X
23. Globally Consolidated Supervision	X
24. Host Country Supervision	X
25. Supervision Over Foreign Banks’ Establishments	X

^1/C: Compliant.

^2/LC: Largely compliant.

^3/MNC: Materially non-compliant.

^4/NC: Non-compliant.

^5/NA: Not applicable.

18. The CCIs have heretofore been subject to fewer regulations; however, the need to be in line with EU banking directives requires that all credit cooperatives sharply improve their prudential ratios by end-2007. A number of CCIs will comply on an individual basis; the remaining CCIs will comply by affiliating themselves with the CCB and by meeting the prudential requirements on a consolidated basis. The assessment therefore evaluates supervision for the commercial banks (whether domestic or international) separately from that of credit cooperatives (see Tables 1 and 2).

D. General Preconditions for Effective Banking Supervision

19. The preconditions for effective banking supervision in Cyprus are generally in place. Currently, there are no macroeconomic vulnerabilities and risks that could have implications for the effectiveness of prudential safeguards or the stability of the financial system. The public infrastructure provides for an environment that fosters the honoring and enforcement of financial contracts.

20. There is a comprehensive set of laws, which governs the financial sector. These laws are supported by a body of professional lawyers and judges. The court system is efficient. Cyprus has adopted both International Accounting Standards and International Auditing Standards. The supervision of other financial sectors and markets is generally efficient. There has been no evidence of government efforts to influence lending operations. There is a deposit insurance program in place. The financial services regulators have a process in place to address distressed financial institutions.

E. Principle by Principle Assessment—Central Bank of Cyprus

F. Recommended Action Plan and Authorities’ Response to the Assessment Recommended action plan

Table 3.

Recommended Action Plan to Improve Compliance of the Basel Core Principles (CBC)

Table 3.

Recommended Action Plan to Improve Compliance of the Basel Core Principles (CBC)

Reference Principle	Recommended Action
CP 1.2 Independence	Additional qualified supervision staff is needed.
CP 8 Loan Evaluating and Loan Loss Provisioning	Finalize implementation of the more stringent criteria for interest suspension.6
CP 11 Country Risk	Establish formal guidance for a framework for country and transfer risk.
CP 12 Market Risks	Improve interest rate risk expertise expertise and supervision.

View Table

Table 3.

Recommended Action Plan to Improve Compliance of the Basel Core Principles (CBC)

Reference Principle	Recommended Action
CP 1.2 Independence	Additional qualified supervision staff is needed.
CP 8 Loan Evaluating and Loan Loss Provisioning	Finalize implementation of the more stringent criteria for interest suspension.6
CP 11 Country Risk	Establish formal guidance for a framework for country and transfer risk.
CP 12 Market Risks	Improve interest rate risk expertise expertise and supervision.

Authorities’ response to the assessment

The CBC welcomes the assessors’ recognition of the overall quality and effectiveness of Cyprus’s banking regulatory and supervisory framework in place and the resulting very high degree of compliance with the Basel Core Principles.

Following is the CBC’s Action Plan to address the specific recommendations cited in the report:

Reference Principle	Planned Action
CP 1.2 Independence	The CBC aims at taking all necessary steps to strengthen its Banking Supervision and Regulation Division in all aspects, in order to meet the increased demands emerging from Cyprus’s accession to the EU and the development and innovation process of the banking sector.
CP 8 Loan Evaluating and Loan Loss Provisioning	The CBC has issued, in December 2005, a new “Directive on the suspension of interest and other income on non-performing credit facilities” which took effect on 1st of January, 2006 and by which the 90-days rule has been applied in full conformity with international practice..
CP 11 Country Risk	The CBC shall proceed with the drafting of guidelines to banks for the management of country and transfer risk in the near future.
CP 12 Market Risks	Although the level of activities of banks in Cyprus which can generate market risk remains low, the CBC aims at enhancing the scope of its supervision to ensure that banks perform scenario analysis, stress testing and contingency planning, as appropriate, and periodic validation or testing of the internal systems/models used to measure market risk as provided in the EU Capital Requirements Directive, which shall come into force on the 1st January, 2007. Market risk expertise shall be enhanced by additional training provided by th+e Financial Stability Institute of the Bank of International Settlements as well the supervisory authorities of other EU countries such as the UK, France, Germany and the Netherlands, to specialised staff of the Banking Supervision and Regulation Division of the CBC.

View Table

Reference Principle	Planned Action
CP 1.2 Independence	The CBC aims at taking all necessary steps to strengthen its Banking Supervision and Regulation Division in all aspects, in order to meet the increased demands emerging from Cyprus’s accession to the EU and the development and innovation process of the banking sector.
CP 8 Loan Evaluating and Loan Loss Provisioning	The CBC has issued, in December 2005, a new “Directive on the suspension of interest and other income on non-performing credit facilities” which took effect on 1st of January, 2006 and by which the 90-days rule has been applied in full conformity with international practice..
CP 11 Country Risk	The CBC shall proceed with the drafting of guidelines to banks for the management of country and transfer risk in the near future.
CP 12 Market Risks	Although the level of activities of banks in Cyprus which can generate market risk remains low, the CBC aims at enhancing the scope of its supervision to ensure that banks perform scenario analysis, stress testing and contingency planning, as appropriate, and periodic validation or testing of the internal systems/models used to measure market risk as provided in the EU Capital Requirements Directive, which shall come into force on the 1st January, 2007. Market risk expertise shall be enhanced by additional training provided by th+e Financial Stability Institute of the Bank of International Settlements as well the supervisory authorities of other EU countries such as the UK, France, Germany and the Netherlands, to specialised staff of the Banking Supervision and Regulation Division of the CBC.

G. Principle by Principle Assessment—Cooperative Societies’ Supervision and Development Authority

Table 4.

Detailed Assessment of Compliance with the Basel Core Principles (CSSDA)

Table 4.

Detailed Assessment of Compliance with the Basel Core Principles (CSSDA)

Principle 1.	Objectives, Autonomy, Powers, and Resources An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks. Each such agency should possess operational independence and adequate resources. A suitable legal framework for banking supervision is also necessary, including provisions relating to the authorization of banking establishments and their ongoing supervision; powers to address compliance with laws, as well as safety and soundness concerns; and legal protection for supervisors. Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Principle 1(1)	An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks.
Description	There are 358 cooperative credit institutions (“CCI”) with limited or unlimited liability and 104 non-credit limited liability cooperatives. They operate in various sectors (banking, consumer, trading of agricultural products and services), and are shareholders-members of the Cooperative Central Bank (CCB). The CCIs have as their main objective the extension of credit and the provision of services to their members in accordance with the cooperative principles of mutual help and assistance. The activities and supervision of the 358 CCIs are regulated according to the contents of the Cooperative Societies Laws of 1985 to 2004 (“CSL”), by their own supervisory authority—the Cooperative Societies Supervision and Development Authority (“CSSDA”). However, the CCB, being the apex of the cooperative movement (CM) in Cyprus, has a dual status for it is also a bank for the purposes of the Banking Law (“BL”) and is therefore supervised by the Central Bank of Cyprus (CBC), as well as the CSSDA. It acts as the banker to the CCIs by accepting their surplus funds as deposits, granting loans to those CCIs in need of liquidity and delivering general support services. The locus of lender-of-last-resort responsibilities of the CCB is generally governed by Article 26 of the CSL, and it will be regulated in detail by the Committee of the CSSDA according to Article 94 of the Cooperative Societies Rules of 1985 to 2004, that authorizes the committee to issue further detailed prudential instructions on the matter. According to article 41D of the CSL the Commissioner of the CSSDA is responsible for the supervision of the CCIs and the application of the CSL. Part VI A of the CSL provides a framework of minimum prudential standards addressing issues such as: licensing conditions; minimum capital; capital adequacy ratio; organizational and management requirements (“four-eyes” principle, fit-and-proper character); shareholder requirements; exposure restrictions; connected lending limits; prudential reporting; on-site examinations; administrative sanctions; remedial measures. Section 44 of the CSL authorizes the commissioner to decide on the winding up of a CCI and to nominate a liquidator to that effect. The audit of the accounts and the financial management of the individual CCIs is performed by the Audit Office of Cooperative Societies (“AOCS”), which is an independent legal entity established by Section 19.1 of the CSL and whose audit costs are covered by the examined CCIs by means of annual fees. The AOCS, which also audits the other non-credit cooperative institutions is administered by a committee composed of five members appointed by the Council of Ministers for a term of three years. At present, usually, the committee is chaired by the Auditor General of Cyprus. The auditor general also audits the financial statements of the CBC and performs the audit of the CSSDA. The CCIs have been operating in a relatively stable social and economic environment. There has been no need for implementing major structural changes since the division of the CM (into Turkish-Cypriot and Greek-Cypriot CMs) by the then British-Colonial Authorities almost half a century ago. In 1987, the audit function for the CCIs was separated from the supervisory function with the establishment of the AOCS. However, the negotiations with the EU have introduced a process of change, which led to the harmonization of policies and legislation with the EU standards and Banking Directives (BD). A five-year transitional period as from January 1, 2003 has been agreed upon by the EU within which all CCIs will be compliant with the BD. In this context, the CSL has been modified in 2003 and 2004 in order to ensure full conformity with the acquis communautaire. A two-layered approach will be followed with a number of CCIs complying individually on a stand-alone basis with the remaining CCIs complying by becoming affiliates of the CCB (called the “Central Body”). However, any conforming CCI can also join the permanent affiliation arrangement if it so wishes. The Central Body arrangements will be introduced within the context of the permanent affiliation arrangements set out in Article 2, paragraph 5 of the BD 2000/12/EC where the CCB, as the “Central Body,” and the affiliated CCIs will have to satisfy the provisions on a consolidated basis. The supervisory framework of the affiliated CCIs will be as follows: the affiliated CCIs will be supervised by their own supervisory authority (the CSSDA) as stated in Section 41D of the CSL; simultaneously, and according to Section 35 of the Banking Law (BL), the affiliated CCIs are subject to the provisions of the BL to the extent that this is considered necessary for the CBC to exercise supervision on a consolidated basis. Therefore, the CSSDA will have to provide the CBC with all the necessary data and information regarding affiliated CCIs and will participate in joint on-site examinations of the affiliated CCIs. On the other hand, the CCB, being the Central Body of the affiliated CCIs, is empowered to supervise these affiliated CCIs explicitly and only for the purposes of the permanent affiliation arrangements and in accordance with the provisions of the BD. The CCB/Central Body has no authority to perform prudential supervision but will have the power to monitor their solvency and liquidity as well as to issue compulsory instructions to the affiliated CCIs that would include concrete management issues covering administrative, organizational, and operational areas (e.g., internal audit, risk management, credit policy, etc.). These instructions to be issued by the Central Body to the affiliated CCIs will: lay down the main principles by applying generally accepted banking principles and procedures in order to ensure the financial stability and competitiveness of the affiliated CCIs; and be general and be directed towards all CCIs except in cases where due to reasons relating to their size and/or other reasons it is considered necessary to issue specially-formulated or modified instructions. On the other hand these instructions are not intended to: aim at full control of the CCIs nor will they cover routine operations (their routine operations will be conducted in accordance with the CCIs’ internal control procedure manuals); replace or reduce the role and authority of the CCIs’ management but rather form the basis for a framework under which the Central Body will be offering support and conducting the required monitoring and control in specific areas and operations which are important; alter the authority and powers of the CSSDA or their authority and independence; or replace the supervisory and prudential instructions issued by the CSSDA. Furthermore, the law requires that before such instructions are issued, the Central Body will have to consult the commissioner and collaborate with him in order to assure full conformity with the legal and regulatory framework of the CCIs. The CSSDA and the Central Body are also to collaborate systematically in order to resolve any pending issues and problems so as to meet their respective duties and obligations. A Memorandum of Understanding has been signed between the CBC and the CSSDA under which it was decided that the supervision of the CBC over the CCB has to take into account the permanent affiliation arrangements of the CCB as a Central Body with the affiliated CCIs. The arrangements for the CBC’s supervision of the CCB and its affiliates on a consolidated basis are governed by the BL and Article 5A (3)(b) of the CSL. The CSSDA’s annual report highlights the financial situation of the CCIs and informs the reader on regulatory developments. A new website in English is also under construction.
Assessment	Materially Noncompliant.
Comments	A comprehensive transitional regulatory and supervisory system has been set in place that will require every CCI to conform to the EU-banking directives before the end of 2007. During this transitional period, the CCIs are allowed to continue their existing business within Cyprus under the CSL without any restrictions or conditions, with the result that the cooperative credit sector will not be fully compliant with the EU banking directives during that period. However, and pursuant to Section 2 of the transitional provisions of the CSL, the CCIs have been asked to inform the CSSDA on the measures they intend to take in order to comply with the upcoming prudential requirements. The CSSDA has also developed a monitoring system of a number of prudential issues for each CCI (e.g., “four-eyes” principle, capital, large exposures, connected lending, etc.). Although, prima facia, there is a basic framework of prudential standards in the law and supporting regulations, the arrangements for the transitional period that is currently progressing fundamentally restricts the full, proper enforcement of and supervision under them. The mission has been informed that a sample of CCIs representing different types of CCIs will probably decide without further delay on their affiliation. This will enable the CCB to start a pilot project in the second half of 2005, the benefits of which will then be extended to the rest of the CCIs that chose to affiliate with the CCB. It is therefore recommended that the ongoing efforts in order to accelerate the affiliation process be further stepped up, particularly the formulation of the rules governing the affiliation of the non-conforming cooperatives with the CCB. The mission has also been informed of the ongoing efforts of the CCB and the CSSDA to encourage mergers in the cooperative credit sector in order to enhance the critical mass and economies of scale that will be required in view of the upcoming regulatory and supervisory reinforcement. These dramatic regulatory changes and the many players involved also highlight the need to organize and manage the change process very closely. The mission therefore recommends that the work of the different working groups and committees be coordinated under the umbrella of a global change committee.
Principle 1(2)	Each such agency should possess operational independence and adequate resources.
Description	According to the CSL, the Minister of Commerce and Industry supervises the cooperative societies and is authorized to give instructions to the Commissioner of the CSSDA regarding the exercise of his powers. However, Section 3(2) explicitly exempts the CCIs from the application of this requirement and Section 41D (1) of the CSL confers the responsibility for supervising the CCIs to the commissioner. The commissioner is appointed by the Council of Ministers for a period of five years with the possibility of renewal. He is not allowed to hold any other position or public office in Cyprus or be employed against remuneration in the private sector. The commissioner is the presiding officer of the CSSDA. He chairs the Committee of the CSSDA, which is composed of the commissioner or his deputy (the senior director) and four other members appointed by the Council of Ministers for a term of five years. The committee is responsible for determining the strategy and policy of the CSSDA and for the regulation of CCIs according to specific provisions of the CSL. The operational services of the CSSDA are composed of a recently established Supervision Department (7 staff) and a Development Department (33 staff). This picture has to be completed by mentioning that staff of the development department are assuming tasks that are related to the supervisory area (e.g., continuous monitoring of CCI’s compliance with the CSL, validating prudential returns, input of data into the central data system). The supervison division of the CSSDA also profits to some extent in its supervisory function from the intense contacts of support staff with the CCIs which increases the staff’s understanding of the individual CCIs. The intelligence so acquired is subsequently used in the on-site supervisory process. However, the recent character of the Supervision Department and the limited number of its staff illustrate that in the past the activities of the CSSDA were mainly, if not exclusively, directed to support the great number of very small CCIs (50 CCIs out of 360 account for 75 percent of the assets of the sector ). In the past, the activities of the CSSDA centered on monitoring of CCI’s compliance with the old CSL (before its harmonization with EU directives), as well as the development and support of the CCIs. However, against the backdrop of the dramatic regulatory and supervisory changes described under the assessment of Principle 1(1), which will have to materialize in the near future, the CSSDA has developed, in cooperation with the governmental personnel department, a transition plan providing for 17 additional staff. Fourteen will reinforce the supervisory staff, tripling the present supervisory resources. A number of these additional staff will fill existing vacancies and pending their entry the supervisor tends to hire nonpermanent experienced staff in order to meet the most urgent needs. The plans call for upgrading the salary levels of both officers and staff. The salary scales of the CSSDA are equivalent to government salary scales. However, the public sector salaries are considered to be higher than the private sector salaries, at least as far as the entry level is concerned. Therefore, hiring additional staff with adequate academic and professional background is reportedly not to be problematic. According to Section 4(6)(c) of the CSL, the commissioner shall have at his disposal the financial means necessary for the unobstructed and immediate exercise of the duties imposed upon him by the CSL regarding the supervision and control of the CCIs. In view of the future regulatory and supervisory changes the CSSDA liaises intensively with the CBC. A six-month training program has been organized during which four CCIs have been submitted to joint on-site examinations. The CSSDA also combines its efforts with the CBC and the CCB in preparing for the new supervisory and regulatory environment. Also, the establishment of the affiliation arrangements will allow the progressive transfer of a great deal of the support efforts of the CSSDA to the Central Body (the CCB). The latter process will also allow CSSDA staff involved in the development area to switch to the supervisory sector. An Administrative Co-operation Program between Cyprus and the European Union has been set up in order to provide for technical assistance for the effective supervision of co-operative credit institutions (Twinning Light Project). The project will cover a period of five months and should start no later than September 2005. The specific objectives aim at strengthening the administrative capacity of the CSSDA for effective on-site and off-site supervision, including the enhancement of electronic monitoring, based on the relevant acquis communautaire as well as on the supervisory principles of the Basel Committee, taking into account the common position agreed upon with the EU. The Commissioner may also contract or hire lawyers, auditors or other professional experts related to the execution of its legal duties. However, the Commissioner has not yet done this. The Commissioner’s mandate may only be terminated by the Council of Ministers when he no longer fulfills the conditions required for the execution of his duties or when he has committed a serious offence.
Assessment	Materially Noncompliant.
Comments	The annual budget of the CSSDA is prepared by the Committee and then forwarded to the Council of Ministers through the Ministry of Finance and, finally, submitted to and approved by the House of Representatives. This may raise questions and doubts about the financial independency of the supervisory authority. The matter is especially sensitive since the supervisory capacity of the CSSDA must be developed in a very substantial way in order to cope with the new regulatory environment. The number of required additional staff is testimony to that. The mission therefore recommends that the government proceed without further delay with the execution of the various plans in order to strengthen the supervisory capacity of the CSSDA.
Principle 1(3)	A suitable legal framework for banking supervision is also necessary, including provisions relating to authorization of banking establishments and their ongoing supervision.
Description	As stated above, the CSL confers the responsibility for supervising the CCIs to the commissioner and gives him the power to grant or revoke the license. Article 41J of the CSL allows the Council of Ministers to set prudential rules and also to delegate this power to the Committee of the CSSDA. By Regulative Administrative Act N°110/2004, published in the Official Gazette on February 27, 2004, the Council has delegated this power to the Committee. The committee has made an extensive use of this power in the past and continues to do so as is shown in the descriptions of other principles. Also, article 41G of the CSL empowers the committee to make additional rules for the CCIs. Article 41JC (1) of the law gives the commissioner the power to demand and collect information useful for the exercise of his power pursuant to the cooperative law (see also Principle 16).
Assessment	Compliant.
Comments	None.
Principle 1(4)	A suitable legal framework for banking supervision is also necessary, including powers to address compliance with laws, as well as safety and soundness concerns.
Description	Article 41D of the CSL enables the commissioner to address compliance with the CSL and the safety and soundness of the CCIs. The commissioner is allowed to exercise qualitative judgment in the forming of his/her opinion. The commissioner has also the right to conduct audits and collect information [Article 41D (2)(b)]. The Commissioner also has the power to take prompt remedial measures or impose sanction, including the revocation of the license when a CCI is not complying with laws and regulations or is engaged in unsafe or unsound practices [Articles 41F (3) and 4 and 41JH].
Assessment	Compliant.
Comments	None.
Principle 1(5)	A suitable legal framework for banking supervision is also necessary, including legal protection for supervisors.
Description	According to Section 4(5) of the CSL, the commissioner and the supervisory staff are exempt from any civil liability regarding any action or omission in exercising their duties and powers unless it is proven that the action or omission was performed in bad faith involved serious negligence. The defense of CSSDA staff against lawsuits rests with the Office of the Attorney General and all legal expenses incurred are covered by the Cyprus government.
Assessment	Compliant.
Comments	None.
Principle 1(6)	Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Description	According to Section 41D (1)(c), the commissioner is allowed to cooperate and share information with other local or foreign agencies, provided that this information is treated as confidential by the receiving agency. A Memorandum of Understanding has been signed between the CBC, the Cyprus Securities and Exchange Commission, the Insurance Companies’ Control Service, and the CSSDA. The memorandum came into effect on January 1, 2003. This Memorandum is based on the application of Articles 41D (1)(c) and 41H of the CSL, which allows the competent supervisory authorities of the financial sector to cooperate and exchange information between them and/or with other supervisory authorities, whether in Cyprus or elsewhere, with a view of discharging their functions and responsibilities in a more effective manner. Any exchange of information will only take place when the CSSDA is satisfied that the information provided is subject to the same confidentiality rules in the hands of the receiving competent supervisory authority as apply to the CSSDA. The information exchange between the competent supervisory authorities is exclusively used in the discharge of their functions and responsibilities and is subject to confidentiality rules in the hands of the receiving supervisory authority as applied to the supervisory authority which provides the information on the basis of legislation in force from time to time. Confidential information exchanged between the competent supervisory authorities on the basis of the legislation in force may not be disclosed without the expressed agreement of the competent supervisory authority which disclosed it and, where appropriate, solely for the purposes for which this authority gave its agreement. As stated above, in view of the future regulatory and supervisory changes, the CSSDA liaises intensively with the CBC. A six-month program has been organized during which four CCIs have been submitted to joint on-site examinations. The CSSDA also combines its efforts with the CCB in preparing for the new supervisory and regulatory environment. Also, the establishment of the affiliation arrangements will allow the progressive transfer of a great deal of the support efforts of the CSSDA to the Central Body (the CCB). The latter process will also allow CSSDA staff involved in the development area to switch to the supervisory section. According to Section 41H (1), the Commissioner, the Committee, and the staff of the CSSDA are to preserve the confidentiality of the information in their possession and may only use this information within the exercise of their duties.
Assessment	Compliant.
Comments	None.
Principle 2.	Permissible Activities The permissible activities of institutions that are licensed and subject to supervision as banks must be clearly defined, and the use of the word “bank” in names should be controlled as far as possible.
Description	Article 1 of the CSL defines a CCI as a society whose business it is to receive deposits or other repayable funds from the public, to grant credit for its own account, or to provide electronic money services. The CSL further stipulates (Section 41A 1) that only licensed cooperative credit institutions established in Cyprus or in an EU member state or a third country may carry out the business of accepting deposits. The Committee of the CSSDA is mandated to define the services or activities that the CCIs are allowed to offer or exercise. The CSSDA plans to issue a Regulatory Decision on this. The licensed CCI is required to mention at a distinct point near its name, on its stationary and on any other document used in receiving money, on its annual accounts, on leaflets of provided services, or on internet websites, whether it operates as a stand-alone CCI or as a CCI affiliated with the “Central Body.” The use of the phrase “cooperative credit institution” is not currently protected, but the protection of the word “cooperative” which is part of that phrase may provide protection. According to Section 55.1, the use of any name of which the word “cooperative” forms part is also prohibited without the sanction of the Council of Ministers. Contravening this provision represents a criminal offense.
Assessment	Materially Noncompliant.
Comments	The Committee should complete the issuance of its Regulatory Decision defining the services or activities that the CCIs are allowed to offer or exercise.
Principle 3.	Licensing Criteria The licensing authority must have the right to set criteria and reject applications for establishments that do not meet the standards set. The licensing process, at a minimum, should consist of an assessment of the banking organization’s ownership structure, directors and senior management, its operating plan and internal controls, and its projected financial condition, including its capital base; where the proposed owner or parent organization is a foreign bank, the prior consent of its home country supervisor should be obtained.
Description	Article 41F (1) of the CSL authorizes the CSSDA to set criteria for licensing the CCIs. These criteria are set in the CSL [Article 41B (1)]. According to Section 41E, these criteria are to be complied with on a continuous basis. The commissioner retains the right to reject a license application. He also has the authority to amend or withdraw any imposed terms or to impose any new terms on an existing license (Article 41F). The commissioner verifies the organizational structure, and he satisfies himself that the CCI provides all the necessary guarantees or conditions for the execution of an effective supervision [Article 41B (1) (ii)]. The shareholders-members of the CCIs are individuals. The CCIs are non-profit motivated organizations governed by the one-member-one vote principle with each entity having its own committee elected from among the members. Article 41B (1)(a)(iii) of the CSL also stipulates that the license shall only be granted if the CSSDA is satisfied with the fit-and-proper character of members that hold a percentage of capital that exceeds 10 percent. In practice, this situation does not exist, and as stated above the cooperative system is based on the one- member,-one-vote principle. A minimum initial amount of capital in Cyprus pounds of an equivalent of one million Euros is required by Article 41B (i). The CSL also requires the CCI to be directed by at least two persons with the necessary expertise and skills in order to effectively define the orientation of the activities, a good administrative and accounting organization, and a proper internal control system [Article 41B (ii)]. According to Article 41B (iv) the applicant CCI shall also have to satisfy the commissioner that it shall have prior to the commencement of its activity the requisite financial capacity and liquidity to achieve the proposed program of activities that is submitted with its application. A CCI of a EU-member state has the right to exercise its activities in Cyprus, defined in the Appendix of the CSL, either by establishing a branch or via cross-border services, if the following conditions are met: for a branch: (e.g.,) licensed by the home-member state, the activities that will be undertaken are compatible with the home license and contact is to be taken with the home supervisor; for cross-border provision of services: the presence of a home license and the intended activities should be consistent with the intended license. CCIs from third countries (i.e., nonEU member states) have the right to exercise activities in Cyprus if the conditions of article 41B (1) are met. The commissioner has the right to withdraw a license at any time if it is established that the license has been obtained on false statements or by concealed substantial evidence [Article 41F (4)].
Assessment	Compliant.
Comments	Currently, the necessary regulatory framework is in place. Existing CCIs have a transition period in which to decide whether to affiliate with the Central Body or continue to stand-alone.
Principle 4.	Ownership Banking supervisors must have the authority to review and reject any proposals to transfer significant ownership or controlling interests in existing banks to other parties.
Description	According to the Cooperative Laws (Articles 6 and 7), each Cooperative Credit Institution (CCI), which may have either limited or unlimited liability, is independent and self-governing. Where the liability of the members of a Cooperative Credit Institution is limited by shares, no member, other than a registered cooperative society, shall hold a portion of the share capital of the institution which exceeds the maximum limit prescribed by the CSL, which in percentage shall not exceed one-fifth of the share capital of the institution. Irrespective of the liability or the shareholdings of a CCI, each member holds only one vote. It is apparent that under the present legal framework the subsidiary status based on controlling interest cannot exist. As stated above, Section 41B (1)(a)(iii) of the CSL also stipulates that the license shall only be granted if the CSSDA is satisfied with the fit-and-proper character of members that hold a percentage of capital that exceeds 10 percent. In practice, this situation does not exist, and, as stated above, the cooperative system is based on the one- member, one-vote principle. According to Section 41E, these criteria are to be complied with on a continuous basis.
Assessment	Not applicable.
Comments	Given the existing legal framework, controlling interests cannot exist for CCIs.
Principle 5.	Investment Criteria Banking supervisors must have the authority to establish criteria for reviewing major acquisitions or investments by a bank and ensuring that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision.
Description	Under Article 40(a) of the CSL, with the approval of the Commissioner, each CCI is allowed to use its funds for the purchase of immovable or movable property necessary for the execution of the purposes for which the society was incorporated. Under article 41J (e) of the CSL, the Council of Ministers, within the framework of the European Community’s Acts, may define the limits of the participation in other enterprises of the CCI that applies for or holds a license. The Council of Ministers has duly delegated this authority to the committee. Against the general backdrop of the ongoing implementation of the EU regulations, it is the committee’s firm intention to issue a Regulatory Decision according to the above article to adopt the relevant provisions of Directive 2000/12/EC in 2005, with regard to the limits of participation in other enterprises. A participation in a company outside the financial sector, exceeding 10 percent of the capital of that company will be considered as a qualifying holding, which should not exceed 15 percent of the own funds of the CCI. The aggregate portfolio of qualifying participations in nonfinancial-sector companies must not exceed 60 percent of the own funds of each CCI. The mission has been informed that the introduction of these limits will not present a problem for the CCIs. At present, few CCIs hold qualified participations in non-financial institutions. However, these participations are well below the 15 percent limit that will be introduced in the future.
Assessment	Largely Compliant.
Comments	The committee should complete the issuance of its Regulatory Decision regarding participation in other enterprises. This decision should incorporate the provisions of Directive 2000/12/EC with respect to participations outside the financial sector. Before granting its approval for any new acquisition by a CCI, the CSSDA will require that any new acquisitions and investments do not expose the CCI to undue risks or hinder effective supervision. The CCI will have to demonstrate that it has, from the outset, adequate financial and organizational resources to handle the acquisition/investment.
Principle 6.	Capital Adequacy Banking supervisors must set minimum capital adequacy requirements for banks that reflect the risks that the bank undertakes, and must define the components of capital, bearing in mind its ability to absorb losses. For internationally active banks, these requirements must not be less than those established in the Basel Capital Accord.
Description	Following the accession of Cyprus to the EU, the Regulative Directive 58/2005 of the CSSDA’s Committee introduced a risk-based capital requirement regime applicable to CCIs based on the provisions of Directive 2000/12/EC (Official Gazette February 11, 2005). This directive was drafted in cooperation with the CBC and the CCB. The CSSDA Directive is comparable with the CBC’s Directive. However, the following differences are to be mentioned: a) the minimum ratio requirement is set at 8 percent, based on the EU Directive 200/12/EC minimum requirements (compared to 10 percent for the banking sector); b) Tier 2 capital includes two additional items, i.e., members reserve liability and uncalled capital based on Article 36 of the EU Directive 2000/12/EC; c) Tier 1 capital includes an item regarding reserves for general banking risks, and Tier 2 does not include an item regarding general provisions for bad debts (approach based on the EU Directive mentioned above). The mission was also informed that the committee has approved a new Regulative Directive introducing CAD II. This decision was published in the Official Gazette in April 2005 (Regulative Administrative Act No. 195/2005). This directive tends to fully harmonize the CSSDA’s capital requirements with EU Directives 93/6/EEC as amended by Directives 98/31/EC, 98/33/EC, 2002/87/EC and 2004/39/39. It has also been drafted in collaboration with the CBC. Again, the CSSDA has followed the same approach as the CBC with the same differences as for CAD I (a, b, and c) as described above. The risk profile of the CCIs is determined by their main function, which is the acceptance of deposits and granting of loans to the members of the cooperative system in their particular area of operations. The total membership of the cooperatives covering the multiple activities in Cyprus has exceeded 500,000, whereas membership of CCIs totals around 358,000. Should a licensee’s capital fall below the minimum capital ratio, Article 41D empowers the commissioner to impose the necessary measures.
Assessment	Largely Compliant.
Comments	The CSSDA should require reporting on CCIs’ capital ratios and their components at least semi-annually. Current reporting is only on an annual basis.
Principle 7.	Credit Policies An essential part of any supervisory system is the independent evaluation of a bank’s policies, practices, and procedures related to the granting of loans and making of investments and the ongoing management of the loan and investment portfolios.
Description	The assets created in the normal course of the business of CCIs are generally limited to home mortgage loans, personal/consumer loans, and small business/professional loans granted mainly to their members, mostly on a collateralized or guaranteed basis. Pursuant to Article 37 of the CSL Societies Law, loans to any non-members of any CCI must be approved by the commissioner. Individual CCIs do not normally make investments directly. Article 40(a) of the CSL requires that each CCC invest its excess funds in government securities or deposit the excess funds in the Cooperative Central Bank, which is regulated and supervised by the Central Bank of Cyprus and the CSSDA, or, with the consent of the commissioner, in any other bank. Consequently, credit risk for CCIs is limited and investment risk is moderated. Article 41JA of the CSL sets maximum limitations and controls for large exposures and exposures to connected parties. According to Rules 58(2), internal maximum lending limits must be included in the CCIs by-laws. By-laws are approved by the general meeting of the members and are subject to the approval of the commissioner. The Commissioner’s Directives 3-01 and 3-02, regarding the basic principles for the internal procedures and internal control systems of CCIs, require that CCIs have established well-documented credit policies, practices, and procedures. CSSDA supervisors determine whether these directives are implemented by each CCI. The CSSDA reviews and evaluates compliance with pertinent legal and prudential requirements through both off-site supervision/monitoring and on-site examination. In the course of on-site examinations, the CSSDA examiners review extensively the credit procedures, practices, and administration policies of the CCI. These include the appraisal and authorization of individual credit exposures, procedures for identification of substandard lending, and provisioning policy. The examinations also include evaluation of internal systems and procedures for record keeping and control. The CSSDA monthly and annually collects and analyzes information on loans, by sector of economic activity, interest rate duration, and security, as well as overdue and excess exposures.
Assessment	Materially Noncompliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDA’s on-site work, but do not mitigate the need for completion of planned expansion and development of staff.
Principle 8.	Loan Evaluation and Loan-Loss Provisioning Banking supervisors must be satisfied that banks establish and adhere to adequate policies, practices, and procedures for evaluating the quality of assets and the adequacy of loan-loss provisions and reserves.
Description	As stated above, the assets created in the normal course of business of CCIs are generally limited to home mortgage loans, personal/professional loans, and small business/professional loans granted to their members, mostly on a collateralized or guaranteed basis. Pursuant to Article 37 of the CSL, loans to any nonmembers of any CCI must be approved by the commissioner. Individual CCIs do not normally make investments directly. Article 40(a) of the CSL requires that each CCC invest its excess funds in government securities or deposit the excess funds in the Cooperative Central Bank, which is regulated and supervised by the Central Bank of Cyprus and the CSSDA, or, with the consent of the Commissioner, in any other bank. Consequently, credit risk for CCIs is limited and investment risk is moderated. The Commissioner’s Directives 3-01 and 3-02, regarding the basic principles for the internal procedures and internal control systems of CCIs, require that CCIs have established well-documented credit policies, practices, and procedures. CSSDA supervisors determine whether these directives are implemented by each CCI during on-site examinations. One of the prime objectives of these examinations is to assess the quality of the assets of the CCIs. In the course of an on-site examination, the CBC examiners review extensively the bank’s lending practices, its credit granting standards, and the level and adequacy of provisions. CCIs themselves are required to review individual credits, asset classifications, and provisioning, including those for both on- and off-balance sheet exposures, at least annually. In addition, the external AOCS, when conducting the annual audit of each CCI’s financial statements and management/ performance, reviews its provisioning policies and adequacy. During the course of on-site examinations, the CSSDA examiners assess the quality of assets individually, especially major loan accounts, and the level and adequacy of provisions and compare their results with those of the CCI under examination. CSSDA examiners review a sample of at least 30 percent of the balance sheet value of CSI credit exposures; the sample selected is biased towards large or problematic loans and includes both on- and off-balance sheet exposures. Each borrower selected is individually assessed, together with connected persons, by account, collateral held, financial condition, and other pertinent factors. Then, according to the risk entailed, each account is classified on the basis of CSSDA’s established asset quality classification criteria. These classifications are Pass, Special Mention, Substandard, and Doubtful; the definition of the characteristics of each of these classifications is very comparable to the definitions of similar classifications that are used by other competent supervisory authorities worldwide, as is the approach to evaluating the adequacy of provisioning.
Assessment	Materially Noncompliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDAs on-site work, but do not mitigate the need for completion of planned expansion and development of staff. The CSSDA should provide for additional regular reporting, in relevant detail, from CCIs on a broader range of credit-related matters (e.g., classification of credits and other assets, non-performing assets, provisioning, assets with suspended interest, etc.) and include such reporting in its ongoing analysis of each CCI.
Principle 9.	Large Exposure Limits Banking supervisors must be satisfied that banks have management information systems that enable management to identify concentrations within the portfolio, and supervisors must set prudential limits to restrict bank exposures to single borrowers or groups of related borrowers.
Description	Pursuant to Article 41JA of the CSL: 1) It is forbidden for a registered cooperative credit institution, with the exceptions of the institutions affiliated with the Central Body: (a) to allow the total value of exposures to a client or group of connected clients to exceed 25 percent of its own funds at any time or any other lower percentage that the CSSDA Committee may from time to time define, in general or in specific for a particular category of a cooperative credit institution; (b) to allow the total value of all large exposures to exceed the eightfold of its own funds at any time or any other lower percentage that the CSSDA Committee may from time to time define, in general or in specific for a particular category of a cooperative credit institution; or (c) to allow the total value of exposure without the guarantee of collateral security granted to the members of the committee or the board or the Supervisory Board, the secretary or the manager of the said cooperative credit institution or the legal persons, in which the aforesaid or their spouses or children or grandchildren hold a percentage bigger than 10 percent of the share capital, to exceed five percent of its own funds at any time or any other lower percentage that the CSSDA Committee may from time to time define, in general or in specific for a particular category of a cooperative credit institution. 2) During the ascertainment of the obligation for compliance with the provisions of subsection (1), the CSSDA Committee is authorized to exempt totally or partly any exposure, after taking into consideration the extreme low risk entailed by the said exposure, provided that such exemption does not violate any European Community Act enforced in Cyprus. The terms “exposure,” “large exposure,” “exposure not guaranteed by collateral security,” and “group of connected clients” are specifically defined in the law in a manner that is similar to the practice in other competent jurisdictions. In the course of on-site examinations, the CSSDA examiners verify that CCIs have management information systems to timely identify concentrations within the portfolio. In addition, the CSSDA examiners assess the accuracy of management information with regard to concentrations. The CSSDA also annually collects information on large exposures and analyzes it for compliance with the law as part of its ongoing process of off-site supervision/monitoring. The CSSDA is currently revising and updating its return on large exposures.
Assessment	Materially Noncompliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management, in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDA’s on-site work, but do not mitigate the need for completion of planned expansion and development of staff.
Principle 10.	Connected Lending In order to prevent abuses arising from connected lending, banking supervisors must have in place requirements that banks lend to related companies and individuals on an arm’s-length basis, that such extensions of credit are effectively monitored, and that other appropriate steps are taken to control or mitigate the risks.
Description	Pursuant to Article 41JA of the CSL: 1) It is forbidden for a registered cooperative credit institution, with the exceptions of the institutions affiliated with the Central Body: (c) to allow the total value of exposure without the guarantee of collateral security granted to the members of the committee or the board or the Supervisory Board, the secretary or the manager of the said cooperative credit institution or the legal persons, in which the aforesaid or their spouses or children or grandchildren hold a percentage bigger than 10 percent of the share capital, to exceed 5 percent of its own funds at any time or any other lower percentage that the Committee may from time to time define, in general or in specific for a particular category of a cooperative credit institution. 2) During the ascertainment of the obligation for compliance with the provisions of subsection (1), the CSSDA Committee is authorized to exempt totally or partly any exposure, after taking into consideration the extreme low risk entailed by the said exposure, provided that such exemption does not violate any European Community Act enforced in the Republic. The terms “exposure” and “exposure not guaranteed by collateral security” are specifically defined in the law in a manner that is similar to the practice in other competent jurisdictions. Facilities to the members of the committee of the CCI and their connected persons are required to be approved by the CCI’s Committee, irrespective of the amount, without the member concerned voting on the resolution. However, there is no apparent requirement that the facilities may not be granted on more favorable terms than corresponding loans to nonrelated counterparties. Article 43(2) does permit the commissioner to deal with problems arising in connected lending to the Committee of a CCI and its related persons. Although Article 43(2) gives the commissioner general authority to deal with problems, the law should more explicitly prohibit loans to be granted on more favorable terms than corresponding loans to non-related counterparties. Following delegation of the relevant power by the Council of Ministers, Article 41J (a) of the CSL empowers the Committee of the CSSDA to regulate the computation of the capital of a CCI, but regulations do not currently provide for the deduction of connected lending exposures. CCIs are required to submit, on a semi-annual basis, a return showing all their loans related to the members of their committee or the board or the Supervisory Board, the secretary, or the manager. These are analyzed for compliance with the law as part of the off-site supervision/monitoring program. The CSSDA is currently testing a revised return on the monitoring and control of credit facilities to CCIs’ Committee members and their connected persons. In the course of on-site examinations, the CSSDA examiners verify that CCIs have management information systems to timely identify exposures to connected parties assess their accuracy.
Assessment	Materially Noncompliant.
Comments	The CSSDA should specifically require that the facilities granted to connected persons of CCIs may not be granted on more favorable terms than corresponding loans to nonrelated counterparties. Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management, in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDAs on-site work, but do not mitigate the need for completion of planned expansion and development of staff.
Principle 11.	Country Risk Banking supervisors must be satisfied that banks have adequate policies and procedures for identifying, monitoring, and controlling country risk and transfer risk in their international lending and investment activities, and for maintaining appropriate reserves against such risks.
Description	Currently, CCIs do not engage in cross-border lending and investment activities.
Assessment	Not Applicable.
Comments	However, the CSSDA has issued its Regulative Decision regarding Cross-Border Credit Transfers, pursuant to its authority under Article 41G (2) of the CSL to define the terms, conditions, and any other item that requires definition as regards the conduct of business by the credit cooperatives institutions.
Principle 12.	Market Risks Banking supervisors must be satisfied that banks have in place systems that accurately measure, monitor, and adequately control market risks; supervisors should have powers to impose specific limits and/or a specific capital charge on market risk exposure, if warranted.
Description	As stated above, the mission has also been informed that the committee has approved a new Regulative Directive introducing CAD II. This decision is to be published in the Official Gazette in April 2005. This directive tends to fully harmonize the CSSDA’s capital requirements with EU Directives 93/6/EEC as amended by Directives 98/31/EC, 98/33/EC, 2002/87/EC and 2004/39/39. It has also been drafted in collaboration with the CBC. Again, the CSSDA has followed the same approach as the CBC with the same differences as for CAD I (a, b, and c) as described above. Article 40(a) of the CSL requires that each CCC invest its excess funds in government securities or deposit the excess funds in the Cooperative Central Bank, which is regulated and supervised by the Central Bank of Cyprus and the CSSDA, or, with the consent of the commissioner, in any other bank. However, the CCIs are not currently authorized foreign exchange dealers (except when acting as agents of the CCB) and do not offer foreign exchange services. These services are offered to the individual CCIs by the CCB, which is also supervised by the CBC. This allows the members to execute their international dealings and business through the CCB at special rates.
Assessment	Largely Compliant.
Comments	The mission has been informed that the CSSDA intends to issue a directive that will specify the rules and conditions required in order to obtain a license for foreign exchange operations. These rules and conditions will address such issues as, e.g., the required organizational structure and the necessary staff and expertise. The mission recommends that the supervisor adjust and develop the necessary expertise in order to supervise the new risks that will be assumed by the CCIs in this context.
Principle 13.	Other Risks Banking supervisors must be satisfied that banks have in place a comprehensive risk management process (including appropriate board and senior management oversight) to identify, measure, monitor, and control all other material risks and, where appropriate, to hold capital against these risks.
Description	The commissioner has issued Directives 3-01 and 3-02 regarding the requirements for the basic principles for the internal operating procedures and internal control systems for CCIs. These provide a detailed instructional manual for the establishment of such systems by CCIs that can vary significantly in size and complexity of operations. The scope of the annual audit of each CCI that is conducted by the independent AOCS includes coverage of internal operations management systems and controls, as does the scope of the CSSDA’s on-site examination function. The commissioner has issued a Directive on the Liquidity Ratio. The minimum acceptable liquidity ratio level has been set at 25 percent. Article 41F of the CSL provides the commissioner with the authority to address failure to comply with this requirement, protecting the interest of depositors. CCIs provide monthly returns on their liquidity to the CSSDA. The CSSDA is currently testing a revised and updated prudential liquidity return. For all CCIs that are connected electronically to the central server of the Cooperative Computer Society (currently 220 CCIs, including all of the larger institutions), a computerized gap analysis system exists to provide for the ongoing monitoring and evaluation of the effects of interest rate fluctuations. This information is currently available to the management of the CCIs; the CSSDA supervisors will not have direct access until the end of 2005. The CSSDA is currently testing a return on the monitoring of interest rate risk. For all CCIs that are connected electronically to the central server of the Cooperative Computer Society (currently 220 CCIs, including all of the larger institutions), a back-up of record keeping is provided to protect against possible operational problems created by general business interruption, disaster, or accident.
Assessment	Materially Noncompliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDAs on-site work, but do not mitigate the need for completion of planned expansion and development of staff. The CSSDA should enhance its ability to regularly acquire and analyze information on interest rate risk in the CCIs, either directly from the CCIs or through accelerated access to the reporting system of the Cooperative Computer Society.
Principle 14.	Internal Control and Audit Banking supervisors must determine that banks have in place internal controls that are adequate for the nature and scale of their business. These should include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding its assets; and appropriate independent internal or external audit and compliance functions to test adherence to these controls, as well as applicable laws and regulations.
Description	Article 41B (1)(a)(ii) of the Cooperatives Societies Law requires that a registered society be “…directed by at least two persons who have the necessary honesty and requisite experience to effectively define the orientation of the society’s activities and with good administrative and accounting organization and proper internal control systems.” Article 41F (3)(e) authorizes the Commissioner to demand the removal or alteration of the duties of any CCI officer or employee and Article 43 describes the circumstances when, including situations where the CCI is not properly managed, and authorizes the commissioner to dismiss the committee of a CCI. The commissioner has issued Directives 3-01 and 3-02 regarding the requirements for the basic principles for the internal operating procedures and internal control systems for CCIs. These provide a detailed instructional manual for the establishment of such systems by CCIs that can vary significantly in size and complexity of operations. The CSSDA is also planning to issue a future directive on the broader principles of internal control. In the course of its on-site examinations, the CSSDA determines whether the directives are implemented or other relevant internal controls are adopted; reviews the adequacy and efficiency of the institution’s organizational structure; evaluates the effectiveness of its internal control system, including internal auditors where they exist; and makes recommendations as necessary. In the course of the on-site examination, the reports to the institution’s committee from its internal auditor, where they exist, are reviewed by the examiners. The scope of the annual audit conducted in each CCI by the independent AOCS addresses the management of the CCIs, including an evaluation of the society’s internal control systems’ operations. CSSDA officers have access to the reports on these audits, participate in meetings with the management of the CCI regarding them, and provide support for the CCI’s actions to address identified deficiencies, as necessary.
Assessment	Largely Compliant.
Comments	Due to the limited size of their management and staff, many small cooperative societies lack the ability to employ an internal audit function and/or operate under effective internal controls and segregation of duties. The absence of proper, effective internal control systems in a CCI will be a material factor in its decision on possible affiliation with the Central Body, subsequent to the expiration of the ongoing transitional period that ends on December 31, 2007. Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDA’s on-site work, but do not mitigate the need for completion of planned expansion and development of staff.
Principle 15.	Money Laundering Banking supervisors must determine that banks have adequate policies, practices, and procedures in place, including strict “know-your-customer” rules, that promote high ethical and professional standards in the financial sector and prevent the bank being used, intentionally or unintentionally, by criminal elements.
Description	The Prevention and Suppression of Money Laundering Activities Laws of 1996 to 2004, (hereafter referred to as the “PSMLAL”), establish a solid framework that covers the various aspects of money laundering and the role of the financial system in this regard. The salient features of the PSMLAL are as follows: It defines and criminalizes laundering of proceeds from serious criminal offenses. It provides for the confiscation of proceeds from serious crime. It empowers courts to issue freezing and restraint orders in respect of such proceeds. It requires suspicion of money laundering to be reported to the Unit for Combating Money Laundering (UCML) without this being treated as a breach of confidentiality. It empowers the courts to order the disclosure and production of information held by natural or legal persons, including banks, related to money laundering investigations. It requires all persons carrying on relevant financial business to maintain procedures in relation to customer identification, record keeping, internal control, and communication and staff training in the recognition and handling of suspicious transactions. It enables the registration and enforcement of foreign orders for the freezing and confiscation of proceeds. The Commissioner’s Directives dated July 30, 1999, August 9, 2000, and November 7, 2000, address the prevention and suppression of money laundering by the CCIs. These directives are identical to the Guidance Notes and Supplements/Amendments issued by the Central Bank of Cyprus (CBC) prior to its November 2004 Guidance Note that takes into account: (i) the harmonization of Cyprus’s legislation with the EU Directive 2001/97EC; (ii) the revised recommendations for combating money laundering issued by the Financial Action Task Force (FATF) on money in June 2003; and (iii) the recommendations included in the paper on “Customer Due Diligence for Banks” issued in October 2001, by the Basel Committee on Banking Supervision. The provisions of these Directives include the following: a) prohibition of secret, anonymous, and numbered accounts as well as fictitious names; b) obligation to obtain data file for its customers; c) the appointment of a conforming officer that will act as the intermediary link between the CCI and the Financial Intelligence Unit (MOKAS). The conforming officer is required to advise and direct other employees regarding the procedures required for money laundering, and has to decide whether employees need to participate in specialized seminars. In the course of on-site supervision, the examiners verify and control the policies and practices followed by the CCIs with regard to “Know-Your-Customer” rules. A comprehensive new Commissioner’s Directive will soon revise the existing one and it will be issued based on the November 2004 Guidance Notes of the CBC mentioned above. At this stage, the said directive is in draft form subject to the commissioner’s approval and will thereafter be circulated to the CCIs.
Assessment	Largely Compliant.
Comments	The CSSDA should complete the issuance of the new Guidance Note. In assessing compliance with this principle, it has to be noted that the activities of the CCIs, although important in volume and market share, are still of a very basic nature and are mainly confined to their members, which introduces an amount of social control into the system.
Principle 16.	On-Site and Off-Site Supervision An effective banking supervisory system should consist of some form of both on-site and off-site supervision.
Description	Pursuant to Article 41D of the CSL, the commissioner is responsible for supervising compliance with that law. Article 41JD empowers the commissioner or a person authorized by him “…to conduct investigations necessary for the carrying out of his competences or for a possible violation of the provided obligations in virtue of the Cooperative Law and for the purpose of this he may: a) check the records, the books, the accounts and any other documents and data stored in computers at each cooperative credit institution or in the possession of any person for whom there is reasonable suspicion that he holds information of the Cooperative Credit Institution that may assist the commissioner in his investigation, and to take copies or extracts from them; and b) to enter the office and professional premises of the persons under investigation. Also, pursuant to article 3(5), “… the Commissioner … has the power to inspect the books, accounts, and documents of a registered society and every officer of such society shall provide the necessary facilitations and all of the requested information for such inspection.” Article 41JC empowers the Commissioner “… to demand and collect information useful for exercising his powers pursuant to the cooperative law, and to demand through a written request the submission of this information within the set deadline, from registered co-operative credit institutions, their subsidiary companies, members of their Committee or their Board or the members of their Supervisory Board.” Supervision is carried out through on-site examination and of-site monitoring. The Supervision Division of the CSSDA has two subdivisions: on-site supervision and off-site supervision and regulation. Currently, there are only seven officers and staff members in the division; however, plans and budgets have been prepared and are awaiting government approval for increasing the total number of the CSSDA’s staff to 57, out of whom initially 21 will be allocated to the Supervision Division. The work of the Supervision Division is, inter alia, supported by the 33 officers and staff of the Development Division of the CSSDA, who also support the operations of the CCI’s by working with them on supervisory, regulatory, and operational/ administrative matters. Supervisory findings from the on- and off-site supervision processes are also used by the Development Division to assist the CCIs in enhancing their operations. The CSSDA’s off-site supervision/monitoring and on-site examination functions benefit from their ongoing relationship with the independent Audit Office for Cooperatives Societies and the results of its annual audits of each CCI. These audits cover both financial and overall management/performance issues. CSSDA officers take part in the meetings with CCI management on results of the audit following each audit; they provide support for management’s efforts to address any deficiencies identified in the audit. The CSSDA’s on-site examination process began as a separate function within the CSSDA in November 2003; prior to that, the supervision and development functions were one group. A total of 16 examinations, including 4 that were conducted with the assistance of the Central Bank of Cyprus as part of a training exercise, have been conducted since the inception of the program. Examinations have included all sizes and complexity of CCIs, including the largest of these institutions. The CCI is normally notified in advance of a planned examination, but the CSSDA does, on occasion, conduct ad hoc examinations without prior notice. On-site examinations are planned using a basic risk-based approach, concentrating on those institutions that present the higher risks to the system, an using the findings of the off-site supervision/monitoring system, the findings of the independent external audit, and the knowledge about the CCI from the CSSDA’s development officers as a base of knowledge on each institution. The CSSDA’s goal is to conduct an annual examination of all CCIs that remain unaffiliated after the formation of the Central Body, as well as an annual examination of the Central Body and its affiliates, on a consolidated basis. The CSSDA’s on-site supervision examines whether: the CCI complies with the CSL, by-laws, and regulations; the organizational structure and the management is proper and effective; the administrative and accounting procedures are adequate and effective; the books and records are properly kept; the computerization as well as the internal control systems are adequate; there are sufficient measures to prevent fraud and irregularities as well as money laundering; the CCI has adopted and follows adequate loan evaluation and authorization procedures in order to minimize risk exposure; the credit policies are followed, the loan portfolio is of good quality, and provisioning is adequate; the loans in arrears are monitored; adequate levels of liquidity are maintained; the CCI’s profitability is adequate; the CCI’s assets are properly safeguarded; and the overall soundness and solvency of the institution is achieved. In the course of the on-site examination, the reports to the institution’s committee from their internal auditor, where they exist, are reviewed by the examiners. The findings of the on-site examination are provided to and discussed with the management of the CCI. Plans for corrective action, as necessary, are required from the institutions. Information on a wide variety of matters related to each CCI’s activities is provided to the CSSDA through a series of periodic returns. Article 41JC (7) of the CSL states that such information provided is confidential, and Article 41H provides for the obligation of confidentiality for management and staff of the CSSDA and for sharing of such information for supervisory purposes. Article 41JC (1) gives the commissioner the power to demand and collect information useful for the exercise of his power pursuant to the co-operative law. Off-site supervision/monitoring involves the examination and analysis of these periodic returns, such as those relating to, inter alia, monthly statistical data, annual balance sheet and profit and loss accounts, the level of own funds, solvency ratio, large exposures, and credit facilities to staff and committee members. This monitoring covers the following: the level of deposits and their distribution per time duration and per interest rate; the level of loans and whether they are within the set limits; the distribution of loans per time duration and per sector of economic activity; the level of loan excesses and arrears; the level of liquid assets; the liquidity ratio; and returns, regarding the prudential requirements of Directive 2000/12/EC, such as Own Funds, Solvency Ratio, and Large Exposures. Also, for all CCIs that are connected electronically to the central server of the Cooperative Computer Society (currently 220 CCIs, including all of the larger institutions), a uniform computerized recordkeeping and reporting system is in place that enables the supervisors to have effective and efficient access to ongoing financial information of the CCIs. Findings emerging during off-site supervision are analyzed, trended, and compared with other institutions and are verified during on-site supervision. Currently, the CSSDA is evaluating a comprehensive questionnaire that has been submitted by the CCIs regarding each institution’s current overall condition (soundness, profitability, liquidity, etc.), as well as presenting a timetable scheme for compliance with the conditions for obtaining an ongoing operating license, as part of the program to harmonize the credit cooperative system in Cyprus with the requirements of the EU.
Assessment	Materially Noncompliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management, in cooperation with the Government Personnel Department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDA’s on-site work, but do not mitigate the need for completion of planned expansion and development of staff. Also, the CSSDAs ability to perform off-site supervision/monitoring is materially impacted by the limited size of the staff in the Supervision Division. Currently, this deficiency is somewhat mitigated by the oversight work performed the Development Division; but, for the longer-term, Supervision Division staff should be augmented permanently.
Principle 17.	Bank Management Contact Banking supervisors must have regular contact with bank management and a thorough understanding of the institution’s operations.
Description	The AOCS (which is responsible for performing the annual audit of the institutions’ accounts) submits to the Commissioner the audited annual report for each institution. The CSSDA’s officers hold meetings with the institution’s Committee and the external auditors to discuss the results of their work and to agree on the action/measures for corrective action. The CSSDAs officers hold meetings (e.g., during and after on-site examinations) with the institution’s committee members, department managers, and internal auditors, as well as senior management, to discuss matters relevant to the assessment of specific problems, the overall condition of the institution, and future prospects. Officers of CSSDAs Development Division have regular contact in performing their function to support the institution’s supervisory, regulatory, and operational/administrative needs. The regular contact of the officers of the CSSDAs Development Division with the CCIs for which they have specific oversight and support responsibilities provides the CSSDA with an ongoing ability to maintain current knowledge of each institution’s activities. The CSSDA’s off-site supervision/monitoring program also provides an ongoing ability to understand the institution’s activities and condition. Pursuant to Articles 12(2) and (3) of the CSL, no amendment of the by-laws (including material changes in their activities) of a registered society will be valid until the amendment has been registered under the CSL, for which purpose two copies of the amendment will be forwarded to the commissioner. If the commissioner is satisfied that any amendment of the by-laws is not contrary to the CSL or to the rules and the cooperative principles, takes into account the proper operation and financial position of the society in connection with the Cooperatives Societies general interest, registers the amendment. Also, pursuant to article 41Z (1)(b), the CSSDA’s cCommittee has the power to define, regulate, and amend with a regulative decision: the accounts, the figures, or the information that have to be submitted periodically, or on certain occasions by the CCIs that apply to obtain or hold an operating license, as well as the form, the type, and the timeframes within which these must be submitted. The issuing of a regulative decision, based on the transitional provisions of the CSL, referring to the CSI’s obligation to conform at least to their existing prudential levels and to notify the CSSDA of any material adverse developments regarding those prudential levels, is underway.
Assessment	Largely Compliant.
Comments	The CSSDA should complete the issuance of its planned Regulative Decision to specifically require that each CCI notify it in a timely manner of any material changes in its activities and any adverse developments.
Principle 18.	Off-Site Supervision Banking supervisors must have a means of collecting, reviewing, and analyzing prudential reports and statistical returns from banks on a solo and consolidated basis.
Description	Pursuant to Article 3(5) of the CSL, “… the Commissioner … has the power to inspect the books, accounts, and documents of a registered society and every officer of such society shall provide the necessary facilitations and all of the requested information for such inspection.” Article 41JC empowers the Commissioner “… to demand and collect information useful for exercising his powers pursuant to the cooperative law, and to demand through a written request the submission of this information within the set deadline, from registered cooperative credit institutions, their subsidiary companies, members of their committee or their board or the members of their Supervisory Board.” This article also provides administrative sanctions for failure to comply with such requests or to fail to supply complete and accurate information or within prescribed timeframes. Information requested covers only the CCIs themselves, since they have no subsidiaries or affiliated companies. Supervision is carried out through off-site monitoring and on-site examination. Off-site supervision/monitoring is conducted and information is collected only on a solo basis, since cooperative societies do not currently have subsidiaries or affiliated companies. This monitoring covers the following: the level of deposits and their distribution per time duration and per interest rate; the level of loans and whether they are within the set limits; the distribution of loans per time duration and per sector of economic activity; the level of loan excesses and arrears; the level of liquid assets; the liquidity ratio; and returns, regarding the prudential requirements of Directive 2000/12/EC, such as own funds, solvency ratio, and large exposures. The CSSDA requires the cooperative societies to submit, inter alia, the following periodic returns to facilitate its supervisory process: statistical data (monthly and annually) on: deposits by type and interest rate; loans by sector and interest rate; overdue and excess loans; maximum levels of lending and accepting of deposits; liquidity; share capital and reserves; and general expenses and revenues; balance sheet accounts (annually); profit and loss account (annually); credit facilities to the CCI’s committee members (semi-annually); loans to legal entities (quarterly); prudential requirements (own funds, solvency ration, large exposures, qualifying holdings outside the financial sector) (annually); and balance sheet information on the CCIs that are connected to the CSSDA central processing system (220 CCIs) (monthly). A range of additional detailed statistical and administrative information can be obtained from the CSSDA central processing system. All of these reports can be analyzed by CSSDA supervisory officers by individual CCI, by sector (e.g., region/geographic area), and by the entire industry. These analyses are used in the ongoing off-site monitoring, as well as in the planning and conduct of on-site examinations, of CCIs. Findings emerging during off-site supervision are analyzed, trended, and compared with other institutions and are verified during on-site supervision. The CCIs also supply statistical information to the Central Bank of Cyprus, the Cooperative Central Bank, and the Statistics Service. A series of new and redesigned prudential and statistical reports are being developed by the CSSDA that will be in better harmony with EU requirements.
Assessment	Materially Noncompliant
Comments	To date, the CSSDA’s off-site supervision/monitoring has been limited by the small number of current staff, although the Supervision Division staff is supplemented in some monitoring functions by CSSDA’s Development Division staff. CSSDA management has developed plans for augmenting overall supervision staff. There is a pressing need for the completion of planned expansion and development of supervision staff. The CSSDA is working to design and build new automated analytical/monitoring and early-warning systems that will use information provided by those CCIs that are and will be connected through the central server of the Cooperative Computer Society. Currently, the analysis uses information from existing returns and from the existing computer system. The CSSDA should proceed in a timely manner to establish a complete direct connection in order to facilitate its access to the central server.
Principle 19.	Validation of Supervisory Information Banking supervisors must have a means of independent validation of supervisory information either through on-site examinations or use of external auditors.
Description	Pursuant to article 41D of the CSL, the commissioner is responsible for supervising compliance with that law. Article 41JD empowers the commissioner or a person authorized by him “…to conduct investigations necessary for the carrying out of his competences or for a possible violation of the provided obligations in virtue of the Cooperative Law and for the purpose of this he may: a) check the records, the books, the accounts and any other documents and data stored in computers at each cooperative credit institution or in the possession of any person for whom there is reasonable suspicion that he holds information of the Cooperative Credit Institution that may assist the Commissioner in his investigation, and to take copies or extracts from them; and b) to enter the office and professional premises of the persons under investigation. Also, pursuant to Article 3(5), “… the Commissioner … has the power to inspect the books, accounts, and documents of a registered society and every officer of such society shall provide the necessary facilitations and all of the requested information for such inspection.” Article 41JC empowers the Commissioner “… to demand and collect information useful for exercising his powers pursuant to the cooperative law, and to demand through a written request the submission of this information within the set deadline, from registered co-operative credit institutions, their subsidiary companies, members of their Committee or their Board or the members of their Supervisory Board.” The scope of the both the CSSDAs on- and off-site supervisory activities includes the regular validation of the periodic supervisory information from the CCIs by the CSSDA’s Development Division, as well as its ongoing review and analysis by the Supervision/Monitoring Division. The CSSDA’s process for planning the scope and conducting on-site examinations includes assessing the results of the independent external audit and the prudential and statistical information provided by the CCIs through their periodic supervisory returns. Meetings are held following each examination to discuss the results and initiate corrective actions, as necessary. Article 19 of the CSL provides for the establishment and operation of the Inspections Service of Cooperative Societies (the independent AOCS). The Council of Ministers has issued the Cooperative Societies Audit Service Regulations (174/89, 14/92, 328/91, 115/98). The accounts of all CCIs are audited annually by the independent Audit Office of Cooperative Societies, a group within the Office of Auditor General of Cyprus. These audits are both financial audits and overall management/performance audits. They address credit/compliance/ operational/ funding risk, as well as the financial audit of the society’s financial statements. CSSDA officers participate in the independent AOCS’ meetings with CCI management following each audit and provide support for the CCI’s actions to correct identified deficiencies.
Assessment	Largely Compliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for seventeen percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s, management in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDA’s on-site work, but do not mitigate the need for completion of planned expansion and development of staff.
Principle 20.	Consolidated Supervision An essential element of banking supervision is the ability of the supervisors to supervise the banking group on a consolidated basis.
Description	Currently, CCIs do not have subsidiaries or affiliated companies.
Assessment	Not Applicable.
Comments	However, pursuant to Article 41D (1)(e) of the CSL, the commissioner is responsible for supervising the compliance of the registered societies that will become affiliated to the Central Body with the provisions of the CSL, for the purposes of consolidated supervision.
Principle 21.	Accounting Standards Banking supervisors must be satisfied that each bank maintains adequate records drawn up in accordance with consistent accounting policies and practices that enable the supervisor to obtain a true and fair view of the financial condition of the bank and the profitability of its business, and that the bank publishes on a regular basis financial statements that fairly reflect its condition.
Description	Articles 53(jb), (jc), and (jd) empower the Council of Ministers to issue rules for the better application of the provisions of the CSL and for the determination of every issue where determination is necessary. Such rules may: prescribe the accounts and books to be kept by a registered society, and provides for the periodical publication of a balance sheet showing the assets and liabilities of a registered society; provide for the audit of the accounts of registered societies and for the charges, if any, to be paid for such an audit; and prescribe the returns to be submitted by registered societies to the commissioner and the persons by whom and the form in which the same shall be submitted. Article 19, which provides for the establishment and operation of the Inspections Service of Cooperative Societies (the independent Audit Office of Cooperative Societies), also provides for the annual audit of every CCI by it and requires that the accounts of the CCIs must be ready for audit within one month from the end of its economic year. The audit report must be provided to the CCI and to the commissioner upon its completion. The CCI provides information on the results of the audits to its management and members. Regulative Decision 59/2005 regarding the publishing of the annual accounts of CCIs states that accounts must be prepared and audited to establish a “true and fair view,” in accordance with international auditing and accounting standards. Article 41JC empowers the commissioner to demand and collect information useful for exercising his powers pursuant to the CSL, and to demand through a written request the submission of this information within a set deadline, from registered cooperative credit institutions, their subsidiary companies, members of their committee or their board or the members of their supervisory board.
Assessment	Compliant.
Comments	None.
Principle 22.	Remedial Measures Banking supervisors must have at their disposal adequate supervisory measures to bring about timely corrective action when banks fail to meet prudential requirements (such as minimum capital adequacy ratios), when there are regulatory violations, or where depositors are threatened in any other way. In extreme circumstances, this should include the ability to revoke the banking license or recommend its revocation.
Description	Article 41D (1)(d) of the CSL empowers the commissioner “… to take remedial measures, to cease the Committee or any officer, and to appoint a liquidator of registered societies that carry out the activities of a cooperative credit institution.” Article 41(D)(2)(a) authorizes the commissioner to suspend or withdraw operating licenses and articles 41D (2)(c) and 41JE both authorize the imposition of administrative sanctions. Article 41F (3) and (4) empower the commissioner to withdraw the license of a CCI when anyone associated with the CCI fails to comply with the law, of any rule, order, or decision, or the terms of the license, or when the liquidity or solvency are diminished, or when the depositors or creditors’ interests must be secured, as well as a range of other formal and informal remedial measures. Article 41F (3)(e) authorizes the commissioner to demand the removal or alteration of the duties of any CCI officer or employee and Article 43 describes the circumstances when and authorizes the commissioner to dismiss thecommittee of a CCI. The range of remedial measures available can be used in a timely manner commensurate with the severity of the issues involved. Actions may be taken against the institution, as well as against the individuals involved in the management and direction of it.
Assessment	Compliant.
Comments	None.
Principle 23.	Globally Consolidated Supervision Banking supervisors must practice global consolidated supervision over their internationally active banking organizations, adequately monitoring and applying appropriate prudential norms to all aspects of the business conducted by these banking organizations worldwide, primarily at their foreign branches, joint ventures, and subsidiaries.
Description	Currently, CCIs do not have overseas activities, joint ventures, or foreign branches or subsidiaries.
Assessment	Not Applicable.
Comments	However, pursuant to article 41G (1)(d) of the CSL, the committee of the CSSDA has the power to define, regulate, or amend, within the framework of the EU’s acts that are in force in Cyprus, the conditions or terms of the operations of the branches or of the provision of cross-border services by registered societies that carry out the business of a cooperative credit institution in a member state or a third country.
Principle 24.	Host Country Supervision A key component of consolidated supervision is establishing contact and information exchange with the various other supervisors involved, primarily host country supervisory authorities.
Description	Currently, CCIs do not have overseas activities, joint ventures, or foreign branches or subsidiaries.
Assessment	Not Applicable.
Comments	However, pursuant to Article 41D (1)(c) of the CSL, the commissioner is responsible for “…the cooperation, exchange of information, verification of data, assigning or undertaking of the responsibility of prudential supervision of the co-operative credit institutions or of their subsidiaries or of other societies that appertain to the Commissioner’s powers, with other competent supervisory authorities of a member state or of a third country, provided that the communicated information is covered, as regards to the professional secrecy, by guaranteed liabilities.”
Principle 25.	Supervision Over Foreign Banks’ Establishments Banking supervisors must require the local operations of foreign banks to be conducted with the same high standards as are required of domestic institutions and must have powers to share information needed by the home country supervisors of those banks for the purpose of carrying out consolidated supervision.
Description	Currently, there are no branches or subsidiaries of foreign credit cooperative societies in Cyprus.
Assessment	Not Applicable.
Comments	However, pursuant to Articles 41(D)(b) and (c) of the Cooperatives Societies Law, the commissioner is responsible for “. the cooperative credit institutions that have established a branch or that provide cross-border services to the Republic, the control of liquidity, the market risk, as well as the abiding by these to the principles set from time to time as to the monetary policy…” and “… the cooperation, exchange of information, verification of data, assigning or undertaking of the responsibility of prudential supervision of the cooperative credit institutions or of their subsidiaries or of other societies that appertain to the Commissioner’s powers, with other competent supervisory authorities of a member state or of a third country, provided that the communicated information is covered, as regards to the professional secrecy, by guaranteed liabilities.”

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Table 4.

Detailed Assessment of Compliance with the Basel Core Principles (CSSDA)

Principle 1.	Objectives, Autonomy, Powers, and Resources An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks. Each such agency should possess operational independence and adequate resources. A suitable legal framework for banking supervision is also necessary, including provisions relating to the authorization of banking establishments and their ongoing supervision; powers to address compliance with laws, as well as safety and soundness concerns; and legal protection for supervisors. Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Principle 1(1)	An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks.
Description	There are 358 cooperative credit institutions (“CCI”) with limited or unlimited liability and 104 non-credit limited liability cooperatives. They operate in various sectors (banking, consumer, trading of agricultural products and services), and are shareholders-members of the Cooperative Central Bank (CCB). The CCIs have as their main objective the extension of credit and the provision of services to their members in accordance with the cooperative principles of mutual help and assistance. The activities and supervision of the 358 CCIs are regulated according to the contents of the Cooperative Societies Laws of 1985 to 2004 (“CSL”), by their own supervisory authority—the Cooperative Societies Supervision and Development Authority (“CSSDA”). However, the CCB, being the apex of the cooperative movement (CM) in Cyprus, has a dual status for it is also a bank for the purposes of the Banking Law (“BL”) and is therefore supervised by the Central Bank of Cyprus (CBC), as well as the CSSDA. It acts as the banker to the CCIs by accepting their surplus funds as deposits, granting loans to those CCIs in need of liquidity and delivering general support services. The locus of lender-of-last-resort responsibilities of the CCB is generally governed by Article 26 of the CSL, and it will be regulated in detail by the Committee of the CSSDA according to Article 94 of the Cooperative Societies Rules of 1985 to 2004, that authorizes the committee to issue further detailed prudential instructions on the matter. According to article 41D of the CSL the Commissioner of the CSSDA is responsible for the supervision of the CCIs and the application of the CSL. Part VI A of the CSL provides a framework of minimum prudential standards addressing issues such as: licensing conditions; minimum capital; capital adequacy ratio; organizational and management requirements (“four-eyes” principle, fit-and-proper character); shareholder requirements; exposure restrictions; connected lending limits; prudential reporting; on-site examinations; administrative sanctions; remedial measures. Section 44 of the CSL authorizes the commissioner to decide on the winding up of a CCI and to nominate a liquidator to that effect. The audit of the accounts and the financial management of the individual CCIs is performed by the Audit Office of Cooperative Societies (“AOCS”), which is an independent legal entity established by Section 19.1 of the CSL and whose audit costs are covered by the examined CCIs by means of annual fees. The AOCS, which also audits the other non-credit cooperative institutions is administered by a committee composed of five members appointed by the Council of Ministers for a term of three years. At present, usually, the committee is chaired by the Auditor General of Cyprus. The auditor general also audits the financial statements of the CBC and performs the audit of the CSSDA. The CCIs have been operating in a relatively stable social and economic environment. There has been no need for implementing major structural changes since the division of the CM (into Turkish-Cypriot and Greek-Cypriot CMs) by the then British-Colonial Authorities almost half a century ago. In 1987, the audit function for the CCIs was separated from the supervisory function with the establishment of the AOCS. However, the negotiations with the EU have introduced a process of change, which led to the harmonization of policies and legislation with the EU standards and Banking Directives (BD). A five-year transitional period as from January 1, 2003 has been agreed upon by the EU within which all CCIs will be compliant with the BD. In this context, the CSL has been modified in 2003 and 2004 in order to ensure full conformity with the acquis communautaire. A two-layered approach will be followed with a number of CCIs complying individually on a stand-alone basis with the remaining CCIs complying by becoming affiliates of the CCB (called the “Central Body”). However, any conforming CCI can also join the permanent affiliation arrangement if it so wishes. The Central Body arrangements will be introduced within the context of the permanent affiliation arrangements set out in Article 2, paragraph 5 of the BD 2000/12/EC where the CCB, as the “Central Body,” and the affiliated CCIs will have to satisfy the provisions on a consolidated basis. The supervisory framework of the affiliated CCIs will be as follows: the affiliated CCIs will be supervised by their own supervisory authority (the CSSDA) as stated in Section 41D of the CSL; simultaneously, and according to Section 35 of the Banking Law (BL), the affiliated CCIs are subject to the provisions of the BL to the extent that this is considered necessary for the CBC to exercise supervision on a consolidated basis. Therefore, the CSSDA will have to provide the CBC with all the necessary data and information regarding affiliated CCIs and will participate in joint on-site examinations of the affiliated CCIs. On the other hand, the CCB, being the Central Body of the affiliated CCIs, is empowered to supervise these affiliated CCIs explicitly and only for the purposes of the permanent affiliation arrangements and in accordance with the provisions of the BD. The CCB/Central Body has no authority to perform prudential supervision but will have the power to monitor their solvency and liquidity as well as to issue compulsory instructions to the affiliated CCIs that would include concrete management issues covering administrative, organizational, and operational areas (e.g., internal audit, risk management, credit policy, etc.). These instructions to be issued by the Central Body to the affiliated CCIs will: lay down the main principles by applying generally accepted banking principles and procedures in order to ensure the financial stability and competitiveness of the affiliated CCIs; and be general and be directed towards all CCIs except in cases where due to reasons relating to their size and/or other reasons it is considered necessary to issue specially-formulated or modified instructions. On the other hand these instructions are not intended to: aim at full control of the CCIs nor will they cover routine operations (their routine operations will be conducted in accordance with the CCIs’ internal control procedure manuals); replace or reduce the role and authority of the CCIs’ management but rather form the basis for a framework under which the Central Body will be offering support and conducting the required monitoring and control in specific areas and operations which are important; alter the authority and powers of the CSSDA or their authority and independence; or replace the supervisory and prudential instructions issued by the CSSDA. Furthermore, the law requires that before such instructions are issued, the Central Body will have to consult the commissioner and collaborate with him in order to assure full conformity with the legal and regulatory framework of the CCIs. The CSSDA and the Central Body are also to collaborate systematically in order to resolve any pending issues and problems so as to meet their respective duties and obligations. A Memorandum of Understanding has been signed between the CBC and the CSSDA under which it was decided that the supervision of the CBC over the CCB has to take into account the permanent affiliation arrangements of the CCB as a Central Body with the affiliated CCIs. The arrangements for the CBC’s supervision of the CCB and its affiliates on a consolidated basis are governed by the BL and Article 5A (3)(b) of the CSL. The CSSDA’s annual report highlights the financial situation of the CCIs and informs the reader on regulatory developments. A new website in English is also under construction.
Assessment	Materially Noncompliant.
Comments	A comprehensive transitional regulatory and supervisory system has been set in place that will require every CCI to conform to the EU-banking directives before the end of 2007. During this transitional period, the CCIs are allowed to continue their existing business within Cyprus under the CSL without any restrictions or conditions, with the result that the cooperative credit sector will not be fully compliant with the EU banking directives during that period. However, and pursuant to Section 2 of the transitional provisions of the CSL, the CCIs have been asked to inform the CSSDA on the measures they intend to take in order to comply with the upcoming prudential requirements. The CSSDA has also developed a monitoring system of a number of prudential issues for each CCI (e.g., “four-eyes” principle, capital, large exposures, connected lending, etc.). Although, prima facia, there is a basic framework of prudential standards in the law and supporting regulations, the arrangements for the transitional period that is currently progressing fundamentally restricts the full, proper enforcement of and supervision under them. The mission has been informed that a sample of CCIs representing different types of CCIs will probably decide without further delay on their affiliation. This will enable the CCB to start a pilot project in the second half of 2005, the benefits of which will then be extended to the rest of the CCIs that chose to affiliate with the CCB. It is therefore recommended that the ongoing efforts in order to accelerate the affiliation process be further stepped up, particularly the formulation of the rules governing the affiliation of the non-conforming cooperatives with the CCB. The mission has also been informed of the ongoing efforts of the CCB and the CSSDA to encourage mergers in the cooperative credit sector in order to enhance the critical mass and economies of scale that will be required in view of the upcoming regulatory and supervisory reinforcement. These dramatic regulatory changes and the many players involved also highlight the need to organize and manage the change process very closely. The mission therefore recommends that the work of the different working groups and committees be coordinated under the umbrella of a global change committee.
Principle 1(2)	Each such agency should possess operational independence and adequate resources.
Description	According to the CSL, the Minister of Commerce and Industry supervises the cooperative societies and is authorized to give instructions to the Commissioner of the CSSDA regarding the exercise of his powers. However, Section 3(2) explicitly exempts the CCIs from the application of this requirement and Section 41D (1) of the CSL confers the responsibility for supervising the CCIs to the commissioner. The commissioner is appointed by the Council of Ministers for a period of five years with the possibility of renewal. He is not allowed to hold any other position or public office in Cyprus or be employed against remuneration in the private sector. The commissioner is the presiding officer of the CSSDA. He chairs the Committee of the CSSDA, which is composed of the commissioner or his deputy (the senior director) and four other members appointed by the Council of Ministers for a term of five years. The committee is responsible for determining the strategy and policy of the CSSDA and for the regulation of CCIs according to specific provisions of the CSL. The operational services of the CSSDA are composed of a recently established Supervision Department (7 staff) and a Development Department (33 staff). This picture has to be completed by mentioning that staff of the development department are assuming tasks that are related to the supervisory area (e.g., continuous monitoring of CCI’s compliance with the CSL, validating prudential returns, input of data into the central data system). The supervison division of the CSSDA also profits to some extent in its supervisory function from the intense contacts of support staff with the CCIs which increases the staff’s understanding of the individual CCIs. The intelligence so acquired is subsequently used in the on-site supervisory process. However, the recent character of the Supervision Department and the limited number of its staff illustrate that in the past the activities of the CSSDA were mainly, if not exclusively, directed to support the great number of very small CCIs (50 CCIs out of 360 account for 75 percent of the assets of the sector ). In the past, the activities of the CSSDA centered on monitoring of CCI’s compliance with the old CSL (before its harmonization with EU directives), as well as the development and support of the CCIs. However, against the backdrop of the dramatic regulatory and supervisory changes described under the assessment of Principle 1(1), which will have to materialize in the near future, the CSSDA has developed, in cooperation with the governmental personnel department, a transition plan providing for 17 additional staff. Fourteen will reinforce the supervisory staff, tripling the present supervisory resources. A number of these additional staff will fill existing vacancies and pending their entry the supervisor tends to hire nonpermanent experienced staff in order to meet the most urgent needs. The plans call for upgrading the salary levels of both officers and staff. The salary scales of the CSSDA are equivalent to government salary scales. However, the public sector salaries are considered to be higher than the private sector salaries, at least as far as the entry level is concerned. Therefore, hiring additional staff with adequate academic and professional background is reportedly not to be problematic. According to Section 4(6)(c) of the CSL, the commissioner shall have at his disposal the financial means necessary for the unobstructed and immediate exercise of the duties imposed upon him by the CSL regarding the supervision and control of the CCIs. In view of the future regulatory and supervisory changes the CSSDA liaises intensively with the CBC. A six-month training program has been organized during which four CCIs have been submitted to joint on-site examinations. The CSSDA also combines its efforts with the CBC and the CCB in preparing for the new supervisory and regulatory environment. Also, the establishment of the affiliation arrangements will allow the progressive transfer of a great deal of the support efforts of the CSSDA to the Central Body (the CCB). The latter process will also allow CSSDA staff involved in the development area to switch to the supervisory sector. An Administrative Co-operation Program between Cyprus and the European Union has been set up in order to provide for technical assistance for the effective supervision of co-operative credit institutions (Twinning Light Project). The project will cover a period of five months and should start no later than September 2005. The specific objectives aim at strengthening the administrative capacity of the CSSDA for effective on-site and off-site supervision, including the enhancement of electronic monitoring, based on the relevant acquis communautaire as well as on the supervisory principles of the Basel Committee, taking into account the common position agreed upon with the EU. The Commissioner may also contract or hire lawyers, auditors or other professional experts related to the execution of its legal duties. However, the Commissioner has not yet done this. The Commissioner’s mandate may only be terminated by the Council of Ministers when he no longer fulfills the conditions required for the execution of his duties or when he has committed a serious offence.
Assessment	Materially Noncompliant.
Comments	The annual budget of the CSSDA is prepared by the Committee and then forwarded to the Council of Ministers through the Ministry of Finance and, finally, submitted to and approved by the House of Representatives. This may raise questions and doubts about the financial independency of the supervisory authority. The matter is especially sensitive since the supervisory capacity of the CSSDA must be developed in a very substantial way in order to cope with the new regulatory environment. The number of required additional staff is testimony to that. The mission therefore recommends that the government proceed without further delay with the execution of the various plans in order to strengthen the supervisory capacity of the CSSDA.
Principle 1(3)	A suitable legal framework for banking supervision is also necessary, including provisions relating to authorization of banking establishments and their ongoing supervision.
Description	As stated above, the CSL confers the responsibility for supervising the CCIs to the commissioner and gives him the power to grant or revoke the license. Article 41J of the CSL allows the Council of Ministers to set prudential rules and also to delegate this power to the Committee of the CSSDA. By Regulative Administrative Act N°110/2004, published in the Official Gazette on February 27, 2004, the Council has delegated this power to the Committee. The committee has made an extensive use of this power in the past and continues to do so as is shown in the descriptions of other principles. Also, article 41G of the CSL empowers the committee to make additional rules for the CCIs. Article 41JC (1) of the law gives the commissioner the power to demand and collect information useful for the exercise of his power pursuant to the cooperative law (see also Principle 16).
Assessment	Compliant.
Comments	None.
Principle 1(4)	A suitable legal framework for banking supervision is also necessary, including powers to address compliance with laws, as well as safety and soundness concerns.
Description	Article 41D of the CSL enables the commissioner to address compliance with the CSL and the safety and soundness of the CCIs. The commissioner is allowed to exercise qualitative judgment in the forming of his/her opinion. The commissioner has also the right to conduct audits and collect information [Article 41D (2)(b)]. The Commissioner also has the power to take prompt remedial measures or impose sanction, including the revocation of the license when a CCI is not complying with laws and regulations or is engaged in unsafe or unsound practices [Articles 41F (3) and 4 and 41JH].
Assessment	Compliant.
Comments	None.
Principle 1(5)	A suitable legal framework for banking supervision is also necessary, including legal protection for supervisors.
Description	According to Section 4(5) of the CSL, the commissioner and the supervisory staff are exempt from any civil liability regarding any action or omission in exercising their duties and powers unless it is proven that the action or omission was performed in bad faith involved serious negligence. The defense of CSSDA staff against lawsuits rests with the Office of the Attorney General and all legal expenses incurred are covered by the Cyprus government.
Assessment	Compliant.
Comments	None.
Principle 1(6)	Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Description	According to Section 41D (1)(c), the commissioner is allowed to cooperate and share information with other local or foreign agencies, provided that this information is treated as confidential by the receiving agency. A Memorandum of Understanding has been signed between the CBC, the Cyprus Securities and Exchange Commission, the Insurance Companies’ Control Service, and the CSSDA. The memorandum came into effect on January 1, 2003. This Memorandum is based on the application of Articles 41D (1)(c) and 41H of the CSL, which allows the competent supervisory authorities of the financial sector to cooperate and exchange information between them and/or with other supervisory authorities, whether in Cyprus or elsewhere, with a view of discharging their functions and responsibilities in a more effective manner. Any exchange of information will only take place when the CSSDA is satisfied that the information provided is subject to the same confidentiality rules in the hands of the receiving competent supervisory authority as apply to the CSSDA. The information exchange between the competent supervisory authorities is exclusively used in the discharge of their functions and responsibilities and is subject to confidentiality rules in the hands of the receiving supervisory authority as applied to the supervisory authority which provides the information on the basis of legislation in force from time to time. Confidential information exchanged between the competent supervisory authorities on the basis of the legislation in force may not be disclosed without the expressed agreement of the competent supervisory authority which disclosed it and, where appropriate, solely for the purposes for which this authority gave its agreement. As stated above, in view of the future regulatory and supervisory changes, the CSSDA liaises intensively with the CBC. A six-month program has been organized during which four CCIs have been submitted to joint on-site examinations. The CSSDA also combines its efforts with the CCB in preparing for the new supervisory and regulatory environment. Also, the establishment of the affiliation arrangements will allow the progressive transfer of a great deal of the support efforts of the CSSDA to the Central Body (the CCB). The latter process will also allow CSSDA staff involved in the development area to switch to the supervisory section. According to Section 41H (1), the Commissioner, the Committee, and the staff of the CSSDA are to preserve the confidentiality of the information in their possession and may only use this information within the exercise of their duties.
Assessment	Compliant.
Comments	None.
Principle 2.	Permissible Activities The permissible activities of institutions that are licensed and subject to supervision as banks must be clearly defined, and the use of the word “bank” in names should be controlled as far as possible.
Description	Article 1 of the CSL defines a CCI as a society whose business it is to receive deposits or other repayable funds from the public, to grant credit for its own account, or to provide electronic money services. The CSL further stipulates (Section 41A 1) that only licensed cooperative credit institutions established in Cyprus or in an EU member state or a third country may carry out the business of accepting deposits. The Committee of the CSSDA is mandated to define the services or activities that the CCIs are allowed to offer or exercise. The CSSDA plans to issue a Regulatory Decision on this. The licensed CCI is required to mention at a distinct point near its name, on its stationary and on any other document used in receiving money, on its annual accounts, on leaflets of provided services, or on internet websites, whether it operates as a stand-alone CCI or as a CCI affiliated with the “Central Body.” The use of the phrase “cooperative credit institution” is not currently protected, but the protection of the word “cooperative” which is part of that phrase may provide protection. According to Section 55.1, the use of any name of which the word “cooperative” forms part is also prohibited without the sanction of the Council of Ministers. Contravening this provision represents a criminal offense.
Assessment	Materially Noncompliant.
Comments	The Committee should complete the issuance of its Regulatory Decision defining the services or activities that the CCIs are allowed to offer or exercise.
Principle 3.	Licensing Criteria The licensing authority must have the right to set criteria and reject applications for establishments that do not meet the standards set. The licensing process, at a minimum, should consist of an assessment of the banking organization’s ownership structure, directors and senior management, its operating plan and internal controls, and its projected financial condition, including its capital base; where the proposed owner or parent organization is a foreign bank, the prior consent of its home country supervisor should be obtained.
Description	Article 41F (1) of the CSL authorizes the CSSDA to set criteria for licensing the CCIs. These criteria are set in the CSL [Article 41B (1)]. According to Section 41E, these criteria are to be complied with on a continuous basis. The commissioner retains the right to reject a license application. He also has the authority to amend or withdraw any imposed terms or to impose any new terms on an existing license (Article 41F). The commissioner verifies the organizational structure, and he satisfies himself that the CCI provides all the necessary guarantees or conditions for the execution of an effective supervision [Article 41B (1) (ii)]. The shareholders-members of the CCIs are individuals. The CCIs are non-profit motivated organizations governed by the one-member-one vote principle with each entity having its own committee elected from among the members. Article 41B (1)(a)(iii) of the CSL also stipulates that the license shall only be granted if the CSSDA is satisfied with the fit-and-proper character of members that hold a percentage of capital that exceeds 10 percent. In practice, this situation does not exist, and as stated above the cooperative system is based on the one- member,-one-vote principle. A minimum initial amount of capital in Cyprus pounds of an equivalent of one million Euros is required by Article 41B (i). The CSL also requires the CCI to be directed by at least two persons with the necessary expertise and skills in order to effectively define the orientation of the activities, a good administrative and accounting organization, and a proper internal control system [Article 41B (ii)]. According to Article 41B (iv) the applicant CCI shall also have to satisfy the commissioner that it shall have prior to the commencement of its activity the requisite financial capacity and liquidity to achieve the proposed program of activities that is submitted with its application. A CCI of a EU-member state has the right to exercise its activities in Cyprus, defined in the Appendix of the CSL, either by establishing a branch or via cross-border services, if the following conditions are met: for a branch: (e.g.,) licensed by the home-member state, the activities that will be undertaken are compatible with the home license and contact is to be taken with the home supervisor; for cross-border provision of services: the presence of a home license and the intended activities should be consistent with the intended license. CCIs from third countries (i.e., nonEU member states) have the right to exercise activities in Cyprus if the conditions of article 41B (1) are met. The commissioner has the right to withdraw a license at any time if it is established that the license has been obtained on false statements or by concealed substantial evidence [Article 41F (4)].
Assessment	Compliant.
Comments	Currently, the necessary regulatory framework is in place. Existing CCIs have a transition period in which to decide whether to affiliate with the Central Body or continue to stand-alone.
Principle 4.	Ownership Banking supervisors must have the authority to review and reject any proposals to transfer significant ownership or controlling interests in existing banks to other parties.
Description	According to the Cooperative Laws (Articles 6 and 7), each Cooperative Credit Institution (CCI), which may have either limited or unlimited liability, is independent and self-governing. Where the liability of the members of a Cooperative Credit Institution is limited by shares, no member, other than a registered cooperative society, shall hold a portion of the share capital of the institution which exceeds the maximum limit prescribed by the CSL, which in percentage shall not exceed one-fifth of the share capital of the institution. Irrespective of the liability or the shareholdings of a CCI, each member holds only one vote. It is apparent that under the present legal framework the subsidiary status based on controlling interest cannot exist. As stated above, Section 41B (1)(a)(iii) of the CSL also stipulates that the license shall only be granted if the CSSDA is satisfied with the fit-and-proper character of members that hold a percentage of capital that exceeds 10 percent. In practice, this situation does not exist, and, as stated above, the cooperative system is based on the one- member, one-vote principle. According to Section 41E, these criteria are to be complied with on a continuous basis.
Assessment	Not applicable.
Comments	Given the existing legal framework, controlling interests cannot exist for CCIs.
Principle 5.	Investment Criteria Banking supervisors must have the authority to establish criteria for reviewing major acquisitions or investments by a bank and ensuring that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision.
Description	Under Article 40(a) of the CSL, with the approval of the Commissioner, each CCI is allowed to use its funds for the purchase of immovable or movable property necessary for the execution of the purposes for which the society was incorporated. Under article 41J (e) of the CSL, the Council of Ministers, within the framework of the European Community’s Acts, may define the limits of the participation in other enterprises of the CCI that applies for or holds a license. The Council of Ministers has duly delegated this authority to the committee. Against the general backdrop of the ongoing implementation of the EU regulations, it is the committee’s firm intention to issue a Regulatory Decision according to the above article to adopt the relevant provisions of Directive 2000/12/EC in 2005, with regard to the limits of participation in other enterprises. A participation in a company outside the financial sector, exceeding 10 percent of the capital of that company will be considered as a qualifying holding, which should not exceed 15 percent of the own funds of the CCI. The aggregate portfolio of qualifying participations in nonfinancial-sector companies must not exceed 60 percent of the own funds of each CCI. The mission has been informed that the introduction of these limits will not present a problem for the CCIs. At present, few CCIs hold qualified participations in non-financial institutions. However, these participations are well below the 15 percent limit that will be introduced in the future.
Assessment	Largely Compliant.
Comments	The committee should complete the issuance of its Regulatory Decision regarding participation in other enterprises. This decision should incorporate the provisions of Directive 2000/12/EC with respect to participations outside the financial sector. Before granting its approval for any new acquisition by a CCI, the CSSDA will require that any new acquisitions and investments do not expose the CCI to undue risks or hinder effective supervision. The CCI will have to demonstrate that it has, from the outset, adequate financial and organizational resources to handle the acquisition/investment.
Principle 6.	Capital Adequacy Banking supervisors must set minimum capital adequacy requirements for banks that reflect the risks that the bank undertakes, and must define the components of capital, bearing in mind its ability to absorb losses. For internationally active banks, these requirements must not be less than those established in the Basel Capital Accord.
Description	Following the accession of Cyprus to the EU, the Regulative Directive 58/2005 of the CSSDA’s Committee introduced a risk-based capital requirement regime applicable to CCIs based on the provisions of Directive 2000/12/EC (Official Gazette February 11, 2005). This directive was drafted in cooperation with the CBC and the CCB. The CSSDA Directive is comparable with the CBC’s Directive. However, the following differences are to be mentioned: a) the minimum ratio requirement is set at 8 percent, based on the EU Directive 200/12/EC minimum requirements (compared to 10 percent for the banking sector); b) Tier 2 capital includes two additional items, i.e., members reserve liability and uncalled capital based on Article 36 of the EU Directive 2000/12/EC; c) Tier 1 capital includes an item regarding reserves for general banking risks, and Tier 2 does not include an item regarding general provisions for bad debts (approach based on the EU Directive mentioned above). The mission was also informed that the committee has approved a new Regulative Directive introducing CAD II. This decision was published in the Official Gazette in April 2005 (Regulative Administrative Act No. 195/2005). This directive tends to fully harmonize the CSSDA’s capital requirements with EU Directives 93/6/EEC as amended by Directives 98/31/EC, 98/33/EC, 2002/87/EC and 2004/39/39. It has also been drafted in collaboration with the CBC. Again, the CSSDA has followed the same approach as the CBC with the same differences as for CAD I (a, b, and c) as described above. The risk profile of the CCIs is determined by their main function, which is the acceptance of deposits and granting of loans to the members of the cooperative system in their particular area of operations. The total membership of the cooperatives covering the multiple activities in Cyprus has exceeded 500,000, whereas membership of CCIs totals around 358,000. Should a licensee’s capital fall below the minimum capital ratio, Article 41D empowers the commissioner to impose the necessary measures.
Assessment	Largely Compliant.
Comments	The CSSDA should require reporting on CCIs’ capital ratios and their components at least semi-annually. Current reporting is only on an annual basis.
Principle 7.	Credit Policies An essential part of any supervisory system is the independent evaluation of a bank’s policies, practices, and procedures related to the granting of loans and making of investments and the ongoing management of the loan and investment portfolios.
Description	The assets created in the normal course of the business of CCIs are generally limited to home mortgage loans, personal/consumer loans, and small business/professional loans granted mainly to their members, mostly on a collateralized or guaranteed basis. Pursuant to Article 37 of the CSL Societies Law, loans to any non-members of any CCI must be approved by the commissioner. Individual CCIs do not normally make investments directly. Article 40(a) of the CSL requires that each CCC invest its excess funds in government securities or deposit the excess funds in the Cooperative Central Bank, which is regulated and supervised by the Central Bank of Cyprus and the CSSDA, or, with the consent of the commissioner, in any other bank. Consequently, credit risk for CCIs is limited and investment risk is moderated. Article 41JA of the CSL sets maximum limitations and controls for large exposures and exposures to connected parties. According to Rules 58(2), internal maximum lending limits must be included in the CCIs by-laws. By-laws are approved by the general meeting of the members and are subject to the approval of the commissioner. The Commissioner’s Directives 3-01 and 3-02, regarding the basic principles for the internal procedures and internal control systems of CCIs, require that CCIs have established well-documented credit policies, practices, and procedures. CSSDA supervisors determine whether these directives are implemented by each CCI. The CSSDA reviews and evaluates compliance with pertinent legal and prudential requirements through both off-site supervision/monitoring and on-site examination. In the course of on-site examinations, the CSSDA examiners review extensively the credit procedures, practices, and administration policies of the CCI. These include the appraisal and authorization of individual credit exposures, procedures for identification of substandard lending, and provisioning policy. The examinations also include evaluation of internal systems and procedures for record keeping and control. The CSSDA monthly and annually collects and analyzes information on loans, by sector of economic activity, interest rate duration, and security, as well as overdue and excess exposures.
Assessment	Materially Noncompliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDA’s on-site work, but do not mitigate the need for completion of planned expansion and development of staff.
Principle 8.	Loan Evaluation and Loan-Loss Provisioning Banking supervisors must be satisfied that banks establish and adhere to adequate policies, practices, and procedures for evaluating the quality of assets and the adequacy of loan-loss provisions and reserves.
Description	As stated above, the assets created in the normal course of business of CCIs are generally limited to home mortgage loans, personal/professional loans, and small business/professional loans granted to their members, mostly on a collateralized or guaranteed basis. Pursuant to Article 37 of the CSL, loans to any nonmembers of any CCI must be approved by the commissioner. Individual CCIs do not normally make investments directly. Article 40(a) of the CSL requires that each CCC invest its excess funds in government securities or deposit the excess funds in the Cooperative Central Bank, which is regulated and supervised by the Central Bank of Cyprus and the CSSDA, or, with the consent of the Commissioner, in any other bank. Consequently, credit risk for CCIs is limited and investment risk is moderated. The Commissioner’s Directives 3-01 and 3-02, regarding the basic principles for the internal procedures and internal control systems of CCIs, require that CCIs have established well-documented credit policies, practices, and procedures. CSSDA supervisors determine whether these directives are implemented by each CCI during on-site examinations. One of the prime objectives of these examinations is to assess the quality of the assets of the CCIs. In the course of an on-site examination, the CBC examiners review extensively the bank’s lending practices, its credit granting standards, and the level and adequacy of provisions. CCIs themselves are required to review individual credits, asset classifications, and provisioning, including those for both on- and off-balance sheet exposures, at least annually. In addition, the external AOCS, when conducting the annual audit of each CCI’s financial statements and management/ performance, reviews its provisioning policies and adequacy. During the course of on-site examinations, the CSSDA examiners assess the quality of assets individually, especially major loan accounts, and the level and adequacy of provisions and compare their results with those of the CCI under examination. CSSDA examiners review a sample of at least 30 percent of the balance sheet value of CSI credit exposures; the sample selected is biased towards large or problematic loans and includes both on- and off-balance sheet exposures. Each borrower selected is individually assessed, together with connected persons, by account, collateral held, financial condition, and other pertinent factors. Then, according to the risk entailed, each account is classified on the basis of CSSDA’s established asset quality classification criteria. These classifications are Pass, Special Mention, Substandard, and Doubtful; the definition of the characteristics of each of these classifications is very comparable to the definitions of similar classifications that are used by other competent supervisory authorities worldwide, as is the approach to evaluating the adequacy of provisioning.
Assessment	Materially Noncompliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDAs on-site work, but do not mitigate the need for completion of planned expansion and development of staff. The CSSDA should provide for additional regular reporting, in relevant detail, from CCIs on a broader range of credit-related matters (e.g., classification of credits and other assets, non-performing assets, provisioning, assets with suspended interest, etc.) and include such reporting in its ongoing analysis of each CCI.
Principle 9.	Large Exposure Limits Banking supervisors must be satisfied that banks have management information systems that enable management to identify concentrations within the portfolio, and supervisors must set prudential limits to restrict bank exposures to single borrowers or groups of related borrowers.
Description	Pursuant to Article 41JA of the CSL: 1) It is forbidden for a registered cooperative credit institution, with the exceptions of the institutions affiliated with the Central Body: (a) to allow the total value of exposures to a client or group of connected clients to exceed 25 percent of its own funds at any time or any other lower percentage that the CSSDA Committee may from time to time define, in general or in specific for a particular category of a cooperative credit institution; (b) to allow the total value of all large exposures to exceed the eightfold of its own funds at any time or any other lower percentage that the CSSDA Committee may from time to time define, in general or in specific for a particular category of a cooperative credit institution; or (c) to allow the total value of exposure without the guarantee of collateral security granted to the members of the committee or the board or the Supervisory Board, the secretary or the manager of the said cooperative credit institution or the legal persons, in which the aforesaid or their spouses or children or grandchildren hold a percentage bigger than 10 percent of the share capital, to exceed five percent of its own funds at any time or any other lower percentage that the CSSDA Committee may from time to time define, in general or in specific for a particular category of a cooperative credit institution. 2) During the ascertainment of the obligation for compliance with the provisions of subsection (1), the CSSDA Committee is authorized to exempt totally or partly any exposure, after taking into consideration the extreme low risk entailed by the said exposure, provided that such exemption does not violate any European Community Act enforced in Cyprus. The terms “exposure,” “large exposure,” “exposure not guaranteed by collateral security,” and “group of connected clients” are specifically defined in the law in a manner that is similar to the practice in other competent jurisdictions. In the course of on-site examinations, the CSSDA examiners verify that CCIs have management information systems to timely identify concentrations within the portfolio. In addition, the CSSDA examiners assess the accuracy of management information with regard to concentrations. The CSSDA also annually collects information on large exposures and analyzes it for compliance with the law as part of its ongoing process of off-site supervision/monitoring. The CSSDA is currently revising and updating its return on large exposures.
Assessment	Materially Noncompliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management, in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDA’s on-site work, but do not mitigate the need for completion of planned expansion and development of staff.
Principle 10.	Connected Lending In order to prevent abuses arising from connected lending, banking supervisors must have in place requirements that banks lend to related companies and individuals on an arm’s-length basis, that such extensions of credit are effectively monitored, and that other appropriate steps are taken to control or mitigate the risks.
Description	Pursuant to Article 41JA of the CSL: 1) It is forbidden for a registered cooperative credit institution, with the exceptions of the institutions affiliated with the Central Body: (c) to allow the total value of exposure without the guarantee of collateral security granted to the members of the committee or the board or the Supervisory Board, the secretary or the manager of the said cooperative credit institution or the legal persons, in which the aforesaid or their spouses or children or grandchildren hold a percentage bigger than 10 percent of the share capital, to exceed 5 percent of its own funds at any time or any other lower percentage that the Committee may from time to time define, in general or in specific for a particular category of a cooperative credit institution. 2) During the ascertainment of the obligation for compliance with the provisions of subsection (1), the CSSDA Committee is authorized to exempt totally or partly any exposure, after taking into consideration the extreme low risk entailed by the said exposure, provided that such exemption does not violate any European Community Act enforced in the Republic. The terms “exposure” and “exposure not guaranteed by collateral security” are specifically defined in the law in a manner that is similar to the practice in other competent jurisdictions. Facilities to the members of the committee of the CCI and their connected persons are required to be approved by the CCI’s Committee, irrespective of the amount, without the member concerned voting on the resolution. However, there is no apparent requirement that the facilities may not be granted on more favorable terms than corresponding loans to nonrelated counterparties. Article 43(2) does permit the commissioner to deal with problems arising in connected lending to the Committee of a CCI and its related persons. Although Article 43(2) gives the commissioner general authority to deal with problems, the law should more explicitly prohibit loans to be granted on more favorable terms than corresponding loans to non-related counterparties. Following delegation of the relevant power by the Council of Ministers, Article 41J (a) of the CSL empowers the Committee of the CSSDA to regulate the computation of the capital of a CCI, but regulations do not currently provide for the deduction of connected lending exposures. CCIs are required to submit, on a semi-annual basis, a return showing all their loans related to the members of their committee or the board or the Supervisory Board, the secretary, or the manager. These are analyzed for compliance with the law as part of the off-site supervision/monitoring program. The CSSDA is currently testing a revised return on the monitoring and control of credit facilities to CCIs’ Committee members and their connected persons. In the course of on-site examinations, the CSSDA examiners verify that CCIs have management information systems to timely identify exposures to connected parties assess their accuracy.
Assessment	Materially Noncompliant.
Comments	The CSSDA should specifically require that the facilities granted to connected persons of CCIs may not be granted on more favorable terms than corresponding loans to nonrelated counterparties. Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management, in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDAs on-site work, but do not mitigate the need for completion of planned expansion and development of staff.
Principle 11.	Country Risk Banking supervisors must be satisfied that banks have adequate policies and procedures for identifying, monitoring, and controlling country risk and transfer risk in their international lending and investment activities, and for maintaining appropriate reserves against such risks.
Description	Currently, CCIs do not engage in cross-border lending and investment activities.
Assessment	Not Applicable.
Comments	However, the CSSDA has issued its Regulative Decision regarding Cross-Border Credit Transfers, pursuant to its authority under Article 41G (2) of the CSL to define the terms, conditions, and any other item that requires definition as regards the conduct of business by the credit cooperatives institutions.
Principle 12.	Market Risks Banking supervisors must be satisfied that banks have in place systems that accurately measure, monitor, and adequately control market risks; supervisors should have powers to impose specific limits and/or a specific capital charge on market risk exposure, if warranted.
Description	As stated above, the mission has also been informed that the committee has approved a new Regulative Directive introducing CAD II. This decision is to be published in the Official Gazette in April 2005. This directive tends to fully harmonize the CSSDA’s capital requirements with EU Directives 93/6/EEC as amended by Directives 98/31/EC, 98/33/EC, 2002/87/EC and 2004/39/39. It has also been drafted in collaboration with the CBC. Again, the CSSDA has followed the same approach as the CBC with the same differences as for CAD I (a, b, and c) as described above. Article 40(a) of the CSL requires that each CCC invest its excess funds in government securities or deposit the excess funds in the Cooperative Central Bank, which is regulated and supervised by the Central Bank of Cyprus and the CSSDA, or, with the consent of the commissioner, in any other bank. However, the CCIs are not currently authorized foreign exchange dealers (except when acting as agents of the CCB) and do not offer foreign exchange services. These services are offered to the individual CCIs by the CCB, which is also supervised by the CBC. This allows the members to execute their international dealings and business through the CCB at special rates.
Assessment	Largely Compliant.
Comments	The mission has been informed that the CSSDA intends to issue a directive that will specify the rules and conditions required in order to obtain a license for foreign exchange operations. These rules and conditions will address such issues as, e.g., the required organizational structure and the necessary staff and expertise. The mission recommends that the supervisor adjust and develop the necessary expertise in order to supervise the new risks that will be assumed by the CCIs in this context.
Principle 13.	Other Risks Banking supervisors must be satisfied that banks have in place a comprehensive risk management process (including appropriate board and senior management oversight) to identify, measure, monitor, and control all other material risks and, where appropriate, to hold capital against these risks.
Description	The commissioner has issued Directives 3-01 and 3-02 regarding the requirements for the basic principles for the internal operating procedures and internal control systems for CCIs. These provide a detailed instructional manual for the establishment of such systems by CCIs that can vary significantly in size and complexity of operations. The scope of the annual audit of each CCI that is conducted by the independent AOCS includes coverage of internal operations management systems and controls, as does the scope of the CSSDA’s on-site examination function. The commissioner has issued a Directive on the Liquidity Ratio. The minimum acceptable liquidity ratio level has been set at 25 percent. Article 41F of the CSL provides the commissioner with the authority to address failure to comply with this requirement, protecting the interest of depositors. CCIs provide monthly returns on their liquidity to the CSSDA. The CSSDA is currently testing a revised and updated prudential liquidity return. For all CCIs that are connected electronically to the central server of the Cooperative Computer Society (currently 220 CCIs, including all of the larger institutions), a computerized gap analysis system exists to provide for the ongoing monitoring and evaluation of the effects of interest rate fluctuations. This information is currently available to the management of the CCIs; the CSSDA supervisors will not have direct access until the end of 2005. The CSSDA is currently testing a return on the monitoring of interest rate risk. For all CCIs that are connected electronically to the central server of the Cooperative Computer Society (currently 220 CCIs, including all of the larger institutions), a back-up of record keeping is provided to protect against possible operational problems created by general business interruption, disaster, or accident.
Assessment	Materially Noncompliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDAs on-site work, but do not mitigate the need for completion of planned expansion and development of staff. The CSSDA should enhance its ability to regularly acquire and analyze information on interest rate risk in the CCIs, either directly from the CCIs or through accelerated access to the reporting system of the Cooperative Computer Society.
Principle 14.	Internal Control and Audit Banking supervisors must determine that banks have in place internal controls that are adequate for the nature and scale of their business. These should include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding its assets; and appropriate independent internal or external audit and compliance functions to test adherence to these controls, as well as applicable laws and regulations.
Description	Article 41B (1)(a)(ii) of the Cooperatives Societies Law requires that a registered society be “…directed by at least two persons who have the necessary honesty and requisite experience to effectively define the orientation of the society’s activities and with good administrative and accounting organization and proper internal control systems.” Article 41F (3)(e) authorizes the Commissioner to demand the removal or alteration of the duties of any CCI officer or employee and Article 43 describes the circumstances when, including situations where the CCI is not properly managed, and authorizes the commissioner to dismiss the committee of a CCI. The commissioner has issued Directives 3-01 and 3-02 regarding the requirements for the basic principles for the internal operating procedures and internal control systems for CCIs. These provide a detailed instructional manual for the establishment of such systems by CCIs that can vary significantly in size and complexity of operations. The CSSDA is also planning to issue a future directive on the broader principles of internal control. In the course of its on-site examinations, the CSSDA determines whether the directives are implemented or other relevant internal controls are adopted; reviews the adequacy and efficiency of the institution’s organizational structure; evaluates the effectiveness of its internal control system, including internal auditors where they exist; and makes recommendations as necessary. In the course of the on-site examination, the reports to the institution’s committee from its internal auditor, where they exist, are reviewed by the examiners. The scope of the annual audit conducted in each CCI by the independent AOCS addresses the management of the CCIs, including an evaluation of the society’s internal control systems’ operations. CSSDA officers have access to the reports on these audits, participate in meetings with the management of the CCI regarding them, and provide support for the CCI’s actions to address identified deficiencies, as necessary.
Assessment	Largely Compliant.
Comments	Due to the limited size of their management and staff, many small cooperative societies lack the ability to employ an internal audit function and/or operate under effective internal controls and segregation of duties. The absence of proper, effective internal control systems in a CCI will be a material factor in its decision on possible affiliation with the Central Body, subsequent to the expiration of the ongoing transitional period that ends on December 31, 2007. Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDA’s on-site work, but do not mitigate the need for completion of planned expansion and development of staff.
Principle 15.	Money Laundering Banking supervisors must determine that banks have adequate policies, practices, and procedures in place, including strict “know-your-customer” rules, that promote high ethical and professional standards in the financial sector and prevent the bank being used, intentionally or unintentionally, by criminal elements.
Description	The Prevention and Suppression of Money Laundering Activities Laws of 1996 to 2004, (hereafter referred to as the “PSMLAL”), establish a solid framework that covers the various aspects of money laundering and the role of the financial system in this regard. The salient features of the PSMLAL are as follows: It defines and criminalizes laundering of proceeds from serious criminal offenses. It provides for the confiscation of proceeds from serious crime. It empowers courts to issue freezing and restraint orders in respect of such proceeds. It requires suspicion of money laundering to be reported to the Unit for Combating Money Laundering (UCML) without this being treated as a breach of confidentiality. It empowers the courts to order the disclosure and production of information held by natural or legal persons, including banks, related to money laundering investigations. It requires all persons carrying on relevant financial business to maintain procedures in relation to customer identification, record keeping, internal control, and communication and staff training in the recognition and handling of suspicious transactions. It enables the registration and enforcement of foreign orders for the freezing and confiscation of proceeds. The Commissioner’s Directives dated July 30, 1999, August 9, 2000, and November 7, 2000, address the prevention and suppression of money laundering by the CCIs. These directives are identical to the Guidance Notes and Supplements/Amendments issued by the Central Bank of Cyprus (CBC) prior to its November 2004 Guidance Note that takes into account: (i) the harmonization of Cyprus’s legislation with the EU Directive 2001/97EC; (ii) the revised recommendations for combating money laundering issued by the Financial Action Task Force (FATF) on money in June 2003; and (iii) the recommendations included in the paper on “Customer Due Diligence for Banks” issued in October 2001, by the Basel Committee on Banking Supervision. The provisions of these Directives include the following: a) prohibition of secret, anonymous, and numbered accounts as well as fictitious names; b) obligation to obtain data file for its customers; c) the appointment of a conforming officer that will act as the intermediary link between the CCI and the Financial Intelligence Unit (MOKAS). The conforming officer is required to advise and direct other employees regarding the procedures required for money laundering, and has to decide whether employees need to participate in specialized seminars. In the course of on-site supervision, the examiners verify and control the policies and practices followed by the CCIs with regard to “Know-Your-Customer” rules. A comprehensive new Commissioner’s Directive will soon revise the existing one and it will be issued based on the November 2004 Guidance Notes of the CBC mentioned above. At this stage, the said directive is in draft form subject to the commissioner’s approval and will thereafter be circulated to the CCIs.
Assessment	Largely Compliant.
Comments	The CSSDA should complete the issuance of the new Guidance Note. In assessing compliance with this principle, it has to be noted that the activities of the CCIs, although important in volume and market share, are still of a very basic nature and are mainly confined to their members, which introduces an amount of social control into the system.
Principle 16.	On-Site and Off-Site Supervision An effective banking supervisory system should consist of some form of both on-site and off-site supervision.
Description	Pursuant to Article 41D of the CSL, the commissioner is responsible for supervising compliance with that law. Article 41JD empowers the commissioner or a person authorized by him “…to conduct investigations necessary for the carrying out of his competences or for a possible violation of the provided obligations in virtue of the Cooperative Law and for the purpose of this he may: a) check the records, the books, the accounts and any other documents and data stored in computers at each cooperative credit institution or in the possession of any person for whom there is reasonable suspicion that he holds information of the Cooperative Credit Institution that may assist the commissioner in his investigation, and to take copies or extracts from them; and b) to enter the office and professional premises of the persons under investigation. Also, pursuant to article 3(5), “… the Commissioner … has the power to inspect the books, accounts, and documents of a registered society and every officer of such society shall provide the necessary facilitations and all of the requested information for such inspection.” Article 41JC empowers the Commissioner “… to demand and collect information useful for exercising his powers pursuant to the cooperative law, and to demand through a written request the submission of this information within the set deadline, from registered co-operative credit institutions, their subsidiary companies, members of their Committee or their Board or the members of their Supervisory Board.” Supervision is carried out through on-site examination and of-site monitoring. The Supervision Division of the CSSDA has two subdivisions: on-site supervision and off-site supervision and regulation. Currently, there are only seven officers and staff members in the division; however, plans and budgets have been prepared and are awaiting government approval for increasing the total number of the CSSDA’s staff to 57, out of whom initially 21 will be allocated to the Supervision Division. The work of the Supervision Division is, inter alia, supported by the 33 officers and staff of the Development Division of the CSSDA, who also support the operations of the CCI’s by working with them on supervisory, regulatory, and operational/ administrative matters. Supervisory findings from the on- and off-site supervision processes are also used by the Development Division to assist the CCIs in enhancing their operations. The CSSDA’s off-site supervision/monitoring and on-site examination functions benefit from their ongoing relationship with the independent Audit Office for Cooperatives Societies and the results of its annual audits of each CCI. These audits cover both financial and overall management/performance issues. CSSDA officers take part in the meetings with CCI management on results of the audit following each audit; they provide support for management’s efforts to address any deficiencies identified in the audit. The CSSDA’s on-site examination process began as a separate function within the CSSDA in November 2003; prior to that, the supervision and development functions were one group. A total of 16 examinations, including 4 that were conducted with the assistance of the Central Bank of Cyprus as part of a training exercise, have been conducted since the inception of the program. Examinations have included all sizes and complexity of CCIs, including the largest of these institutions. The CCI is normally notified in advance of a planned examination, but the CSSDA does, on occasion, conduct ad hoc examinations without prior notice. On-site examinations are planned using a basic risk-based approach, concentrating on those institutions that present the higher risks to the system, an using the findings of the off-site supervision/monitoring system, the findings of the independent external audit, and the knowledge about the CCI from the CSSDA’s development officers as a base of knowledge on each institution. The CSSDA’s goal is to conduct an annual examination of all CCIs that remain unaffiliated after the formation of the Central Body, as well as an annual examination of the Central Body and its affiliates, on a consolidated basis. The CSSDA’s on-site supervision examines whether: the CCI complies with the CSL, by-laws, and regulations; the organizational structure and the management is proper and effective; the administrative and accounting procedures are adequate and effective; the books and records are properly kept; the computerization as well as the internal control systems are adequate; there are sufficient measures to prevent fraud and irregularities as well as money laundering; the CCI has adopted and follows adequate loan evaluation and authorization procedures in order to minimize risk exposure; the credit policies are followed, the loan portfolio is of good quality, and provisioning is adequate; the loans in arrears are monitored; adequate levels of liquidity are maintained; the CCI’s profitability is adequate; the CCI’s assets are properly safeguarded; and the overall soundness and solvency of the institution is achieved. In the course of the on-site examination, the reports to the institution’s committee from their internal auditor, where they exist, are reviewed by the examiners. The findings of the on-site examination are provided to and discussed with the management of the CCI. Plans for corrective action, as necessary, are required from the institutions. Information on a wide variety of matters related to each CCI’s activities is provided to the CSSDA through a series of periodic returns. Article 41JC (7) of the CSL states that such information provided is confidential, and Article 41H provides for the obligation of confidentiality for management and staff of the CSSDA and for sharing of such information for supervisory purposes. Article 41JC (1) gives the commissioner the power to demand and collect information useful for the exercise of his power pursuant to the co-operative law. Off-site supervision/monitoring involves the examination and analysis of these periodic returns, such as those relating to, inter alia, monthly statistical data, annual balance sheet and profit and loss accounts, the level of own funds, solvency ratio, large exposures, and credit facilities to staff and committee members. This monitoring covers the following: the level of deposits and their distribution per time duration and per interest rate; the level of loans and whether they are within the set limits; the distribution of loans per time duration and per sector of economic activity; the level of loan excesses and arrears; the level of liquid assets; the liquidity ratio; and returns, regarding the prudential requirements of Directive 2000/12/EC, such as Own Funds, Solvency Ratio, and Large Exposures. Also, for all CCIs that are connected electronically to the central server of the Cooperative Computer Society (currently 220 CCIs, including all of the larger institutions), a uniform computerized recordkeeping and reporting system is in place that enables the supervisors to have effective and efficient access to ongoing financial information of the CCIs. Findings emerging during off-site supervision are analyzed, trended, and compared with other institutions and are verified during on-site supervision. Currently, the CSSDA is evaluating a comprehensive questionnaire that has been submitted by the CCIs regarding each institution’s current overall condition (soundness, profitability, liquidity, etc.), as well as presenting a timetable scheme for compliance with the conditions for obtaining an ongoing operating license, as part of the program to harmonize the credit cooperative system in Cyprus with the requirements of the EU.
Assessment	Materially Noncompliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for 17 percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s management, in cooperation with the Government Personnel Department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDA’s on-site work, but do not mitigate the need for completion of planned expansion and development of staff. Also, the CSSDAs ability to perform off-site supervision/monitoring is materially impacted by the limited size of the staff in the Supervision Division. Currently, this deficiency is somewhat mitigated by the oversight work performed the Development Division; but, for the longer-term, Supervision Division staff should be augmented permanently.
Principle 17.	Bank Management Contact Banking supervisors must have regular contact with bank management and a thorough understanding of the institution’s operations.
Description	The AOCS (which is responsible for performing the annual audit of the institutions’ accounts) submits to the Commissioner the audited annual report for each institution. The CSSDA’s officers hold meetings with the institution’s Committee and the external auditors to discuss the results of their work and to agree on the action/measures for corrective action. The CSSDAs officers hold meetings (e.g., during and after on-site examinations) with the institution’s committee members, department managers, and internal auditors, as well as senior management, to discuss matters relevant to the assessment of specific problems, the overall condition of the institution, and future prospects. Officers of CSSDAs Development Division have regular contact in performing their function to support the institution’s supervisory, regulatory, and operational/administrative needs. The regular contact of the officers of the CSSDAs Development Division with the CCIs for which they have specific oversight and support responsibilities provides the CSSDA with an ongoing ability to maintain current knowledge of each institution’s activities. The CSSDA’s off-site supervision/monitoring program also provides an ongoing ability to understand the institution’s activities and condition. Pursuant to Articles 12(2) and (3) of the CSL, no amendment of the by-laws (including material changes in their activities) of a registered society will be valid until the amendment has been registered under the CSL, for which purpose two copies of the amendment will be forwarded to the commissioner. If the commissioner is satisfied that any amendment of the by-laws is not contrary to the CSL or to the rules and the cooperative principles, takes into account the proper operation and financial position of the society in connection with the Cooperatives Societies general interest, registers the amendment. Also, pursuant to article 41Z (1)(b), the CSSDA’s cCommittee has the power to define, regulate, and amend with a regulative decision: the accounts, the figures, or the information that have to be submitted periodically, or on certain occasions by the CCIs that apply to obtain or hold an operating license, as well as the form, the type, and the timeframes within which these must be submitted. The issuing of a regulative decision, based on the transitional provisions of the CSL, referring to the CSI’s obligation to conform at least to their existing prudential levels and to notify the CSSDA of any material adverse developments regarding those prudential levels, is underway.
Assessment	Largely Compliant.
Comments	The CSSDA should complete the issuance of its planned Regulative Decision to specifically require that each CCI notify it in a timely manner of any material changes in its activities and any adverse developments.
Principle 18.	Off-Site Supervision Banking supervisors must have a means of collecting, reviewing, and analyzing prudential reports and statistical returns from banks on a solo and consolidated basis.
Description	Pursuant to Article 3(5) of the CSL, “… the Commissioner … has the power to inspect the books, accounts, and documents of a registered society and every officer of such society shall provide the necessary facilitations and all of the requested information for such inspection.” Article 41JC empowers the Commissioner “… to demand and collect information useful for exercising his powers pursuant to the cooperative law, and to demand through a written request the submission of this information within the set deadline, from registered cooperative credit institutions, their subsidiary companies, members of their committee or their board or the members of their Supervisory Board.” This article also provides administrative sanctions for failure to comply with such requests or to fail to supply complete and accurate information or within prescribed timeframes. Information requested covers only the CCIs themselves, since they have no subsidiaries or affiliated companies. Supervision is carried out through off-site monitoring and on-site examination. Off-site supervision/monitoring is conducted and information is collected only on a solo basis, since cooperative societies do not currently have subsidiaries or affiliated companies. This monitoring covers the following: the level of deposits and their distribution per time duration and per interest rate; the level of loans and whether they are within the set limits; the distribution of loans per time duration and per sector of economic activity; the level of loan excesses and arrears; the level of liquid assets; the liquidity ratio; and returns, regarding the prudential requirements of Directive 2000/12/EC, such as own funds, solvency ratio, and large exposures. The CSSDA requires the cooperative societies to submit, inter alia, the following periodic returns to facilitate its supervisory process: statistical data (monthly and annually) on: deposits by type and interest rate; loans by sector and interest rate; overdue and excess loans; maximum levels of lending and accepting of deposits; liquidity; share capital and reserves; and general expenses and revenues; balance sheet accounts (annually); profit and loss account (annually); credit facilities to the CCI’s committee members (semi-annually); loans to legal entities (quarterly); prudential requirements (own funds, solvency ration, large exposures, qualifying holdings outside the financial sector) (annually); and balance sheet information on the CCIs that are connected to the CSSDA central processing system (220 CCIs) (monthly). A range of additional detailed statistical and administrative information can be obtained from the CSSDA central processing system. All of these reports can be analyzed by CSSDA supervisory officers by individual CCI, by sector (e.g., region/geographic area), and by the entire industry. These analyses are used in the ongoing off-site monitoring, as well as in the planning and conduct of on-site examinations, of CCIs. Findings emerging during off-site supervision are analyzed, trended, and compared with other institutions and are verified during on-site supervision. The CCIs also supply statistical information to the Central Bank of Cyprus, the Cooperative Central Bank, and the Statistics Service. A series of new and redesigned prudential and statistical reports are being developed by the CSSDA that will be in better harmony with EU requirements.
Assessment	Materially Noncompliant
Comments	To date, the CSSDA’s off-site supervision/monitoring has been limited by the small number of current staff, although the Supervision Division staff is supplemented in some monitoring functions by CSSDA’s Development Division staff. CSSDA management has developed plans for augmenting overall supervision staff. There is a pressing need for the completion of planned expansion and development of supervision staff. The CSSDA is working to design and build new automated analytical/monitoring and early-warning systems that will use information provided by those CCIs that are and will be connected through the central server of the Cooperative Computer Society. Currently, the analysis uses information from existing returns and from the existing computer system. The CSSDA should proceed in a timely manner to establish a complete direct connection in order to facilitate its access to the central server.
Principle 19.	Validation of Supervisory Information Banking supervisors must have a means of independent validation of supervisory information either through on-site examinations or use of external auditors.
Description	Pursuant to article 41D of the CSL, the commissioner is responsible for supervising compliance with that law. Article 41JD empowers the commissioner or a person authorized by him “…to conduct investigations necessary for the carrying out of his competences or for a possible violation of the provided obligations in virtue of the Cooperative Law and for the purpose of this he may: a) check the records, the books, the accounts and any other documents and data stored in computers at each cooperative credit institution or in the possession of any person for whom there is reasonable suspicion that he holds information of the Cooperative Credit Institution that may assist the Commissioner in his investigation, and to take copies or extracts from them; and b) to enter the office and professional premises of the persons under investigation. Also, pursuant to Article 3(5), “… the Commissioner … has the power to inspect the books, accounts, and documents of a registered society and every officer of such society shall provide the necessary facilitations and all of the requested information for such inspection.” Article 41JC empowers the Commissioner “… to demand and collect information useful for exercising his powers pursuant to the cooperative law, and to demand through a written request the submission of this information within the set deadline, from registered co-operative credit institutions, their subsidiary companies, members of their Committee or their Board or the members of their Supervisory Board.” The scope of the both the CSSDAs on- and off-site supervisory activities includes the regular validation of the periodic supervisory information from the CCIs by the CSSDA’s Development Division, as well as its ongoing review and analysis by the Supervision/Monitoring Division. The CSSDA’s process for planning the scope and conducting on-site examinations includes assessing the results of the independent external audit and the prudential and statistical information provided by the CCIs through their periodic supervisory returns. Meetings are held following each examination to discuss the results and initiate corrective actions, as necessary. Article 19 of the CSL provides for the establishment and operation of the Inspections Service of Cooperative Societies (the independent AOCS). The Council of Ministers has issued the Cooperative Societies Audit Service Regulations (174/89, 14/92, 328/91, 115/98). The accounts of all CCIs are audited annually by the independent Audit Office of Cooperative Societies, a group within the Office of Auditor General of Cyprus. These audits are both financial audits and overall management/performance audits. They address credit/compliance/ operational/ funding risk, as well as the financial audit of the society’s financial statements. CSSDA officers participate in the independent AOCS’ meetings with CCI management following each audit and provide support for the CCI’s actions to correct identified deficiencies.
Assessment	Largely Compliant.
Comments	Within 2004 and 2005, the CSSDA’s on-site examination program has covered only a fraction of the large number of CCIs, although the examined CCIs account for seventeen percent of the total loan portfolio of the sector. The program’s implementation has been limited by the small number of current staff and the need for further training. CSSDA’s, management in cooperation with the government personnel department, has developed plans for augmenting supervision staff and training has already begun. The continuous monitoring of the CCIs that is exercised by the Development Division supplements the work of the Supervision Division and the findings of the independent AOCS assist the CSSDA’s on-site work, but do not mitigate the need for completion of planned expansion and development of staff.
Principle 20.	Consolidated Supervision An essential element of banking supervision is the ability of the supervisors to supervise the banking group on a consolidated basis.
Description	Currently, CCIs do not have subsidiaries or affiliated companies.
Assessment	Not Applicable.
Comments	However, pursuant to Article 41D (1)(e) of the CSL, the commissioner is responsible for supervising the compliance of the registered societies that will become affiliated to the Central Body with the provisions of the CSL, for the purposes of consolidated supervision.
Principle 21.	Accounting Standards Banking supervisors must be satisfied that each bank maintains adequate records drawn up in accordance with consistent accounting policies and practices that enable the supervisor to obtain a true and fair view of the financial condition of the bank and the profitability of its business, and that the bank publishes on a regular basis financial statements that fairly reflect its condition.
Description	Articles 53(jb), (jc), and (jd) empower the Council of Ministers to issue rules for the better application of the provisions of the CSL and for the determination of every issue where determination is necessary. Such rules may: prescribe the accounts and books to be kept by a registered society, and provides for the periodical publication of a balance sheet showing the assets and liabilities of a registered society; provide for the audit of the accounts of registered societies and for the charges, if any, to be paid for such an audit; and prescribe the returns to be submitted by registered societies to the commissioner and the persons by whom and the form in which the same shall be submitted. Article 19, which provides for the establishment and operation of the Inspections Service of Cooperative Societies (the independent Audit Office of Cooperative Societies), also provides for the annual audit of every CCI by it and requires that the accounts of the CCIs must be ready for audit within one month from the end of its economic year. The audit report must be provided to the CCI and to the commissioner upon its completion. The CCI provides information on the results of the audits to its management and members. Regulative Decision 59/2005 regarding the publishing of the annual accounts of CCIs states that accounts must be prepared and audited to establish a “true and fair view,” in accordance with international auditing and accounting standards. Article 41JC empowers the commissioner to demand and collect information useful for exercising his powers pursuant to the CSL, and to demand through a written request the submission of this information within a set deadline, from registered cooperative credit institutions, their subsidiary companies, members of their committee or their board or the members of their supervisory board.
Assessment	Compliant.
Comments	None.
Principle 22.	Remedial Measures Banking supervisors must have at their disposal adequate supervisory measures to bring about timely corrective action when banks fail to meet prudential requirements (such as minimum capital adequacy ratios), when there are regulatory violations, or where depositors are threatened in any other way. In extreme circumstances, this should include the ability to revoke the banking license or recommend its revocation.
Description	Article 41D (1)(d) of the CSL empowers the commissioner “… to take remedial measures, to cease the Committee or any officer, and to appoint a liquidator of registered societies that carry out the activities of a cooperative credit institution.” Article 41(D)(2)(a) authorizes the commissioner to suspend or withdraw operating licenses and articles 41D (2)(c) and 41JE both authorize the imposition of administrative sanctions. Article 41F (3) and (4) empower the commissioner to withdraw the license of a CCI when anyone associated with the CCI fails to comply with the law, of any rule, order, or decision, or the terms of the license, or when the liquidity or solvency are diminished, or when the depositors or creditors’ interests must be secured, as well as a range of other formal and informal remedial measures. Article 41F (3)(e) authorizes the commissioner to demand the removal or alteration of the duties of any CCI officer or employee and Article 43 describes the circumstances when and authorizes the commissioner to dismiss thecommittee of a CCI. The range of remedial measures available can be used in a timely manner commensurate with the severity of the issues involved. Actions may be taken against the institution, as well as against the individuals involved in the management and direction of it.
Assessment	Compliant.
Comments	None.
Principle 23.	Globally Consolidated Supervision Banking supervisors must practice global consolidated supervision over their internationally active banking organizations, adequately monitoring and applying appropriate prudential norms to all aspects of the business conducted by these banking organizations worldwide, primarily at their foreign branches, joint ventures, and subsidiaries.
Description	Currently, CCIs do not have overseas activities, joint ventures, or foreign branches or subsidiaries.
Assessment	Not Applicable.
Comments	However, pursuant to article 41G (1)(d) of the CSL, the committee of the CSSDA has the power to define, regulate, or amend, within the framework of the EU’s acts that are in force in Cyprus, the conditions or terms of the operations of the branches or of the provision of cross-border services by registered societies that carry out the business of a cooperative credit institution in a member state or a third country.
Principle 24.	Host Country Supervision A key component of consolidated supervision is establishing contact and information exchange with the various other supervisors involved, primarily host country supervisory authorities.
Description	Currently, CCIs do not have overseas activities, joint ventures, or foreign branches or subsidiaries.
Assessment	Not Applicable.
Comments	However, pursuant to Article 41D (1)(c) of the CSL, the commissioner is responsible for “…the cooperation, exchange of information, verification of data, assigning or undertaking of the responsibility of prudential supervision of the co-operative credit institutions or of their subsidiaries or of other societies that appertain to the Commissioner’s powers, with other competent supervisory authorities of a member state or of a third country, provided that the communicated information is covered, as regards to the professional secrecy, by guaranteed liabilities.”
Principle 25.	Supervision Over Foreign Banks’ Establishments Banking supervisors must require the local operations of foreign banks to be conducted with the same high standards as are required of domestic institutions and must have powers to share information needed by the home country supervisors of those banks for the purpose of carrying out consolidated supervision.
Description	Currently, there are no branches or subsidiaries of foreign credit cooperative societies in Cyprus.
Assessment	Not Applicable.
Comments	However, pursuant to Articles 41(D)(b) and (c) of the Cooperatives Societies Law, the commissioner is responsible for “. the cooperative credit institutions that have established a branch or that provide cross-border services to the Republic, the control of liquidity, the market risk, as well as the abiding by these to the principles set from time to time as to the monetary policy…” and “… the cooperation, exchange of information, verification of data, assigning or undertaking of the responsibility of prudential supervision of the cooperative credit institutions or of their subsidiaries or of other societies that appertain to the Commissioner’s powers, with other competent supervisory authorities of a member state or of a third country, provided that the communicated information is covered, as regards to the professional secrecy, by guaranteed liabilities.”