Cyprus has a well-developed banking system, which offers a wide range of services catering for the needs of businesses and individuals. The domestic banking system comprises the Central Bank of Cyprus, which is the licensing and supervisory Authority, nine commercial banks and three specialised financial institutions. It should be pointed out, however, that since the Turkish invasion of 1974 three Turkish banks, which operate in the area occupied by the Turkish troops, which is inaccessible to the official authorities of the Republic of Cyprus, are not under Central Bank supervision and they are not counted within the above numbers.

The Central Bank was established in 1963 and is responsible for formulating and implementing monetary and credit policy. It also administers the foreign exchange reserves of the Republic, supervises banks and acts as banker and financial agent of the government.

Eight out of the nine commercial banks operating in the government-controlled area are locally incorporated. These are: Bank of Cyprus Ltd, The Cyprus Popular Bank Ltd, Hellenic Bank Ltd, Co-operative Central Bank Ltd, Universal Bank Ltd, National Bank of Greece (Cyprus) Ltd, Alpha Bank Ltd and Commercial Bank of Greece (Cyprus) Ltd. The last three are foreign controlled. In addition, Arab Bank Plc operates as a branch of the foreign bank with a branch network all over Cyprus. Co-operative Central Bank Ltd acts as banker of numerous co-operative credit societies.

The specialised financial institutions are: The Cyprus Development Bank Ltd, Housing Finance Corporation and Mortgage Bank of Cyprus Ltd. The Housing Finance Corporation specialises in long-term housing loans. The Cyprus Development Bank Ltd was established in 1963 in order to meet the needs of medium and long-term financing for development purposes. In addition to extending financing, it also provides technical and management consulting services to companies.

In addition to the above, there is another group of international banking units, which are licensed to operate from within Cyprus, but their shareholders must be non-residents and are also required to confine their activities in foreign currencies and mostly with non-residents. This group comprises twenty-nine Offshore Banking Units as well as two Administered Banking Units and three offshore representative offices of foreign banks. Offshore Banking Business Licences are granted only to banks of good international reputation established in countries which exercise, in the opinion of the Central Bank of Cyprus, adequate banking supervision and which subscribe to the principles embodied in the “Concordat%26rdquo; (%26ldquo;Principles for the supervision of banks%26rsquo; foreign establishments%26rdquo;) issued by the Basle Committee on Banking Supervision.

The Cyprus Co-operatives

The Co-operative Movement was introduced in Cyprus at the beginning of the 20th century. The first Co-operative Society in Cyprus was formed in Lefkoniko village in 1909. In 1914 the legislative body passed the "Co-operative Credit Institutions Law 13". Despite of the constitution of legislation, the development of the co-operative during the years followed was limited. The lack of basic funds and the absence of educated people were the main obstacles towards the establishment of such companies. In 1923 the government passed a separate law, which favoured the formation of Non-credit Co-operative Societies. In addition, during the same period, the government provided the Societies with loans up to 20.000 so as to help the development of the Co-operative Movement.

To cope with the economic problems created with the beginning of The First World War, the government established, in 1925, the Agricultural Bank whose purpose was to provide long-term credits to the farmers. These loans were provided through the Co-operative Societies against mortgages in the name of the Co-operatives. Immediately after the agreement, the mortgages were transferred to the Agricultural Bank.

Despite the fact that the Agricultural Bank, generally speaking, did not succeed in achieving the goals for which it was founded because of their long-term policy, still it positively influenced the growth of the Co-operative Movement in Cyprus. The involvement of the Co-operative Societies in the lending process led the people of the communities to establish such Societies with the result in 1935 the number of Societies increased to 273 as opposed to 24 in 1924.

Until 1936 there was no government department responsible for Co-operative matters. In 1935 the first Commissioner was appointed and by 1936 the Co-operative Development Department was founded which played a decisive role to the spread of Co-operative principles and the development of Co-operative Movement in Cyprus.

In 1937 the Co-operative Central Bank was founded, the purpose of which was the accumulation of Funds and the self- financing within the Co-operative Movement. The bank accepted as deposits any surpluses of the Societies and lend them under favourable conditions. The Co-operative Societies in turn, lend their members mainly in the form of short-term credits. In addition to the acceptance of deposits, the Co-operative Central Bank provided the farmers with different agricultural necessities, acted as representative of the government for the financing of various agricultural development schemes etc, activities that still exist until today.

During the period 1936-1974 the Co-operative Movement experienced a significant growth in Cyprus. However, the Turkish invasion brought a great blow to the Co-operative Societies and the economy of Cyprus in general. The Co-operative Movement, in order to help the refugees to reactivate, has established new large Co-operative Societies operating in the industry sector and/or reactivated existing ones. Unfortunately, the above action failed with a negative effect in the economy of the Movement. The result of the above was the dissolution of these Societies in the early 1980.

Despite the blows, the Cyprus Co-operative Movement survived and today it is considered as one of the strongest and well-organised Co-operative Movements worldwide. That strength is expected to continue and after the accession of Cyprus in the European Union since the Movement has the means to deal with any kind of problems it may be faced to.

Monetary Developments and Policy

The primary objective of the Central Bank of Cyprus is the maintenance of conditions of internal and external stability, thus securing the necessary prerequisites for sustained economic growth. In order to achieve its goals more effectively, and after a thorough study of the operational framework of monetary policy in developed countries, the Bank has successfully introduced since 1996 new monetary instruments and procedures, which are fully in line with the practices followed in the EU.

Repurchase / reverse repurchase transactions and acceptance of deposits are the primary instruments of liquidity management used, which are carried out through auctions between the Central Bank and commercial banks. In addition, the Central Bank introduced a short-term collateralised financing facility (lombard type) and an overnight deposit facility for placing short – term surplus funds at the end of the day. The interest rates on these facilities are intended to provide the upper and lower end of money market interest rates, respectively, and are used to signal changes in the stance of monetary policy. Experience so far has shown that the transition to the new operational monetary policy framework has been smooth and banks have adjusted to the new environment without any problems.

The liberalisation of the financial sector and its harmonisation with the European Union acquis has been greatly facilitated by the enactment of the Law liberalising interest rates, effective since January 1st, 2001. The law lifted the legal interest rate ceiling of 9,0 per cent per annum and at the same time set an obligation on behalf of credit institutions for transparency so that borrowers can clearly be informed about their financing costs. Concurrently with the abolition of the interest rate ceiling, the Central Bank has allowed medium and long-term (over two years) borrowing from international as well as domestic sources in foreign currency by resident entities and individuals. The Monetary Policy Committee, which was set-up by amending the Central Bank law, has currently an advisory role and examines issues pertinent to monetary policy and the liberalisation of interest rates and submits recommendations to the Board of Directors of the Central Bank. The Committee, comprising the Governor and five other members, convened for the first time in December 2000.

In addition, in the context of adapting to the acquis communautaire, the drafting and legal vetting of the bill, which ensures the complete autonomy of the Bank from political influences, has been completed. The new legislation will enhance the Central Bank%26rsquo;s credibility and effectiveness in achieving its monetary policy objectives. It is anticipated that the new legislation on the Central Bank will be implemented by the end of June, 2002.

Monetary policy during 2000 continued to be restrictive and the Central Bank set an indicative credit expansion guideline of 10,0 per cent for the whole 2000 over the previous year. Notwithstanding the above policy stance, excessive credit expansion during the first five months of the year prompted the Central Bank to impose monthly credit ceilings for each bank, with a view to reducing the rate of growth of overall bank credit for the whole of the year to not more than 12,0 per cent. In addition, minimum reserve requirements were raised by 1 percentage point, effective as of July 1. Claims on the private sector by the end of the year rose by 14,8 per cent and the Central Bank imposed penalties on those banks which did not abide by the directives.

Exchange Control and Foreign Investment

Current payments abroad are exempt from exchange control. Foreign exchange is freely purchased and sold in connection with such transactions. The Central Bank, in its effort to harmonise the economy with the Acquis Communautaire, is continuously relaxing the remaining restrictions on capital movements. Specifically, the following policy applies to investments in Cyprus by non-residents and investments abroad by Cypriots:

There are no restrictions on either direct or portfolio investments from member states of the European Union (EU). For investments from other countries, certain restrictions are still in force concerning the maximum percentage and/or the minimum amount of participation depending on the sector of the investment. In particular, natural or legal persons from non-EU countries may acquire up to 49% of the share capital of companies listed on the Cyprus Stock Exchange.

Residents of Cyprus are allowed to undertake direct investment abroad without restriction as to the amount or the sector of the investment. The transfer of capital abroad is affected as soon as the Central Bank is satisfied that it concerns a genuine direct investment and not portfolio investment (e.g. purchase of foreign stocks or bonds) or deposits with foreign banks. Every resident household (including parents and children under 25) is entitled to transfer up to CY£100.000 for the purpose of acquiring a secondary residence abroad for its own use.

Since the beginning of 2001, commercial banks in Cyprus have been authorised to grant medium and long-term loans in foreign currency to residents without reference to the Central Bank. In line with the harmonisation program agreed with the EU the remaining exchange control restrictions, which mainly concern outward capital flows by residents and include portfolio investments as well as short-term loans and deposits with foreign banks, will be removed gradually from 2001 until the time of accession.

Foreign Direct Investment

Foreign participation of up to 100% is permitted in most cases. There are no complicated criteria other than the rejection of applications for projects, which may create environmental problems or may appear detrimental to the country%26rsquo;s national security. Applications are handled by the Central Bank of Cyprus.

In the case of investors from the EU, there are no restrictions concerning the maximum allowable percentage of foreign participation or the minimum level of investment. As far as portfolio investment is concerned, citizens of EU member states may acquire up to 100% of the share capital of Cypriot companies listed on the Cyprus Stock Exchange. In the banking sector, the maximum foreign equity participation is 50%.

In the case of non-EU investors, up to 100% equity participation is permitted in most sectors. However, there are minimum investment requirements.

International Business Companies
The term “international business company%26rdquo; refers to any legal entity whose beneficial ownership and business activities lie outside its country of registration. Since the introduction of the first incentives in 1975, over 52.000 permits for the registration of IBC%26rsquo;s have been issued by the Central Bank of Cyprus.

Regulatory Framework
The Central Bank, through its permit issued to non-resident investors, imposes certain conditions concerning beneficial ownership, business activities, financial arrangements and reporting procedures. Most importantly, IBC%26rsquo;s are not allowed to derive any income from within Cyprus by supplying any goods or services to residents or non-residents.

As long as these conditions are observed, the Central Bank permit remains valid, bringing benefits to owners and expatriate employees living and working in Cyprus. These benefits include exemption from exchange controls and concessions on corporation and income tax.

Fiscal Incentives
The relevant legislation stipulates that:
· IBC%26rsquo;s are taxed at only 4,25% on their profits.
· International business branches which are managed and controlled from abroad and international partnerships are totally exempt from tax.
· The owners of IBC%26rsquo;s, international branches and partnerships are not liable to any additional tax on dividends of profits over and above the amount paid or payable by the respective legal entities.
· The expatriate employees of IBC%26rsquo;s living and working in Cyprus are taxed at half the rates applicable to locals i.e. from 0% to 20%.
· Foreign employees of IBC%26rsquo;s living and working outside Cyprus are either exempt from tax, or taxed at half the standard rates, depending on whether they get paid through Cyprus or directly abroad.
· No capital gains tax is levied on the sale or transfer of shares in an IBC.
· No estate duty is payable on the inheritance of shares in an IBC.

Cyprus has also concluded an impressive number of treaties for the avoidance of double taxation. Currently 32 treaties are in force which, along with the low tax paid by IBC%26rsquo;s, offer significant possibilities for international tax planning through Cyprus. In contrast to tax havens, Cyprus is a tax incentive country, which offers benefits aimed at attracting non-residents who wish to conduct their business affairs from the island.

Secrecy and Confidentiality
If confidentiality is desired, it is possible to use nominee shareholders. The names of nominee shareholders appear in the public records kept at the Department of the Official Receiver and Registrar. The Central Bank of Cyprus keeps the names of non-resident beneficial owners strictly confidential and it does not reveal any information on individual IBC%26rsquo;s. Central Bank employees are bound by oath to secrecy. Only aggregate data are published from time to time in order to enable the government and the public to appreciate progress in this sector.

An Operational Centre
In contrast to IBC%26rsquo;s registered in other centres, those registered in Cyprus are given a realistic choice between operating from the offices of lawyers or accountants or from their own management headquarters.

Over 1.000 IBC%26rsquo;s maintain fully-fledged administrative offices in Cyprus for the purpose of conducting their regional or worldwide affairs. These IBC%26rsquo;s employ more than 3.000 expatriates and 2.700 locals. The expatriates are accompanied by about 6.000 dependants.

Business Activities
IBC%26rsquo;s conduct a diverse range of business activities abroad from their Cyprus base including marketing of consumer goods, transit trade, holding of property and securities, business consulting and services, distribution and repair of equipment, architecture and town planning, electrical and mechanical engineering, road and airport construction, hotel ownership and management, travel and tourism, personnel recruitment and training, advertising, design and graphics, maintenance of computer hardware and software patent and trademark registration, gathering and distribution of news, ship management and other services to shipping, general and captive insurance, third-party financial services and international commercial banking.

In today%26rsquo;s world there is a growing need for highly developed international business centres from where enterprises can operate efficiently and securely worldwide. Cyprus possesses all of the necessary attributes to become one of the leading centres in the world for commercial, financial and maritime activities. The island%26rsquo;s geographical location, English legal system, high quality of life, and low cost of living, combined with its excellent infrastructure and generous tax incentives, create an ideal business environment.

Balance of payments

The substantial improvement of the current account deficit in 1999 was not sustained in 2000, despite the significant growth of exports of both goods and services. The current account deficit reached £284,1 million or 5,2 per cent of GDP in 2000, compared with £118,0 million or 2,4 per cent of GDP in 1999, while the capital and financial account registered a surplus of £192,6 million, slightly below the surplus of £199,7 million in 1999.

The merchandise trade deficit, which had fallen marginally in 1999, widened by £368,0 million in 2000 and reached £1.621,8 million, as a result of the sharp rise in imports, which was not offset by the recovery of exports. Reversing the negative trend observed in the last three years, total exports of goods registered a significant growth of £48,8 million or 9,0 per cent, mainly due to the strong recovery of domestic exports and shipstores. The rise in domestic exports reflected the good performance of industrial products of both agricultural and manufacturing origin. On the other hand, total imports, under the impetus of higher oil prices and an acceleration in private consumption expenditure, grew by 23,2 per cent and reached unprecedented levels. A rise in imports was observed in all the major product categories and was particularly pronounced in fuels and lubricants.

The services sector exhibited an increased surplus amounting to £1.269,8 million, compared with £1.109,1 million the year before, on account firstly of higher receipts from tourism and secondly of higher revenue from the international business sector. Current transfers also exhibited an increased surplus reaching £78,3 million in comparison with the surplus of £47,4 million in 1999, while the deficit of the income account fell from £20,7 million in 1999 to £10,4 million in 2000. However, the aforementioned positive developments could not offset the widening of the trade balance, which resulted in the deterioration of the current account.

The financial account registered a surplus of £192,6 million, comparable to the surplus of £199,7 million recorded in the previous year. Analytically, the direct investment account continued to show net outflows of the same order of magnitude as in 1999. However, the portfolio investment account resulted in net outflows of £108,1 million, in contrast to the net inflows of £0,9 million recorded in 1999. The surplus of the other investment account fell from £559,0 million in 1999 to £307,1 million in 2000. Finally, reserve assets recorded a net inflow of £5,0 million in 2000, compared with a net outflow of £346,7 million in the previous year.

New balance of payments methodology
In the context of harmonisation with the EU and international statistical standards, the Central Bank of Cyprus has adopted the methodology recommended by the IMF in its fifth edition of the Balance of Payments Manual (BPM5) for the compilation of the balance of payments. In this year%26rsquo;s Annual Report, the balance of payments is presented in the format specified by Eurostat in its Balance of Payments Vade Mecum, which is based on the BPM5. Balance of payments data in this format have been compiled for the years 1995 to 2000.