The European Central Bank (ECB) has warned the Central Bank of Cyprus (CBC) that a draft law giving it expanded supervisory powers over leasing firms could create a potential financial risk for the country’s national bank.

The draft law defines the supervisory and regulatory powers of the Central Bank with respect to financial leasing companies. It mentions that the CBC has the power to require that financial leasing companies pay the CBC all costs related to their supervision. In addition, the Cypriot authorities opted not to impose explicit limits on leverage and liquidity requirements at this stage.

According to the explanatory memorandum accompanying the draft law, it aims to provide alternative ways of financing to individuals and businesses and contribute to the growth of the sector.

The ECB welcomed that financial leasing activities are going to be subject to prudential supervision, which it said would avoid regulatory arbitrage. It said it undestood that the draft law may also facilitate private debt restructuring by opening up the possibility to transform mortgage loans into real estate leases through sale and lease-back transactions and "potentially impact the resolution of non-performing loans in Cyprus."

The ECB has "generally accepted" the allocations of supervisory tasks related to the provision of financial leasing services among its members, provided they do not interfere with the performance of ESCB-related tasks.

It wrote: "The ECB considers that there are grounds for regarding the CBC’s task of supervising financial leasing companies as a central banking task in the sense that it complements the CBC’s existing bank supervisory functions."

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By GlobalData

Despite saying that new supervisory functions being financed by supervised entities could have a positive impact on the CBC’s financial capacity to assume them, the ECB also highlighted potential risks.

"The ECB considers that the draft law potentially creates financial risks for the CBC because it does not limit the CBC’s liability, as a public authority, for damages caused in the course of the exercise of its new supervisory powers, in similar terms to the CBC’s liability in connection with its bank supervisory tasks. It would be useful to align the CBC’s liability under the draft law with the liability regime for the CBC when conducting its supervisory powers over credit institutions," the ECB wrote.

In addition, the ECB commented on the CBC’s intention not to set limits on leverage and regulatory requirements: "The ECB understands that the Cypriot authorities opted not to impose explicit limits on leverage and liquidity requirements at this stage so as to offer wider opportunities for financing to new leasing companies, with a view to facilitating private debt restructuring.

"Nevertheless, the ECB considers that it would be useful to explicitly clarify limits on leverage and liquidity requirements for these new entities at some stage, and particularly in the event of the emergence of risks relating to regulatory arbitrage or of concerns about financial stability."