Cyprus borrowers shift toward longer-term fixed-rate loans

ECB policy cycle reshaped Cyprus’ lending landscape, CBC says The Central Bank of Cyprus (CBC) on Friday published a new Economic Brief examining how the European Central Bank’s (ECB) recent monetary policy cycle reshaped the composition of bank lending in Cyprus, concluding that a marked shift towards longer-term fixed-rate loans has brought domestic financing conditions closer to those prevailing across the eurozone. The report, prepared by the CBC’s Economic Analysis and Monetary Policy Division, said the move towards longer-term fixed-rate lending, particularly in the mortgage market, reduced the exposure of new borrowers to interest rate fluctuations, narrowed the gap between lending and deposit rates, and altered how monetary policy is transmitted through the Cypriot economy. According to the central bank, the ECB’s monetary tightening cycle, which ran from July 2022 until September 2023, followed by the subsequent easing phase between June 2024 and June 2025, was accompanied by significant changes in the composition of new lending in Cyprus. The CBC explained that new lending increasingly shifted towards fixed-rate loans with an initial interest rate fixation period of more than one year, especially for housing loans. It added that this trend, together with increased issuance of loans secured by deposits, contributed to lower lending rates, a closer alignment of financing conditions with those in the eurozone, and a significant reduction in the spread between lending and deposit rates. The report also said these developments reflect a broader redistribution of interest rate risk between banks and borrowers. According to the CBC, the changing composition of new lending has become an important factor in understanding financing conditions and the transmission mechanism of monetary policy. It said the growing share of loans with longer fixed-rate periods increasingly resembles the structural characteristics of the eurozone and suggests that future changes in monetary policy are likely to be passed on to borrowing costs more gradually. The central bank explained that the ECB’s recent monetary policy cycle affected not only interest rate levels but also the structure of bank financing throughout the eurozone, with Cyprus experiencing a particularly strong shift towards longer-duration fixed-rate lending. It said the largest change occurred in new mortgage lending. Before 2022, the overwhelming majority of new mortgages carried variable interest rates or interest rates fixed for no longer than one year. Since then, however, there has been a clear movement towards longer-term fixed-rate products. As a result, mortgages with an initial fixed-rate period of between one and five years have become the dominant form of new housing finance in Cyprus. The CBC said a similar but less pronounced trend was also observed in lending to non-financial corporations. At the same time, it pointed to a gradual increase in loans with initial fixed-rate periods exceeding five years for both households and businesses, products that had previously been virtually absent from the Cypriot market. According to the report, these changes reflect adjustments on both the demand and supply sides of the lending market. The central bank explained that in an environment of higher interest rates and increased uncertainty over future borrowing costs, households and businesses placed greater emphasis on predictable debt servicing costs. It said longer-term fixed-rate loans provide greater certainty over future borrowing costs while limiting borrowers’ exposure to future interest rate movements. The report added that banks also expanded their range of fixed-rate lending products, offering more attractive pricing, often in combination with deposits pledged as collateral. The CBC said this shift reduced the immediate sensitivity of new lending to changes in policy interest rates and transferred part of the interest rate risk from borrowers to banks. It added that the change also brought Cyprus’ lending structure closer to that of the eurozone, where loans with long initial fixed-rate periods have traditionally played a much more prominent role. The report said these developments are particularly important when assessing the effectiveness of monetary policy transmission. As the proportion of longer-term fixed-rate loans increases, changes in ECB policy rates are expected to feed through to financing costs more slowly and gradually. Turning to financing conditions, the CBC said the restructuring of new lending was accompanied by a substantial convergence with eurozone financing conditions, particularly in the mortgage market. It explained that the difference between mortgage lending rates in Cyprus and the eurozone median narrowed significantly after 2023. From May 2025 onwards, interest rates on new mortgages in Cyprus fell below the eurozone median, indicating what the central bank described as a meaningful convergence in housing finance conditions. The report added that the eurozone remains dominated by mortgages with fixed-rate periods exceeding ten years, which naturally slows the transmission of monetary policy changes into lending rates. For business lending, the CBC said convergence was also evident, although to a lesser degree. While the gap between Cyprus and the eurozone gradually narrowed, interest rates on new business loans remained, on average, higher than those across the eurozone. According to the report, this reflects the greater diversity of business lending, where pricing depends more heavily on credit risk and the specific characteristics of each financing arrangement. The central bank said the adjustment in Cyprus took place through both changes in the composition of new lending and a substantial reduction in the difference between domestic borrowing costs and eurozone levels. It added that this has reduced disparities in domestic financing conditions and provides a clearer picture of how the ECB’s single monetary policy is transmitted to the Cypriot economy. The report also examined the spread between lending and deposit rates, describing it as a broader indicator of financing conditions because it combines the cost of new borrowing with the return on new deposits. The CBC said this spread narrowed significantly following its peak during the ECB’s tightening cycle. For households, the difference between Cyprus and the eurozone fell from 2.3 percentage points in October 2023 to 0.4 percentage points in April 2026. For non-financial corporations, the equivalent gap declined from 2.5 percentage points in May 2023 to 0.8 percentage points in April 2026. According to the report, the narrowing of this spread was driven largely by the convergence of lending rates with eurozone levels. The trend was particularly strong in the mortgage market, where new lending rates now sit below the eurozone median, while differences in business lending rates have also narrowed considerably. The CBC said the remaining differences largely reflect the comparatively slower adjustment of deposit rates in Cyprus for both households and businesses. It linked this to high levels of excess liquidity, the banking sector’s stable deposit base, competitive conditions in the domestic deposit market, and the relatively limited scale of Cyprus’ banking system. Looking at the broader implications, the central bank said recent monetary developments show that the composition of new lending is an important dimension of monetary policy transmission. It explained that, beyond influencing borrowing costs directly, the structure of lending affects both the speed and extent to which changes in policy rates are transmitted across the wider economy. The report said the convergence of financing conditions has been supported by the shift towards loans with longer fixed-rate periods and more favourable pricing, together with banks introducing new lending products carrying lower interest rates, frequently backed by deposits used as collateral. The CBC concluded that the move towards longer-term fixed-rate lending reduces the immediate sensitivity of new borrowers to policy rate changes while increasing the share of interest rate risk assumed by banks, a risk that can be managed through appropriate risk management practices. It added that, as a result, changes in ECB policy rates are increasingly transmitted to borrowing costs in a more gradual manner. The report also stressed that developments in deposit rates demonstrate that monetary policy transmission depends not only on changes in official interest rates but also on liquidity conditions and the structural characteristics of the banking sector. According to the CBC, taking these factors into account provides a more comprehensive understanding of domestic financing conditions, the evolving composition of bank lending, and the transmission of monetary policy within the Cypriot economy.