“The banking system in Cyprus has undergone major restructuring since mid-2013 and is thus in a much healthier position in terms of capital and resources to deal with the non-performing exposures,” Central Bank Governor Chrystalla Georghadji said.
“At the same time, the liquidity of credit institutions has improved significantly and, in conjunction with the return of the Cyprus economy to growth, all the preconditions are in place to fund the real economy and support further growth.”
However, while saying that the banking system is on the right track, she notes that the legacy assets, in the form of non-performing exposures (bad loans), still exist.
“This leaves no room for complacency,” she said.
Loan workouts should accelerate
Non-performing loans (NPLs) have finally started to fall. According to Central Bank statistics, the non-performing exposures — the official term for NPLs measured on the European Banking Authority basis — dropped to €27.3bn in December 2015 (a ratio of 45.4%) from €28.4bn (47.5%) in December 2014.
Credit institutions have now set up internal workout units to deal with NPLs and Georghadji says there was “was significant progress in the second half of 2015, which can be partly attributed to the target setting framework put in place by the Central Bank of Cyprus”.
Banks now have very detailed targets and reporting requirements to take early action on loans that show signs of going sour.
“The progress in restructuring during the fourth quarter of 2015, together with the experience gained by banks during the last couple of years, give reason to believe that NPL workouts will accelerate significantly during 2016,” said Georghadji.
However, she notes, the speed of resolution is affected by a combination of factors, such as the ability of banks and troubled borrowers to agree on sustainable debt restructuring solutions and the implementation of the new laws on insolvency and foreclosures.
When asked if there was more the government could do, she said: “Due to the high volume of troubled private debt in Cyprus, the Central Bank of Cyprus would welcome actions by the Government to support out of court troubled debt solutions and to accelerate the procedures for cases that need to be resolved in the courts”.
Capital needs for the Bank of Cyprus, Hellenic Bank and the Cooperative Central Bank are now set by the Single Supervisory Mechanism (SSM), which forced increased provisions on all three banks last year as a result of NPLs.
While not wanting to comment specifically on whether the SSM will ask banks for more provisions, Georghadji said that progress in managing their NPLs “is a key factor taken into account by the supervisor in the determination of the minimum capital requirements”.
Another key input is the value assigned to real estate collateral, which also depends on a good record of how restructured loans are performing.
“These losses could be reduced if the revival of the real estate market continues and the implementation of the foreclosure law proceeds as intended, so that the assumptions used to estimate provisions for NPLs are supported by market transactions,” Georghadji explained.
Main risks going forward
Asked what the main risks were going forward, NPLs are still top of the agenda.
“The main risks going forward emanate mainly from the high level of NPLs… A prolonged period of high NPLs weakens the chances for sustainable restructurings and results in more painful solutions for both the banks and the borrowers, while, in general, the actual losses that the former may suffer, increase,” she said.
Very low or zero interest rates are also a risk, the Governor said, as they supresses bank margins and profitability.
“Banks are obliged to keep a sizeable portion of their assets in the form of high quality liquid assets which have a very low or even negative yield,” she explained.
Impact of ECB decisions
Cyprus, as a junk-rated country that is no longer in a bailout programme is not eligible for the European Central Bank’s extended asset-purchasing programme known as quantitative easing (QE). Nor are there any non-bank corporate bonds eligible for the ECB’s new corporate sector purchase programme (CSPP).
However, Cyprus can benefit from some of the recent measures announced by the ECB on March 10.
“Cypriot banks, depending on their financing needs, could benefit from participating in the new series of the four targeted longer-term refinancing operations (TLTRO II) with a four-year duration,” Georghajdi said.
These measures are meant to give banks incentives to lend to the real economy.
“In addition to any new amounts borrowed under TLTRO II, banks will also be allowed to roll over amounts borrowed under the current TLTROs into the new TLTRO II operations, which will offer much more attractive long-term funding conditions to banks.”
Banks could end up paying zero interest, in line with the current main refinancing operations rate, or under certain conditions could actually receive interest linked to the currently negative deposit facility rate.
Negative interest rates should also spur banks to lend. At present, as a result of the negative deposit facility rate applied to reserves placed with the Central Bank of Cyprus, excess liquidity incurs costs.
“As a result, this may motivate affected banks to put to use their excess reserves,” explained the Governor.
Adapt to the future
Asked how banks can make profits when interest rates are low and provisions are high, Georghadji noted that banks currently have “substantial” profits before provisioning for bad loans.
“If banks make progress with managing NPLs and normalise the annual charge for provisions, this will benefit their profitability,” she said.
“Banks need to adapt to the new environment and proceed with the rationalisation of their operations to minimise their cost to income ratio, having regard to the regulatory constraints and the specificities of the markets in which they operate.”