articles | 04 November 2015

Consequences of creating bad bank to tackle NPLs

Setting up a bad bank with government money to tackle the high stock of non-performing loans in Cyprus would require a second bailout, an official familiar with the economic developments has said.

The comments came as political leaders in Cyprus are advocating for the creation of an Asset Management Company (bad bank) that would acquire NPLs burdening the Cypriot banks, which amount to 47% of the total loans, or €28 billion.

The official pointed out that NPLs currently amount to 150% of Cyprus’ GDP, noting that as Cyprus’ public debt is very high, the government could not borrow from the markets to fund the bad bank to acquire a sizeable amount of the distressed loans and therefore the government would have to resort to a new bailout.

He furthermore, noted that even providing government guarantees to support the AMC would gravely deteriorate public finances.

The NPLs would need another year to provide an indication that they are on the way down, as Cyprus has just started implementing the insolvency framework coupled with the new foreclosure law and the new arrears management directives issued by the Central Bank, he said.

Cyprus needs at least one investment grade rating.

Furthermore, as Cyprus is near to the conclusion of its €10 billion bailout, in March 2016, the issue of whether the country’s bonds will eligible for the ECB public sector bond purchasing programme (QE) arose, as the island`s bonds are still rated as junk.

The official noted without an economic adjustment programme, a country whose bonds are still in the non-investment grade, can only participate in the QE following a decision by the ECB’s Governing Council, but he noted that such a decision would be difficult.

He went on to say that this could be possible if one of the four rating agencies upgrade the Cypriot bonds to investment grade, as was the case of Portugal.

The official pointed out that the inclusion of Cyprus in the ECB’s QE would also be possible if Cyprus requests the Precautionary Credit Line or the Enhanced Conditions Credit Line which are essentially financial support associated with milder conditionality.

However Cyprus Finance Minister, Harris Georgiades, said during the Economist summit that Cyprus will not be requesting a credit line as soon as its programmes concludes.

“I have mixed feelings on this because a precautionary programme as ECCL could shield the economy for quite some time,” he said, noting that indeed Cyprus can exit cleanly from its programme but there are vulnerabilities.

With regards to Cyprus latest issuance of a €1 billion ten-year bond, he noted that the high spread compared to the German 10-year bond, which is considered as the benchmark, is attributed to the high level of NPLs.

Source: Famagusta Gazette

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