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December 03, 2018

IMF published its staff report and selected issues report under the 2018 Article IV consultation with Cyprus. Directors welcomed the recent reforms undertaken to address key vulnerabilities in the banking sector, including the resolution of a large systemic state-owned bank. Directors observed, however, that private and public debt remain large while non-performing loan (NPL) ratios are still among the highest in Europe. Directors emphasized the importance of put in place measures to facilitate a steady decline in NPLs on a durable basis.

The staff report highlighted that NPLs remain very high, partly due to weak enforcement and strategic debtor behavior, although NPLs are now declining rapidly as bank balance sheet cleanup efforts pick up. NPLs declined by EUR 11.5 billion, lowering the size of NPLs from 161% of GDP in 2014 to 84% of GDP in second quarter of 2018. The reduction reflects write-offs, restructuring, repayments with cash and debt-to-assets swaps, and new tools such as sale of loans. The NPL ratio is set to decline further as they are removed from bank balance sheets, although they remain high and will be a burden on the economy until fully resolved. The recovery rate has been low and the re-default rate among restructured loans has increased lately. In the face of increased competitive pressures and upcoming regulatory changes, continued vigilance over bank lending policies and adequacy of provisioning coverage and debt-to-asset swaps policy are needed.

To reduce vulnerabilities and catalyze NPL resolution, the authorities recently took two key steps. In September, the assets (primarily performing loans) and all customer deposits of the troubled second-largest, government-owned bank (CCB) were sold to Hellenic Bank, leaving the bulk of the NPLs in a residual entity, which has evolved into a government-owned Asset Management Company (AMC). In July, the Parliament adopted a package of amendments to strengthen the legal framework for NPL resolution. The strengthened foreclosure and insolvency frameworks should discourage strategic defaults and help entice eligible borrowers to engage in durable loan workouts. Little progress has been made toward fundamentally addressing the problems in the issuance and transfer of title deeds, thus further complicating potential restructuring or collection of the corresponding NPLs. A regulatory and supervisory framework for the newly established credit-acquiring companies, with focus on reporting requirements, on-site inspections, and off-site monitoring, needs to be developed.

The selected issues report reveals that sustainable restructuring of NPLs has been challenging. Almost two-third of the restructuring flow is on the loans already restructured at least once. The need to accumulate provisions, along with declining net interest margins, have also put downward pressure on bank profitability, undermining NPL resolution. Loan-loss provisions at Cypriot banks are close to 50% of NPLs, slightly above the EU average, as of first half of 2018. ECB data indicates that provisioning and collateral coverage is close to 100% of NPLs. Nevertheless, given that the time required for the foreclosure process is long, banks needed to continue to accumulate provisions as continued difficulties in collateral recovery increased the risk that transaction price of NPLs may be lower than their book value, leading banks to further recognize losses. More recently, however, the accumulation of provisions has facilitated the sale of NPLs by banks. Despite some revival of lending activity, the role of bank credit as a funding source remains limited. External inflows, draw down of savings, use of own funds, and unpaid debt service obligations are contributing to financing economic activities, but these sources may not be sustainable over the medium term. Addressing NPLs to lower borrowing costs and reviving credit supply will be important for supporting longer-term growth.


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Keywords: Cyprus, EU, Banking, NPL, Article IV, NPL Resolution, IMF

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