June 03, 2019

IMF published its staff report in context of the Third Post-Program Monitoring (PPM) discussions with Cyprus. The Executive Board highlighted that durable declines in non-performing loans (NPLs) remain a priority to further reduce the sovereign-bank linkages. A package of legislative amendments in 2018 has enhanced the toolkit to address NPLs. While banks have made significant progress in offloading NPLs, their successful workout outside the banking system is still needed to reduce the high debt burden in the economy. Banks should be encouraged to maintain adequate provisioning coverage and capital, including by diversifying revenue sources and rationalizing operational costs.

The report mentions that NPLs in Cyprus are among the highest in EU and the efforts to clean up bank balance sheets are ongoing. NPL ratio remains high, even though NPLs had declined to 30.5% of loans at the end of 2018 from 43% of loans at the end of 2017. Given the recent success and continued investor interest, further sales of NPLs are planned. The banking system remains highly liquid and NPL provisioning ratio has increased to 51%, which is above the EU average; however, profitability pressures remain amid a low interest rate environment and potentially higher provisioning needs, as banks seek to further offload NPLs. The banking sector reported the first net profit in eight years in 2018. However, operating profits declined due to falling net interest income and an inefficient cost structure.

As per the report, risks to repayment capacity of Cyprus should be manageable. While banks and the non-financial private sector have undertaken significant deleveraging, risks emanate primarily from the still sizable NPLs and the debt overhang and fiscal contingent liabilities that could potentially undermine financial stability and debt sustainability. Delays in implementing NPL resolution measures or declines in real estate property prices could weaken bank capital positions by failing to generate improved payment discipline or adversely affecting collateral values, particularly if the NPLs are not sufficiently provisioned. The authorities considered risks to repayment to be somewhat smaller than viewed by staff. The strengthening of the foreclosure framework in July 2018, which has already led to increased foreclosure initiations and greater willingness of borrowers to engage in NPL restructuring should further allow banks to work out NPLs. Risks to the sovereign are largely contained, with the completion of the Cyprus Cooperative Bank (CCB) NPLs carve-out, the significant strengthening of the banking system’s loss-absorption capacity, the potential execution of additional market-based solutions for NPL resolution by banks in near future, and the transposition of the EU Bank Recovery and Resolution Directive (BRRD) to national law.

The report further highlights that policies should aim to continue strengthening bank balance sheets while avoiding the commitment of public resources. Facilitating NPL resolution, including durable loan restructuring, collateral execution for NPL recovery, and sales of loans, is the key. Banks should maintain adequate provisioning coverage and capital buffers to insulate against potential losses from NPL workouts and sales of loans as well as any regulatory changes, including for building up of other systemically important institutions capital buffers. Efforts to facilitate NPL resolution should remain a priority. The 2018 amendments to the foreclosure and insolvency legislation and the adoption of a law on securitization have all enhanced the toolkit to address NPLs on a durable basis. To avoid merely converting credit risk into real estate risk, banks should be cautioned against warehousing properties from debt-to-asset swaps. The report notes that continued monitoring of Cyprus’s repayment capacity under PPM is warranted during the next 12 months. The Cypriot authorities have indicated their willingness to continue to engage with IMF under the PPM until 2020. 

 

Related Link: Staff Report

Keywords: EU, Cyprus, Banking, NPLs, Financial Stability, BRRD, NPL Resolution, Credit Risk, IMF

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