The outlook on the Cypriot banking system remains negative, primarily reflecting the expectation of a continued rise in problem loans over the next 12-18 months that will exacerbate losses and erode banks’ capital, Moody’s said on Tuesday.
The outlook also captures the vulnerability of the banks’ funding bases, owing to fragile depositor confidence after the resolution of the two largest banks in March 2013, leading to depositor losses and continued controls on cross-border transfers.
Moody’s expects lower corporate earnings, reduced household wealth, high unemployment and falling real-estate prices to be the main drivers of asset-quality erosion for Cypriot banks.
Problem loans now represent over 1.5 times the country’s GDP, the agency said. This follows their significant acceleration to 45.6 per cent of gross loans as of May 2014, after the disruption from the bail-in, the subsequent controls and the economic contraction.
“Conditions will ease gradually, but the banks’ loan loss reserves against credit losses from these exposures remain low at 35 per cent of NPLs as of March 2014, particularly given Moody’s expectations of further declines in real-estate collateral values,” it added.
Moody’s expectation is that elevated credit costs will likely lead to additional capital needs for the system. Although private resources will provide the capital for the principal domestic banks, funds from the government’s support programme earmarked for the banking system by the Troika are likely to be used to recapitalise the co-operative credit institutions.
Moody’s also expects domestic deposits to continue declining as households dip into their savings to maintain living standards.
“The Cypriot banking system’s reliance on euro-system funding, mainly due to Bank of Cyprus’s exposure, although easing, will also remain significant over the outlook horizon,” said the report.