Cyprus Mail
Business Cyprus

Banks still have their work cut out for them

By Elias Hazou

THREE of four Cyprus-based lenders may have got a clean bill of health in the eurozone-wide bank stress tests, but challenges still lie ahead both for the banking sector and the economy at large, analysts tell the Mail.

“The key challenge is to clear banks’ balance sheets of non-performing loans. Recouping bad loans is what will allow banks to ease lending, thereby boosting the economy, but of course this lending must be done prudently if we have learned anything from past experience,” economist Mike Spanos said.

Likewise Alex Apostolides, an economic historian with the European University Cyprus, observes that whereas Cypriot banks may be solvent and adequately capitalised, they cannot give out substantial new loans unless they first “sort out” the mess of non-performing loans (NPLs), which currently account for approximately 50 per cent of all loans.

The best way to accomplish that is by generating jobs, adds Apostolides.

“With the stress tests over, we can now put emphasis on the banking sector on the backburner and focus on structural reforms, such as public sector reform, improving the competitiveness of the economy. That is the way forward. Like I’ve said before, we need to take ownership of the Memorandum of Understanding.”

That was a somewhat more sombre reading than the upbeat assessments yesterday from public officials – including the finance minister and the Central Bank chief.

The stress tests have been successfully negotiated, but it’s the first of several hurdles ahead to put the economy back on a sound footing.

Bank of Cyprus may have passed the test, but not with flying colours. Taking into account the lender’s recent €1bn capital raise, it registered an overall
capital surplus of just €81m under the ECB’s draconian scenario.

The ECB’s passmark was for banks to have high-quality capital of at least 8 per cent of their risk-weighted assets, a measure of the riskiness of a banks’ loans and other assets, if the economy grows as expected over the next three years, and capital of at least 5.5 per cent if it slides into recession.

Under the adverse scenario, Bank of Cyprus scored 5.85 per cent, the Cooperative Central Bank 9.3 per cent and Russian Commercial Bank 11.6 per cent; Hellenic Bank failed at 1.7 per cent but the lender has a rights issue in the pipeline to raise additional capital.

With the €1bn capital raise, Bank of Cyprus registers 11.62 per cent by the baseline scenario and 5.85 per cent under the adverse. Had the capital increase not been taken into account, the lender would have scored 7.73 per cent and 1.51 per cent, respectively.

In plain speak, said Apostolides, the adverse scenario is a forecast of how economies will fare over the next three years.

“Basically it projects what will happen to banks’ balance sheets should unemployment go up,” he noted. Apostolides played down the fact that Bank of Cyprus only narrowly passed the ECB’s simulation exercise.

“In Cyprus’ case, there was not much difference between the normal and the adverse scenarios because we’re dealing with an economy that’s already in distress,” he offered.

Similarly, Spanos said the stress test results go to show that Bank of Cyprus carried out a thorough due diligence when planning the €1bn capital raise.
“They calculated how much they’d need to pass, and they got it spot-on right,” he said.

Another thing to consider is that the test results indicate the ECB did assume Cypriot banks’ increased ability to recover NPLs following passage of the foreclosures bill earlier this year, despite the fact the bill’s fate is still up in the air.

In hindsight, this suggests that stark warnings from the government camp and the Central Bank – to the effect that passage of the repossessions law with strings attached posed a severe risk to Cypriot lenders pending the stress tests – may well have been inflated.

Less exposure to shocks will be the major benefit to systemic Cypriot banks now coming under direct ECB supervision after passing the tests.

As Spanos explains, in addition to better supervision, the Single Supervisory Mechanism (SSM) creates a buffer between bondholders and depositors. This “insurance cushion,” he said, will vary depending on the size of each bank.

Both analysts agreed that the results should start mending the public’s shattered confidence in banks, by putting paid to rumours of a new bail-in.

The received wisdom is that wary savers keeping their excess cash ‘under the mattress’ or in safety deposit boxes should now put the money back into the banks. Whether the return will take the form of a trickle or a torrent remains to be seen.

Marios Clerides, CEO of the Cooperative Central Bank (CCB) guessed yesterday that as much as €1.8bn was being kept outside the banking system.

Estimates vary on how much cash is being hoarded. The Mail is told that about a year ago the Central Bank calculated that approximately €1bn was out of the system. Whatever the real figure, it’s reasonable to assume that a sizeable amount of these savings have been spent.

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