By Stelios Orphanides
While Cypriot banks are “gradually recovering” with both liquidity and solvency improving last year when the economy performed better than expected, the financial system continues to face challenges, including geopolitical events in and out of the European Union, the central bank said.
“The banking system has unprecedented levels of impaired loans, among the highest in Europe, and addressing these loans will take time,” the bank said in its 2015 Financial Stability Report on Tuesday on its website.
The banking supervisor said households and non-financial corporations showed elevated debt levels, unemployment, albeit falling, remains high and public debt as a percentage of gross domestic product has improved significantly but also remains high. New lending remains “at a low level”.
Cyprus, which last year introduced a modernised foreclosure and insolvency legislative framework in an attempt to speed up loan restructurings and reduce the non-performing loans, had delayed the introduction of legislation on the securitisation of loans, the central bank said. “Access to market financing has improved, as reflected in the successful government debt issuance on international capital markets in April this year”.
“Moreover, despite the reduced real and financial links between Greece and Cyprus, adverse developments in Greece could cause confidence effects,” it added. “We are also observing many geopolitical developments in and around the European Union. Any of these could impact the financial stability of Cyprus”.
Cyprus’ economy, which grew 1.6 per cent in 2016, is expected to grow 2 per cent this year helping towards the reduction of bad loans, the bank said “It is important that the necessary reforms are followed through to ensure a stable and steady recovery”.
“There is positive evidence that loan restructuring is proceeding at a faster pace,” it said. “The macroeconomic environment has been improving and progress has been made in reforming the insolvency and foreclosure laws which will further support banks’ efforts to tackle the high level of non-performing loans”.
The central bank said that while it expected the banks’ asset quality and private indebtedness to stabilise before the respective situation begins to improve, the Cypriot financial sector, including both banks and insurance companies, in particular life insurers, will face pressure on their profitability because of low interest rates and the economy’s low-growth environment.
Real estate risks, amid bottoming-out property prices and a likely medium-term prospect of recovery fuelled by “renewed domestic and foreign demand,” as well as funding risks for banks are expected to remain stable.
“However, the prospects for recovery of the property market are difficult to estimate with certainty,” the central bank said. “Close monitoring of the property sector is required owing to its importance both for the asset position of households and for banks’ loan portfolios”.
Funding risks for banks caused by the March 2013 Eurogroup decision to bail in uninsured depositors subsequently leading to an “erosion of confidence” remain “elevated,” the central bank said. “Access to medium-and longer-term funding at sustainable cost remains a challenge as central bank funding remains a significant proportion of the funding base,” even as banks decreased their reliance on central bank funding and increased their deposits, it said.
The central bank added that it also expected a liquidity squeeze in the banking system to first stabilise before it starts to improve as the deposit outflow slowed down considerably.