By Gregoris Savva
Daniele Nouy, Chair of the European Central Bank’s Supervisory Board, has called for additional and persistent efforts to bring about a sustainable reduction of the extremely high stock of non-performing loans (NPLs) plaguing the Cypriot banking system.
In an interview with CNA, Nouy acknowledged the progress made by the island’s commercial banks to reduce NPLs but noted that NPLs in the Cypriot banking sector remain at extremely high levels, while progress was uneven across banks.
“So, there should be no doubt that additional and persistent efforts are still required to ensure that a sustained, long-term reduction in the stock of NPLs in the Cypriot banking system can be achieved,” she stressed.
The SSM Chair also welcomed the recent hike in the NPLs coverage ratio, pointing out that provisioning levels “need to be continuously reassessed and readjusted, in order to make NPL reduction strategies feasible.”
Furthermore, Nouy pointed out that following the improvement of the economic situation in the Eurozone in general, “the time has indeed come to be more ambitious,” in setting targets for NPL reduction, starting with the banks themselves which should set “ambitious, but realistic and credible targets.”
After setting a proposed timeframe for the full coverage of new NPLs after January 1 2018, Nouy said that work is still in progress regarding the best way to deal with the stock of NPLs.
The full text of the interview follows:
Q: It’s been almost five years since the crisis that swept through the Cypriot banking system. Is ECB Banking Supervision satisfied with the progress made by the Cypriot banks to reduce their high stock of non-performing loans (NPLs)?
A: We recognise the efforts made by the Cypriot banks we supervise in resolving NPLs over the past few years. It is clear, however, that NPLs in the Cypriot banking sector remain at extremely high levels and that the progress made is rather uneven across banks. So there should be no doubt that additional and persistent efforts are still required to ensure that a sustained, long-term reduction in the stock of NPLs in the Cypriot banking system can be achieved.
Q: So far the Central Bank of Cyprus has set targets for the commercial banks, such as proposed viable restructurings and agreed viable restructurings. Do you think the time has come to set more ambitious targets, such as time-bound quantitative reductions of NPLs? And what would be the ECB’s response if these targets were not met?
A: With the improvement of the economic situation in the euro area, the time has indeed come to be more ambitious. This starts with the banks themselves setting their own ambitious, but realistic and credible targets. And it is essential that banks assess and determine the effectiveness of their measures in order to continuously improve their strategies relating to NPLs, as well as their operational capabilities.
Internal targets already need to be included in the banks’ NPL strategies established in line with our NPL guidelines, and these strategies have to be updated on an annual basis. If banks don’t reach their internal targets, they have to identify and implement the appropriate corrective measures.
Q: In their quest to reduce high levels of NPLs, the banks have widely used four tools: restructuring, provisioning, write-offs and debt-to-asset swaps. Do you believe that the sale of loans could constitute an effective tool to move towards a faster clean-up of the banks’ balance sheets, and should such a tool be considered?
A: Undeniably, the sale of loans can be an effective tool in dealing with the high level of NPLs. To make it feasible, however, it is important that an appropriate legal framework and servicing infrastructure are in place. Notwithstanding some progress in NPL resolution, the very high level of NPLs remains a key vulnerability of the Cypriot economy and banking system, and weighs on the ability of banks to carry out their credit intermediation function. It is, therefore, essential that NPL resolution be accelerated. This implies a need to use all available instruments, which should be considered as complimentary rather than alternative options. To help step up the use of the insolvency and foreclosure frameworks, the related legal proceedings need to become much simpler, shorter and hence more efficient. The option of selling loans could indeed constitute another channel for resolving NPLs.
Some banks are exploring this option and some NPLs are in the process of being disposed of. The use of this instrument has been rather timid so far, possibly reflecting the fact that the legal framework is relatively new, but it could also be due to the requirements it imposes. It should also be noted that NPL sales require a high level of provisions, otherwise such sales of loans generate losses that must be covered by capital. Finally, the adoption of the securitisation law will be an essential complement to the framework for creating a secondary market for loans.
Q: Regarding the point you made about the effect of the sale of loans on the banks in terms of capital, there is an impression in Cyprus that each time the banks are on track to register profits, the ECB forces them to increase their provisions, thus eroding their profits and capital. Is this indeed the case? Do you think this approach contradicts the wider concern expressed by the ECB about the banking system’s profitability?
A: A common feature of Cypriot banks is the high level of NPLs, which weighs on profitability as it may lead to additional provisioning requirements or write-downs and makes the banks less likely to provide new financing to the real economy. Experience shows that the longer it takes to deal with high NPL levels, the higher the cost is in terms of losses for financial institutions.
That is why provisioning levels need to be continuously reassessed and readjusted, in order to make NPL reduction strategies feasible. Supervisors continue to focus on ensuring that all the banks we supervise recognise provisions in a timely and accurate manner from a prudential perspective. This is essential to ensure that expected losses are adequately measured while reducing the probability of unexpected losses occurring in the future. This ultimately is to the benefit of the banks, as it minimises threats to their capital base. We have so far engaged extensively with Cypriot banks with respect to their provisioning methodologies and we welcome the recent increase in coverage.
Q: As foreclosed asset auctions do not seem to work, should Cyprus incorporate the option of online auctions, as proposed in Greece?
A: In my view, any improvement aimed at enhancing the effectiveness of the auction process is welcome. The repossession of real estate assets provided as collateral is one of the tools at the disposal of banks to resolve NPLs. But then the banks have to dispose of such foreclosed assets or, at a minimum, make sure that their valuation in the bank’s balance sheet fully reflects their market value. While there has been relatively little use of the framework in the early stages of its implementation, there is some preliminary evidence that banks are stepping up its use.
An effective foreclosure framework is also needed to deter strategic defaulters and incentivise borrowers to engage in voluntary debt restructuring agreements with the banks. A key measure to step up the use of the foreclosure framework would be a reform of the justice system with a view to drastically reducing the time for resolving legal claims. Progress is also essential in relation to the issuance and transfer of title deeds. Regarding the platform for online auctions in Greece, as it is not yet operational, it is too early to draw any lessons from it.
Q: In a speech to the European Parliament recently you said that ECB Banking Supervision will adopt a forward-looking strategy to prevent future bloating of NPLs. Could you explain how this could be done?
A: With the publication of qualitative guidance on NPLs in March 2017, we put in place a rigorous framework for all the banks we supervise; and with the addendum on quantitative expectations for newly classified NPLs, which is currently under public consultation, we are reinforcing this framework even further. Work is still in progress regarding the best way to deal with the stock of NPLs. In addition to this, the ECB conducts its annual Supervisory Review and Evaluation Process, which is a multifaceted, regular assessment of banks’ risk profiles, including credit risk and credit risk management.
Q: Against the backdrop of high levels of NPLs, low profitability, increased capital requirements and an elevated supervisory burden, do you believe the banking system in Cyprus should proceed with consolidation through mergers and acquisitions?
A: The size and characteristics of the banking systems in Europe, not just in Cyprus, are a matter of intense debate. Further consolidation of the banking systems in the euro area would help reduce excess capacity and make banks more efficient and more profitable. And I am not talking about domestic mergers only; the European banking union has set the scene for banks to merge across borders and it has opened up a large pool of potential partners.