Cyprus’ legal frameworks aimed at reducing non-performing loans are inefficient and hardly used by banks whose bad debt stock remains a key vulnerability, according to a report released by the European Stability Mechanism (ESM).
The ESM also stressed that Cyprus must resume reforms in important sectors and diversify economic activity, which currently focuses on tourism and construction.
“Although the necessary legal frameworks aiming at reducing NPLs are now in place, they are still inefficient and little used. Instead, banks are more and more in favour of offloading impaired assets from their balance sheets, mostly via debt-to-asset swaps, which deliver NPL reduction in the short-run but leave banks with significant exposure to the real estate sector,” the ESM board of governors’ report for 2017 said.
“Furthermore, new regulatory requirements challenge the banks’ outlook.”
The ESM has now joined a number of other EU institutions and the International Monetary Fund, which pointed out that the foreclosure framework passed by parliament in 2014 was ineffectual as it made it very difficult for banks to collect their dues.
The high level of NPLs remains a key vulnerability for banks, which suggests the need for a reform of the insolvency and foreclosure framework and poses a risk for the economy going forward, the ESM said.
“The ample liquidity and the relatively high capital ratios were certainly important mitigating factors, but risks stemming from weak profitability, the high NPL ratio of 43 per cent, and the coverage of 47 per cent that is still slightly below the euro area average could quickly destabilise the system.”
The ESM acknowledged the solid recovery achieved by the island in the past few years but stressed that it had to resume the stalled reform programme and diversify economic activity.
To boost economic resilience, the country needs to consolidate public finances by further reducing public debt and counteracting the concentration of economic activities by diversifying from the tourism and construction sectors.
“Cyprus must regain reform momentum to enhance the efficiency of the public sector and judiciary while supporting fiscal sustainability.”