Cyprus loan guarantee scheme credit positive for banks with lending controls — Moody’s

Cyprus’ loan guarantee scheme will be credit positive for banks as long as they control their lending, credit rating agency Moody’s maintained in a note released on Thursday.

“On April 22, the Cypriot parliament passed a law to set up a €1 billion (4 per cent of GDP) loan guarantee scheme. The loan guarantee scheme will be credit positive for Cypriot banks because it will reduce the credit risk on loans participating in the scheme, as long as banks are able to maintain independence in their loan decisions,” Moody’s Senior Analyst Christos Theofilou, and Associate analyst Corina Moustra pointed out.

The scheme provides important aid to the self-employed and large and small businesses by ensuring that they have sufficient access to liquidity and funding to support Cyprus’ post-pandemic recovery. The also scheme aims to encourage banks to lend and will help protect them from defaults on these business loans without shielding them entirely, however, the note continues.

The project provides loans of €550 million to small businesses, €350 million to medium-sized enterprises and €150 million to large enterprises, and the total accounts for about half of all annual business lending in Cyprus, the analysts said.

“The government will cover 70 per cent of a defaulted loan, while the bank will cover the remaining 30 per cent.  This means that banks retain part of the risk for the loans they extend. The scheme will incentivise borrowers to access cheap government-backed loans because the interest rates on these loans will be lower than current market rates.”

The scheme also permit borrowers to delay repayments by 12 months so that the payments do not squeeze much-needed cash from businesses. Banks will also benefit from the lower risk weighing assigned to these loans – this means less pressure on banks’ risk capital.

When banks decline to lend to a company, the firm could, under the scheme, have an option to appeal to a special external monitoring committee which is to help ensure lending to low-credit-rating borrowers.

Banks do have the right to opt out of the scheme, and this option may be deal-breaker for some banks that could fear losing control of lending, the two analysts warned.

Before being implemented, the European Commission must approve the loan guarantee scheme as being in line with state aid rules. Additionally, Cyprus’ Ministry of Finance must issue a relevant decree and the country’s new parliament (which will be elected on 30 May) must discuss the decree. Banks will have a month to decide whether to participate in the plan.