Increased interest income should not stop banks from addressing structural vulnerabilities, says CBC Governor

Increased interest revenue stemming from monetary policy normalisation should not overshadow Cypriot banks’ structural vulnerabilities, Constantinos Herodotou, governor of the Central Bank of Cyprus (CBC) said on Monday.

Speaking to the House Finance Committee, Herodotou said that Cypriot banks are expected to see a significant increase in interest income due to the European Central Bank’s interest rate hikes.

“This significant increase in income should overshadow or hide structural vulnerabilities of the banking sector which should be addressed in spite of the increased profits,” Herodotou said.

He referred to non-performing loans (NPLs), high operational costs, strengthening corporate governance, high competition from non-traditional banks as well as the quality of customer service.

Herodotou said NPLs declined to €2.8 billion by the end of July 2022, corresponding to 11.2 per cent of total loans in the banking system and reiterated that NPL reduction is due to the larger banks which achieved 80 per cent of NPL reduction whereas smaller banks achieved only 26 per cent.

The CBC governor also said the Cypriot regulator is against extending the moratorium on foreclosures, noting that this would create new risks to banks, as they are coping with the challenge of borrower’s reduced disposable income due to high inflation.

He also pointed out that these NPLs are legacy loans created during the 2013 financial crisis and did not emerge as a result of the Covid-19 pandemic and the war in Ukraine.

“This is a new challenge and by allowing banks to manage the backlog (of NPLs) while we know that in 2023, we will have new challenges we are placing new risks which could affect the economy,” he added.

Asked about the impact of rising interest rates to debt-servicing capacity, Herodotou said that there is concern over the rising interest rates but added that macro-prudential rules concerning loan origination could protect both lenders and borrowers.

He specifically said that loan origination stipulates that loan to value ratio amounts to 80 per cent for first home purchase and 70 per cent for second homes, which protects the borrower, while an additional provision states that debt repayment should amount to 80 per cent of a borrower’s disposable income which protects the borrower from assuming a loan he could not repay.

“These (measures) protect both parties but this does not mean that interest rate hikes will create problems,” he said.

On the economy, Herodotou said that the Cyprus’ output is estimated to rise by 5.5 per cent in 2022 despite the war in Ukraine but is expected to slow down to 2.5 per cent in 2023, compared with the Finance Ministry’s 3 per cent projected growth rate.

Herodotou said the state’s macroeconomic scenario is “realistic” but added there is great uncertainty due to the war in Ukraine.

He also stated that public finances are expected to come under pressure due to increased expenditure from rising Cost-Of-Living Allowance (Cola) in public sector salaries and pensions due to rising inflation, increased cost of goods and raw materials and increased debt servicing costs.

Herodotou however, noted that despite pressures, Cyprus’ public debt is expected to continue its downward trajectory, stressing that “it is important to continue prudent fiscal management and to swiftly absorb funds from the national Recovery and Resilience Fund.”

Herodotou called for targeted fiscal support to vulnerable households and businesses due to rising inflation.