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Cyprus banks enter cycle of uncertainty in a strong position, SSM chief says

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Cypriot banks enter the cycle of uncertainty created by the war in Ukraine in a strong position, Andrea Enria, President of the ECB’s Supervisory Council told CNA, calling however for vigilance particularly over credit risk due to a potential economic downturn and to avert a possible wave of non-performing loans.

In an interview with CNA, on the occasion of his visit to Cyprus for talks with Cypriot banks, Enria also warned that continued suspension of foreclosures could impact the banks’ ability to recover their problem loans and consequently their ability to provide credit to the economy.

Enria also said that Cypriot banks could be given the green light to distribute dividends, for the first time since the 2013 financial crisis, if they provide proof that their capital levels would not drop below regulatory requirements both in a baseline and an adverse scenario.

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“Cypriot banks made a lot of progress recently, so yes, I think that they enter into this difficult and uncertain phase in a stronger position,” the ECB’s chief regulator said, adding that there are differences across banks, “but in general, the sector is much more resilient and robust than it was a few years ago. A lot has been done in terms of reducing non-performing loans.”

Noting that “a lot of progress has been made by the Cypriot banks,” Enria added that “they are well ahead in the normalization process that puts them on the same boat as the other European banks.”

But Enria said Cypriot banks operate in a legal environment which is “not easy” due to the continued suspension of foreclosures, which, he added, has increased the uncertainty for banks in their efforts to recover NPLs.

“You need a stable and supportive environment to ensure that banks can manage their non-performing loans portfolios effectively and clean their balance sheet in in a fast way when the crisis hits,” Enria pointed out, adding “if they don’t do so, there is an impact on the economy as a whole because, let’s not forget, when you have a balance sheet which is clogged with non-performing loans, the lending capability of the bank is impaired, so the ability to support households, to support corporates and to support the recovery of the economy is much reduced.”

As the ECB is hiking its policy rates to contain rising inflation, Cypriot banks appear optimistic that they will capitalize on strong liquidity held at the ECB, which accompanied by rising lending rates will boost their net interest margin.

“It is indeed true that the increasing interest rates, the exit from the negative interest rate policy have had a positive impact on the banks’ profitability. That’s a fact and it will continue playing a positive role also for some time,” Enria said, noting however that “we should not forget that at a certain point also deposit rates will start increasing and therefore the positive effect on margins will be reduced accordingly.”

On the banks’ intention to consider dividend distribution this year, Enria said that the supervisor has asked Cypriot banks, as applies to all other European banking institutions under its supervision, to provide their estimates on their capital trajectories under the baseline scenario, which provides for a shallow and short recession, but also under an adverse scenario.

“If the banks are able to prove to us that they will be able to remain above our supervisory requirements, even in an adverse scenario, there would not be negative feedback from our side. That’s the same for all the European banks,” he said.

Furthermore, Enria did not wish to comment on Greek Eurobabank’s move to acquire a significant stake in Hellenic Bank, Cyprus’ second-largest lender, as regulatory approvals are underway.

However, he said that he is in favour of cross-border mergers.

“For me, mergers are an important tool that European banks can use, because they are a transformative, the most transformative opportunity on business models, to make the business models more profitable, generate more capital and put banks on a steadier course going forward. Mergers are a way to reconsider strategies, to reconsider digitalization and to embrace the changes which are which are necessary at the moment.”

“We need to make banks stronger”

Enria said 2022 has been “a very good year for European banks, I mean, as the increase in interest rates has played a positive role on their profitability, while their capital position is strong and the asset quality has improved throughout the year and throughout the pandemic with disposals of non -performing loans or securitization of NPLs.”

Pointing out that “there are risks ahead of us and a lot of uncertainties,” Enria added the recession is estimated now to be “shallow and short,” but “might prove to be deeper and longer than we currently expect, or the interest rate increase might be faster, stronger and longer, in order to keep control of inflation.”

“So banks need to be prudent to look at all possible scenarios and manage to, you know, prepare themselves to deal also with these possibly adverse developments,” he said, noting that in the baseline scenario, European banks should still see on average, their profits increasing and their capital position remaining solid.

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Asked about 2023 supervisory priorities, Enria replied that the SSM is “focusing very much on making banks stronger and strengthening their controls, managing proactively credit risk, getting prepared to avoid a new wave of non-performing loans.”

“They need to proactively manage interest rate risk, and be careful with their exposure to those sectors, which are particularly vulnerable to interest rate increases and to the energy shocks or energy-intensive sectors for instance,” he said, noting that while looking at the immediate challenges we also need not lose sight of the longer-term structural challenges for the banking sector, which has mainly been the digital transformation and the climate change.

Asked whether he is concerned over a possible wave of new non-performing loans, while these fears did not materialize during the pandemic, Enria pointed out that during the Covid-19 pandemic, there was a “huge amount of public support” granted to households to small and medium enterprises and to corporates.

“And these, of course, cushioned the banks from the potential negative impact of the sharp recession that we had,” he said, adding that he does not expect such vast public support because state budgets are burdened by higher levels of debt.

“So, I think that banks might face a more difficult situation, but honestly we need to focus the attention on the robustness of the internal controls, and make sure that we have a prompt identification and management of any credit that starts deteriorating,” he said, noting that “that didn’t happen last time, which meant that we had a pile-up of non-performing loans, this time, we are more prepared, and I think that we can avoid it if banks are focused on the issue.”

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