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The full effects of crisis still remain to be seen


OFFICIAL statistics indicate that non-performing loans (NPLs) reached 30 per cent of total loans in April 2013 (NPLs will be significantly higher in September – figures to be announced soon. Nevertheless, provisioning for loan losses stands at only 30 per cent of total loans, well below the average ratio of 50 per cent for EU banks.

This suggests that Cypriot banks’ profitability will be significantly affected going forward. As expected following the March crisis, credit supply has contracted in the face of rapidly deteriorating loan quality and tight liquidity. As a result, corporate credit contracted by 9 per cent YoY in June, with mortgage lending and consumer credit falling by about 3-7 per cent, respectively.

To increase transparency, a new Central Bank of Cyprus (CBC) directive will enter into force at the end-September, requiring reporting and classification of all loans in arrears for more than 90 days as NPLs, and all loans whose original terms were modified. This is expected to lead to significantly higher officially reported NPLs than the ones currently offering. Also, the CBC agreed to put in place a new regulatory framework on loan origination, requiring banks to consider affordability aspects in their lending decisions.

To allow banks to make better informed loan decisions based on the creditors’ history, while improving monitoring of credit quality, the authorities have decided to merge and expand the databases of the two existing credit registers for commercial banks and CCIs and to require lenders to submit data on performing and non-performing loans to the registers on a regular basis. The CBC, which will oversee the registers and the banks’ contributions, will also develop tools to use the information for macro- and micro-prudential purposes.

Importantly, new steps were agreed to facilitate corporate and household debt restructuring to address the high level of private indebtedness. Given the large number of existing and prospective loans in need of restructuring, the IMF stressed the need for swift improvement in Cyprus’ private debt restructuring framework with a view to facilitate a reduction in NPLs and in private sector indebtedness.

The Cypriot private sector is currently highly leveraged. The current private sector debt-to-GDP ratio is close to 280 per cent, which is the highest in Europe and about double of the EU average. Corporate credit has been concentrated in the real estate and construction sectors. For households, housing loans account for more than half of the total, leading to a high exposure of banks to the decline in house prices that began in 2009.

Unfortunately, unemployment has been taking the brunt of the adjustment, increasing from 11.7 per cent in June 2012 to 17.3 per cent in June 2013, the steepest increase observed in the EU the last few years. Much of this increase also takes into account the employees of Bank of Cyprus (BoC) and Cyprus Popular Bank (CPB) who took the voluntary exit schemes.

Also, the rapid increase in youth and long-term unemployment is particularly worrying, displaying a rate of more than twice that of total unemployment. The authorities should look for ways to promote employment in key areas within their limited policy space.

No one could argue that Cyprus is suffering from severe economic dislocations, the full effects of which remain to be seen. The authorities are resolved to restore Cyprus’s economic health and ensure its long-term sustainability. While a difficult adjustment is still ahead, Cyprus has placed itself in a good position to prosper in the coming years. Yet, no one can indeed argue that the island will face tough days ahead.