Moody’s, which kept the island’s banking system outlook on negative, said Cypruswas going through a deep and prolonged recession that will further strain the already highly stressed operating environment. “In this context the outlook reflects the formidable challenges facing the banks, namely acute asset-quality deterioration, continued concerns over their solvency, and intense funding and liquidity pressures,” Moody’s said. The agency said it expected a 12% contraction of GDP in 2013 and 6.4% in 2014. There will be a sharp dropin domestic consumption, further contraction of the real-estate sector, and reduced business volumes in financial services, given the impairment of the banking system’s offshore business model, Moody’s said.

The economic contraction will worsen the already bad asset quality, leading to exceptionally high loan-loss provisions. The agency said it expected problem loans to rise to over 35% of gross loans by year-end, likely leading banks to require additional capital, above recent recapitalisations. “Under Moody’s central scenario, the Cypriot banks and cooperatives could face capital needs that exceed by some €1.5 billion the €2.5 billion of EU support funds earmarked for the banking sector,” Moody’s said. From that amount, €1.5 billion will be used to cover the capital shortfall of cooperative banks, leaving €1.0 billion as a cushion.

Moody’s also expects banks’ reliance on central bank funding, which totalled €11.3 billion in August, to rise further. This is the result of deposit outflows that followed a Eurogroup decision to ‘bail-in’ or seize depositors’ cash in the island’s two biggest banks, as part of the island’s bailout. Bank of Cyprus (BoC) was the biggest of the two banks deeply affected by the €10 billion bailout. The second, Laiki, was wound down. Large depositors in that bank saw amounts exceeding €100,000 seized and what remained was merged with BoC. Almost half – 47.5% — of uninsured deposits in BoC were also seized to recapitalise the lender. Depositors received equity in return.

Source: Cyprus Mail