Faced with the collapse of Cyprus banking sector and a possible default on its debts, Cyprus last March agreed with the Troika on a €10 billion bailout which featured an unprecedented haircut of deposits over €100,000 to recapitalise the island`s largest banks on basis of a due diligence audit carried out by Pimco that showed the island`s banking sector would registered capital needs of €10 billion until 2016. Furthermore the programme provides for a series of measures aiming at addressing problems in the island`s banking sector, including the restructuring of loans in arrears.

"This is a very pressing issue in Cyprus, with arrears and non-performing loans rising to unprecedented levels," Central Bank Governor Panicos Demetriades said addressing a recent conference on arrears and loan restructuring organized by the CBC. He acknowledged that "for many years the banking sector in Cyprus, in common with some other countries, adopted poor risk and credit management practices, dominated by asset based lending, and an overexpansion of the real estate market," adding, "many developed economies, including Cyprus, discovered that such recipes lead to a significant increase in arrears, particularly as they strive to overcome the ripple effects of the global financial crisis."

"With falling demand, the economy in recession and rising inability to meet repayments as well as decreasing real estate and other asset prices, the banks find themselves not only with liquidity concerns but also with rising security shortfalls and an increasing need for provisions," he added. Demetriades said "arrears management and loan restructuring is one of the most challenging issues currently facing the banking sector in Cyprus in its path to the restoration of financial soundness. The cleaning up of the banks’ balance sheets will help improve the functioning of the monetary transmission mechanism. More specifically, a reduction in the level of NPLs will result in lower provisioning requirements and this will contribute to the decline in interest rates in the long run, to the benefit of households and businesses, while at the, adequate capital buffers will be created thus strengthening the resilience of banks in the future," he went on to say.

On his part Filip Keereman, Head of unit in the European Commission`s DG for Economic and Financial Affairs attributed the rise of non-performing loans in Cyprus to the high household and corporate indebtedness, which is higher than all countries in the EU and indeed Greece, Spain Hungary Ireland, Latvia Portugal and Romania, the sharp economic contraction and the poor supervision and governance in the banking sector. "The banks are fragile and find difficult to tackle NPLs but the recession is likely to be less severe than in other countries like Greece or Latvia," he said.

According to the Ministry of Finance, contraction in 2013 is estimated to reach around 5.5% much lower than the 7.7% projected by the Troika, which has been revised from an initial 8.7% contraction. Reiner Martin head of the ECB unit for the Cypriot financial sector said "debt restructuring is an absolutely critical component of the programme", noting that so far NPLs are exceeding 40% in major Cypriot banks. "The bank capitalization and ability to resume lending is absolutely critical and depends on maximizing the value of NPLs," he added.

Figures presented by the IMF advisor, Luis Cortavaria, showed that NPLs in Cyprus reached 46% of gross loans or €19 billion which corresponds to 120% of the island`s GDP. "The important message is that the taskof cleaning up the banks takes time. It is a difficult task, there is no magic bullet for this but at least there is light at the end of the tunnel," Cortavaria said. He called on the banks to adopt alternative approaches on debt restructuring. "The banks also need to recognize that some borrowers need to go into liquidation. Unfortunately that is the case in banking crisis. Certainly the objective of this debt restructuring is to minimize those cases but at the same time the objective is to ensure that the borrowers staying to the market are the good borrowers," he concluded.

Source: Financial Mirror