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Pandemic-related economic slump will weigh on banks' balance sheets

22/01/2021 15:49

The coronavirus pandemic and the measures adopted to contain it triggered a severe economic slump in Cyprus in 2020, according to the Economist Intelligence Unit (EIU).

“Based on data available for the first three quarters, and our assessment of the impact on the economy of further restrictions put in place to combat a second wave of the virus, we estimate that real GDP contracted by 6.2% last year. We currently forecast only a partial recovery in 2021, with the economy expanding by about 4% this year. We forecast growth of about 3% in 2022, the year in which we expect real GDP to return to its 2019 pre-pandemic level”, the EIU says in a report.

As shown by the latest banking sector indicators cited above, bank recapitalisation, together with reforms carried out in 2013-16, has made Cyprus's banks more stable and resilient to shocks than was the case in the previous crisis. However, profitability remains weak. According to European Banking Authority data, the cost-to-income ratio of Cypriot banks stood at 68.5% in the third quarter of 2020, down from a peak of 77.8% in the second quarter of 2018, but still well above the level of about 36% recorded in the second half of 2014, when the series was established. 

There is also a considerable risk that the banks' still high levels of NPEs could start to rise again. NPEs declined to EUR6.3bn in September, from EUR6.7bn in June and EUR9bn at end-2019, reflecting banks' disposals of bad loans but also the impact of the suspension of debt repayments for corporates in place since March 2020 as part of the measures to mitigate the pandemic's impact on the economy. The moratorium, which had been due to expire at the end of 2020, has been extended to end-June 2021 but only for companies affected by the pandemic that did not use the loan repayment holiday in 2020 or that did not avail themselves of it for the full nine-month period. Nevertheless, once the moratorium ends, some businesses could cease trading, creating new NPEs. 

According to the EIU, the intensification of domestic political tensions ahead of the legislative election-which must be held by May-has contributed to the vetoing by parliament of the draft 2021 budget and a further delay in bank foreclosures of properties with mortgage arrears.

The recovery of the banking sector from near-collapse in 2013 has made steady progress, but it remains vulnerable to a possible upsurge in new non-performing loans owing to the economic slump caused by the coronavirus (Covid-19) pandemic, as well as to political resistance to further reform.

The president, Nicos Anastasiades, presides over a minority centre-right government, which needs to seek parliamentary support for its initiatives on a case-by-case basis. Although this support has generally been forthcoming in recent years, the imminence of the legislative election has encouraged political parties to increase their demands in exchange for their support, which has exacerbated shortcomings in policymaking. 

Political instability on the rise ahead of the legislative election

In December 2020 parliament rejected the government's draft 2021 budget by 29 votes to 24. This was the first time that this has happened since independence from Britain in 1960. At least in part, the rejection was motivated by opposition parties' demand that the auditor-general be given full access to documents related to the scandal over Cyprus's visas-for-investment scheme. In mid-January the finance minister, Constantinos Petrides, warned parliament that failure to approve a new draft could hinder the planned refinancing of government debt falling due in 2021, which could lead to a default.

Politics and the pandemic halt foreclosures

More relevant to the banking sector have been the changes to legislation adopted in parliament regarding foreclosures on mortgaged properties whose owners have fallen into arrears. In 2018 Cyprus strengthened its foreclosure and insolvency framework in order to help banks to reduce their large stock of non-performing exposures (NPEs) and revive productive lending to the economy. However, in June 2020 the Supreme Court approved subsequent amendments to the framework adopted by parliament, including the introduction of a procedure to appeal to the Ombudsman before the foreclosure process even begins, which risks causing delays and undermining legal certainty for creditors. 

The pandemic has also caused further disruption as all foreclosures have been suspended since the initial coronavirus outbreak in March 2020. In December the second wave prompted parliament to extend the suspension of foreclosures until end-March 2021 for primary residences valued up to EUR350,000 and mortgaged properties owned by small businesses, ignoring the government's and banks' concerns about the inclusion of the latter. Just before the vote, the Association of Cyprus Banks had sought to pre-empt parliament's decision by announcing only the suspension of repossessions of primary residences up to a value of EUR350,000. There is considerable concern among government officials that the broader suspension will further undermine Cyprus's already weak repayment culture and force lenders to raise more capital and increase provisions for bad debts. 

The banking sector is more resilient than in 2013

When the troika of international creditors comprising the EU, the European Central Bank (ECB) and the IMF stepped in to rescue Cyprus in mid-2013, they imposed a draconian bail-in of bank depositors to contribute to the cost of recapitalising the banking system. After restructuring to shrink the country's outsized banking sector, total assets have more than halved from about 750% of GDP in 2009 to just under 300% in 2019, and all non-core assets outside Cyprus-including in Greece, Russia and the UK-have been sold off. The loan-to-deposit ratio has declined dramatically from a range of 130-140% between mid-2013 and end-2015 to just 65% at the end of 2020. Recapitalisation of the banking system has seen Tier 1 capital adequacy rise strongly to 19% in September 2020, from 6.3% at end-2012. NPEs as a share of total loans have declined sharply since mid-2018, to (a still high) 20.1% at end-September 2020, compared with a peak of almost 50% in mid-2016.