By George Theocharides
Cyprus International Institute of Management
There has been a lot of discussion recently, especially after the successful outcome from the stress tests of our main banks, that it’s time for the banks to start offering liquidity to the market to fund growth in our economy. True, the real economy (households and businesses) need liquidity to survive and prosper, but the main question is what type of liquidity? Is it traditional bank financing, or should there be alternative forms of financing?
There are a number of issues that would make it difficult, or even unwanted by households and businesses, of the traditional bank financing:
1. Banks are faced with very strict criteria/conditions that are included in the recent Central Bank of Cyprus (CBC) circular sent to all banks/co-ops as a guideline for new lending. Loan-holders would have to pass these conditions in order for them to receive further (or new) funding from the banks.
2. Households and businesses are over-borrowed with debt/equity ratios much higher than the acceptable levels. According to Eurostat sources, private debt in Cyprus reached a level of 305% of GDP for 2012, one of the highest in Europe.
3. There has been a rapid increase of the banks’ non-performing loans (NPLs) that reached almost 48% of the banks/co-ops’ total credit facilities (for the end of August, according to CBC data). Thus, the main challenge that the banks are faced is to control this rapid increase and gradually lower it to acceptable levels. Giving more costly debt financing to already over-borrowed households and businesses will not help in this endeavour.
4. Our companies are struggling to survive because of the economic crisis, and thus they offer excessive risk that banks might not be willing to take.
5. The bank loans (household, consumer, business) come with very high interest rates (which one would argue is a compensation for risk) that make it prohibitive to borrow (therefore, not enough demand) and exacerbate even further the NPL problem. As of September, according to CBC data, interest rate on consumer credit stood at 5.59%, on loans for house purchases at 4.31%, and on loans for amounts over EUR 1 mln at 5.21%. One can compare these rates with a deposit rate from households with an agreed maturity of up to one year at 2.59%.
6. The Central Credit Register set up recently by the CBC after the interface of the database of the two mechanisms "ARTEMIS " and "AIANTAS", which in the past were kept separately by the commercial banks and cooperative credit institutions, can now provide detailed information on the total indebtedness of all companies from all banks/co-ops, which will inevitably limit the supply of credit in the market.
7. The loan/deposit ratio for the banks/co-ops is now about 130% that makes it difficult to provide extra lending. According to CBC data, as of September, the outstanding amounts of deposits stood at EUR 46 bln (with an annual growth rate of -4.5%) while the outstanding amounts of loans was at EUR 59.8 bln (with an annual growth rate of -2.8%).
8. Banks/co-ops will need to deleverage further as their balance sheet has grown too big in recent years, and one way is to shrink further their loan portfolio. According to CBC data, total assets have shrunk from a total of EUR 154 bln as of the end of 2010 to EUR 77 bln as of the end of June, 2014.
Therefore, corporate financing as we knew it (in the form of ordinary bank loans), will probably no longer be readily available in the near future, thus alternative sources of financing need to be found.
What households and companies need is proper restructuring of their existing loans with the banks/co-ops (that would include a reduction in the interest rate, an extension of the repayment period, or the sale of some of their assets), cheaper source of debt financing as it happens in a number of foreign countries (i.e. non-bank debt financing/peer-to-peer lending), and more importantly, equity financing (i.e. capital injection).
How can they attract non-bank financing? Well, these could come in various ways; through EU-structural funds, through sources such as the European Bank of Reconstruction and Development (EBRD) or the European Investment Bank (EIB), through other private investment vehicles (funds) that are willing to invest/inject capital in viable sectors/companies of our economy, or through some joint ventures with foreign firms which might supply apart from financing, expertise in operations, technology, strategy, marketing, and sales promotion in international markets.
George Theocharides is Associate Professor of Finance and Director of MSc in Financial Services at the Cyprus International Institute of Management (CIIM) www.ciim.ac.cy