With the highest Non-Performing Loans ratio in the eurozone, Cyprus will create a ‘bad bank’ to relieve its financial institutions of €10 bln in Non-Performing loans, hoping to mirror the success of Ireland in removing toxic debt.
In an interview with Phileleftheros newspaper, Finance Minister Constantinos Petrides confirmed the plan, saying the bad bank will essentially buy the bad loans and other risky assets of Cyprus financial institutions.
The idea is that Cypriot banks holding significant non-performing assets will sell them to the bad bank.
He said the bad bank will act as an asset management company (AMC) to consolidate and take over the existing stressed debt of the banks and then manage them.
An AMC taking over the bad debt of commercial banks, or Non-Performing Exposure, has been described as a ‘Bad Bank’.
The assumption is that with the Bad Bank cleansing balance sheets of their NPEs, expected to grow in the aftermath of the pandemic, it will allow Cyprus banks to focus on re-fuelling the economy.
Cyprus banks can clear their balance sheets of a combined €10 bln in toxic loans to the bad bank.
Petrides said the government’s ‘bad bank’ proposal is an ambitious project to support borrowers who defaulted on their mortgages, to keep their homes.
The plan is to transform the Cyprus Asset Management Company (KEDIPES), a former Co-op subsidiary set up to handle its risky assets following the bank’s takeover by Hellenic Bank in 2018.
“The plan is to transform KEDIPES into a national asset management company which will purchase part of the portfolio of Non-Performing Loans of banks.
“Especially those loans to individuals to secure a primary residence or small business,” said the Minister of Finance.
According to the Central Bank of Cyprus, total loans decreased by €111 mln or 0.4% from €30.10 bln at end-June 2020 to €29.99 bln at the end of September.
A fall in the ratio of NPLs to total loans was recorded from 22.3% to 21.1% at the end of September.
Since the end of 2014, there has been a significant reduction in the NPL ratio by around 78%.
“We acknowledge that the ratio of NPLs is still high, the Government has prepared an action plan to address the remaining stock of non-performing loans.
“NPLs peaked in 2014 at €28 bln, equivalent to 45% of loans. Latest available data indicates a stock of €6.3 bln, equivalent to 20% of loans. In 2021, we expect a further reduction to be recorded,” Petrides said in January.
Bad banks are typically set up in times of crisis when long-standing financial institutions are trying to recuperate their reputations and wallets.
While shareholders and bondholders generally stand to lose money from this solution, depositors usually do not.
Banks that become insolvent as a result of the process can be recapitalized, nationalized, or liquidated.
If they do not become insolvent, a bad bank can focus exclusively on maximizing the value of its newly acquired high-risk assets.
Some criticize the setup of bad banks, highlighting how if states take over non-performing loans, this encourages banks to take undue risks, leading to a moral hazard.
The most successful model, which economists point to is Ireland’s National Asset Management Agency (NAMA).
The Irish Bad Bank started with a €30 bln portfolio just after the crisis in 2009.
By 2017, it had disposed of the entire portfolio and made a significant profit. It is still operating and making a profit today.
The annual budget for NAMA is about €230 mln. A small price to pay for solving a big problem.
A not so successful example was Spain’s SAREB the bad bank of the Spanish government, the government-owned company is responsible for managing assets transferred by the four nationalized Spanish financial institutions.
Austria’s HETA, created in 2014, is a notable example of where state intervention in the bad bank’s operations created a complex legal quagmire and left many investors angry.
In Cyprus, the bad bank idea has been mooted many times since the 2013 financial crisis when the banking system nearly collapsed.