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Risk of a new NPLs iceberg

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The decisions made by the European Central Bank (ECB) in the early stages of the Covid-19 pandemic are considered a milestone for the European financial market.

The decisions were diffused by unprecedented prudential regulatory flexibility.

In an interview with the Cyprus News Agency, Elizabeth McCaul, the ECB’s Supervisory Board member, reiterated that a new wave of Non-Performing Loans (NPLs) could occur due to the pandemic.

This is despite the fact the NPLs ratio in the euro area declined during the pandemic, as it did in Cyprus.

According to data from the Central Bank of Cyprus (CBC), the NPLs ratio decreased to 17.6% during the second quarter of 2021, from 27.9% at the end of 2019.

The decrease is mainly due to sales of NPLs packages and their organic reduction to a lesser degree.

Although Cypriot banks have made significant progress in reducing NPLs, their ratio remains well above the European Union average, and the final impact of the pandemic is still a source of uncertainty.

This period, combined with the end of state support measures, is considered to be particularly crucial.

Especially if we consider that, as a rule, any effect on loans is manifested by a time lag.

With the prevailing uncertainty, it isn’t easy to estimate the exact time and final size of the build-up of NPLs.

Therefore, it is important for credit institutions to identify borrowers’ difficulties in fulfilling their obligations promptly.

The EU already has emphasized the risks related to increased NPLs, with regulatory supporting well-planned restructurings in response to such situations being a credit risk management tool.

Such a risk management tool, on the one hand, helps borrowers, and on the other, it can prevent cliff effects.

In this challenging environment, the EU Recovery and Resilience Facility is also expected to play an important role in implementing reforms at improving the insolvency framework and the judicial and administrative framework related to the effective managing of NPLs.

That is why it is crucial that certain decisions are implemented, no matter how difficult these are.

It is also important to recall Article 24, paragraph 6 of Regulation 2021/241 of the European Parliament and the Council of 12 February 2021, establishing the Recovery and Resilience Facility.

According to the specific Article, if the European Commission, examining the submission of a funding request, finds that the milestones and targets have not been met satisfactorily, the payment of all or part of the financial contribution is suspended by a relevant decision of the EU.

What is more, based on the European strategy for preventing future build-up of NPLs, which was presented in December 2020, various objectives and measures have been set that will have to be implemented by the Member States and financial market participants.

For example, banks are required to set minimum loss coverage levels for newly originated loans.

There is also a proposal for a Directive on credit facility managers, credit buyers and collateral recovery, as well as a strategic plan for setting up national asset management companies.

What is certain is that for a country like Cyprus, with a high level of NPLs as well as private debt, more and continuous efforts are required, together with targeted and balanced economic development policies, to achieve a reduction of NPLs close to the euro area average and thus the sustainability of Cyprus’ real economy.

By Nicole K. Phinopoulou, Lawyer, LL.B, LL.M, LPC