Banks must address structural vulnerabilities

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Increased interest revenue from monetary policy normalisation should not overshadow Cypriot banks’ structural vulnerabilities, argued Cyprus Central Bank governor Constantinos Herodotou.

Speaking to MPs, Herodotou said Cypriot banks are expected to significantly increase interest income due to the European Central Bank’s interest rate hikes.

“This significant increase in income should not overshadow or hide structural vulnerabilities of the banking sector, which should be addressed despite the increased profits,” Herodotou said.

He referred to the non-performing loans (NPLs), high operational costs, strengthening corporate governance, high competition from non-traditional banks and the quality of customer service.

Herodotou said NPLs declined to €2.8 bln by end-July, corresponding to 11.2% of total loans in the banking system and reiterated that NPL reduction is due to the larger banks, which achieved 80% of NPL shrinkage.

He said the Cypriot regulator is against extending the moratorium on foreclosures, believing this would create new risks to the banks as they are coping with the challenge of borrowers’ reduced disposable income due to high inflation.

He pointed out that these NPLs are legacy loans created during the 2013 financial crisis and did not emerge due to the Covid-19 pandemic or the Ukraine war.

“This is a new challenge, and by allowing banks to manage the backlog (of NPLs) while we know that in 2023, we will have new challenges, we are placing new risks which could affect the economy”.

On the impact of rising interest rates to debt-servicing capacity, Herodotou said there is a concern, but macroprudential rules concerning loan origination could protect both lenders and borrowers.

Loan origination stipulates that loan to value ratio is 80% for first home purchase and 70% for the second, which protects the borrower.

At the same time, an additional provision states that debt repayment should amount to 80% of a borrower’s disposable income, which protects the borrower from assuming a loan they can’t repay.

On the economy, Herodotou said that Cyprus’ GDP output is estimated to rise by 5.5% in 2022 despite the war in Ukraine but slow to 2.5% in 2023, compared with the Finance Ministry’s 3% projection.

Herodotou said the government’s macroeconomic scenario is “realistic” but added that there is great uncertainty due to the war in Ukraine.

He also stated that public finances are expected to come under pressure due to increased expenditure from rising Cost-Of-Living Allowance in public sector salaries and pensions due to the rising inflation, increased cost of goods and raw materials and debt servicing costs.

Cyprus’ public debt is expected to continue its downward trajectory.

“It is important to continue prudent fiscal management and to swiftly absorb funds from the National Recovery and Resilience Fund.”

He called for targeted fiscal support to vulnerable households and businesses due to rising inflation at around 9%.