Central Bank warns over private debt

Cyprus Central Bank governor Constantinos Herodotou called for awareness over rising private debt as the economic outlook deteriorates due to the prolonged Russian invasion of Ukraine.

Herodotou called for increased vigilance to avert private debt defaults that would lead to increased personal debt levels.

On private sector debt, he said that default rates of loans with stricter loan origination guidelines following the 2013 crisis are quite low.

“But domestic private debt levels are still burdened with legacy loans that are more difficult to tackle and require special attention.”

Cyprus’ private debt to GDP fell to 236% in the second quarter of 2022 from its peak of 353% of GDP in Q1 2015.

Herodotou pointed out that despite this significant reduction, the domestic non-financial private debt ratio is still relatively high compared with an average of 140% for the euro area.

“Both households and non-financial corporations’ debt exhibit a passive deleveraging behaviour, given that their decline is mainly driven by increases in nominal GDP, known as a denominator effect”.

The CBC governor stressed that in today’s economic environment of high inflation, high-interest rates and weakened growth prospects, the risks for a deterioration in asset quality leading to higher private debt levels and crowding out effect are considered to be on the upside.

He also pointed out that the high percentage of loans in Cyprus with a floating interest rate makes them particularly sensitive to the higher interest rate era we are entering.

A prudent CBC supervisory Debt-Service-to-Income ratio (DSTI) tool, defined as a household’s monthly debt payments divided by its monthly net disposable income that is in place in Cyprus, is expected to mitigate the negative impact of higher lending rates,

“Extra vigilance and concerted action are required at all levels to address these debt risks and minimise any crowding out effects.”