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Cyprus banks to maintain stability, but lower profits, says Moody’s

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Moody’s said on Thursday that the risks associated with loans for Cypriot banks are expected to decrease further due to consistent economic growth, alongside declining inflation and unemployment rates.

However, reaffirming the stability of the Cyprus banking system, the rating agency said in its latest report, that profits are likely to decline from their recent highs.

Moody’s anticipates a gradual decrease in net interest margins as deposit costs rise moderately and interest rates begin to fall, a trend influenced by “stiff competition within Cyprus’ small, saturated banking sector and high levels of private sector debt”.

The report acknowledges that stricter loan criteria and ongoing loan restructuring efforts by banks are safeguarding loan quality as they work to reduce problematic loans inherited from the past.

Risks related to asset quality from foreclosed properties are also diminishing, buoyed by a robust real estate market. Moody’s emphasised the resilience of funding and liquidity in Cyprus’ banking sector, highlighting a low loan-to-deposit ratio and ample liquidity reserves.

In terms of economic growth, it predicts stability, but with limited advantages for banks.

Cyprus’ GDP is forecasted to grow by 2.8% in 2024 and 3.2% in 2025-27, outpacing the euro area by 0.8% in 2024.

The report underscores the economy’s resilience to external shocks, driven by continued diversification in the dominant services sector and supported by significant foreign direct investment projects, including the EU Next Generation package reforms and investments.

Despite higher economic growth, the report anticipates moderate growth in the loan portfolio due to the small and saturated banking system, high private sector debt, and elevated interest rates.

It said monetary policy is expected to remain restrictive, even as the European Central Bank initiates interest rate reductions.

Loan quality risks

Moody’s underscores the mitigation of loan quality risks through lower inflation, stable economic growth, continued management of non-performing exposures (NPEs), and enhanced provisioning coverage for loan losses.

The agency expects the NPE ratio to decrease below 3% this year, though it remains higher than the EU average. Additionally, the proportion of foreclosed assets relative to assessed banks’ equity decreased, with expectations for further declines, supported by the strong real estate market.

The report highlights a decline in capital risks, with banks largely completing risk release and balance sheet restructuring. Improved internal capital generation is expected to offset resumed dividend distribution and moderate loan growth.

The overall Common Equity Tier 1 ratio for assessed banks increased to 18.8% at the end of 2023, exceeding regulatory requirements.

Moody’s assessment focuses on Cyprus’ two largest domestic banks, Bank of Cyprus (Baa3 positive, ba2) and Hellenic Bank (Baa3 positive, baa2), which represent significant portions of the banking system’s assets.

Remaining banks consist mainly of subsidiaries and branches of EU-based banks serving Cypriot clients and third-country banks focusing on transactions with foreign companies based in Cyprus.

The weighted average Baseline Credit Assessment (BCA) of the two major banks is ba2, with a weighted average asset-based deposit rating of Baa3.