The outlook for Cyprus`s banking system remains negative, says Moody`s Investors Service in a new Banking System Outlook published Thursday evening entitled "Banking System Outlook: Cyprus." At the same time Moody`s expects that over the 12-18 month outlook period, the Cypriot banks will face substantial recapitalisation needs as a result of acute asset-quality pressure.
According to Moody`s the negative outlook reflects the likelihood of severe capital shortfalls, as the highly adverse operating environments in Cyprus and Greece, the banks` primary markets, will continue to drive a sharp deterioration in asset quality and further weakening of funding and liquidity, as evidenced by continued, significant deposit outflows in Greece and Cyprus. In Moody`s view, ongoing funding and capital support from the local and euro area authorities will be necessary to avoid severe financial disruptions in Cyprus`s banking system.
The rating agency estimates that the cost of recapitalising the three largest banks to a 10% core Tier 1 will exceed 8 billion euros (around 47% of GDP). Although Bank of Cyprus Cyprus Popular Bank continue to seek private-sector solutions, Moody`s believes that the bulk of the recapitalisation will have to come from official support.
According to the report, the Cypriot banks are facing highly adverse operating conditions in both Cyprus and Greece, which is causing the system to deleverage rapidly. In Cyprus, Moody`s expects real GDP to contract by 4% in 2013 following a 2.3% contraction in 2012, due to the steep correction in real-estate prices and the continued retrenchment of the real-estate sector; declining activity in the services sector; and austerity measures that will further suppress domestic consumption.
“In Greece, following a 7.1% decline in real GDP in 2011, we expect real GDP to contract by 6.9% in 2012 and 4.2% in 2013, bringing the cumulative contraction to 25% since 2008”, notes the report.
According to Moody`s deposit outflows in Greece and Cyprus will exacerbate existing funding and liquidity pressures, triggering increased reliance on central bank funding.
It is noted that deposits in Greece declined by 38% in the December 2010-June 2012 period, whilst Moody`s estimates that non-resident, international business unit deposits in Cyprus declined by 22% over the same period. It is added that this exhausted certain banks` liquidity buffers and increased their use of central bank funding.
Although the Cypriot banks remain primarily deposit funded with deposits at 70% of assets as of June 2012, Moody`s considers that a high portion of the deposits are confidence sensitive, rendering the banks` funding base vulnerable to further shocks.
