Nicosia, 26 May 2016
Distinguished audience,
Ladies and gentlemen,
I am honoured to have been invited to address this important event, especially at a time when the debate on how to stimulate growth in the economy is intensifying.
In my capacity as Governor of the Central Bank of Cyprus, I wish to convey a message of confidence, regarding the current state of the banking industry and its future prospects. More specifically, I would like to focus on the positive signs of the gradual recovery of our banking system as well as the, albeit slow, improvement in non-performing loans (NPLs). I will also refer to the significant developments that are taking place to shape the overall debt resolution framework.
The banking sector in Cyprus has gone through significant changes in the last few years as a consequence of the financial crisis. Bond holders and uninsured depositors of the two largest banks at the time had to absorb a part of the losses suffered by the banks. Capital controls were imposed for two years but were subsequently lifted without any adverse consequences. The major banks were recapitalised either through state aid or by substantial foreign investment. At the same time, the real estate bubble that preceded the economic crisis as well as the crisis itself created an enormous stock of NPL’s.
The authorities, including the Central Bank of Cyprus, responded positively and have successfully implemented the much needed reforms under the economic adjustment programme agreed by Cyprus with its Troika partners. This enabled Cyprus to complete the adjustment programme within the agreed three year period.
On a more general issue and as a response to the global financial crisis that erupted in 2008, authorities around the world have strengthened the regulatory and supervisory framework, reflecting the lessons learned from this crisis. New rules have been introduced on: governance of financial institutions, the quantity and quality of capital required, the liquidity requirements and other issues. All these necessary changes are reflected in the various amendments to EU directives and in the issuance of new regulations.
A major breakthrough has been the issuance of the EU’s Bank Resolution and Recovery Directive, which was designed to break the link between stresses in the banking sector and the sovereign and vice versa.
The EU has also adopted a common definition of non-performing exposures for all EU member states.
More regulations are in the pipeline, such as the proposal for the revised standardised approach by the Basel Committee, which will make the calculation of capital requirements more risk sensitive.
In November 2014, the supervision of our banking system came under the responsibility of the Single Supervisory Mechanism (SSM), the supervisory arm of the European Central Bank (ECB). Supervision for the significant institutions, covering more than 90% of our banking system assets, is now performed by joint supervisory teams consisting of ECB and Central Bank of Cyprus staff, which adhere to SSM rules, regulations and practices. Cypriot banks are now in the same arena as their European counterparts and are assessed on an equal footing. For the less significant institutions, supervision is conducted by the Central Bank in close cooperation with the SSM.
Moving on, I would like to map specific elements of our banking system.
Despite the full lifting of capital controls in April 2015, total bank deposits continued to stabilise and at the end of April 2016, registered an increase of €2 billion compared to the end of 2013, reaching €49,1 billion.
In addition, reliance on Emergency Liquidity Assistance (ELA) has been reduced to €3,3 billion as at the end of March 2016, from €3,8 billion at the end of 2015 and significantly down from its peak of €11,2 billion in April 2013.
The above positive trends have also been reflected in the liquidity buffers of domestic banks, which at the end of March 2016 were about 5 percent higher than at the end of 2014.
The common equity Tier 1 capital ratio (i.e. common equity tier 1 capital to total risk exposure amount) of locally active banks continued to improve, reaching 14,5 percent at the end of December 2015 compared to 10,4 percent in December 2013. During the same time (2013 – 2015), risk weighted assets have been reduced by approximately
€4 billion and provisions for bad debts increased by €6,6 billion.
Total outstanding lending by the locally active banks declined between the beginning of 2015 and late March 2016 by approximately €3,6 billion due to deleveraging, higher level of repayments than new lending and loan restructurings.
Nevertheless, positive signs are evident in new lending, with the aggregate amount of new loans to local residents increasing by €1,5 billion in 2015. This trend continued in the first months of 2016.
Banks’ Portfolio composition, Non-Performing Exposures and Provisions coverage
As already mentioned, non-performing exposures have reached very high levels. However, the increasing trends observed in the recent past have stopped and we are now observing a stabilisation, while indications are that the trend will be reverted soon.
As at the end of February 2016, non-performing loans amounted to €26,8 billion, down from €27,3 billion as at the end of 2014. Within this figure, an amount of €10,9 billion relates to exposures that have been restructured but are still under observance and will only be classified as performing once they exhibit capital repayments for at least 12 months.
In addition, the pace of NPL restructuring has accelerated in recent quarters, with the outstanding balance of total restructured exposures reaching €14,2 billion at the end of February 2016 compared with €12,9 billion at the end of 2014.
It is important to mention that the average cure rate (i.e. no arrears since restructuring) of fixed term loans restructured from 1 January 2014 onwards has improved to 76 percent and it is considered encouraging.
As reflected in the Arrears Management Directive of the Central Bank of Cyprus, the correct strategy is to first try to agree on a restructuring solution with a non-performing borrower, before other options are explored. Despite the improvement noted above, the sheer size of NPLs relative to Cyprus’ GDP makes it the biggest problem facing our banking system. It is for this reason that all involved stakeholders have to be decisive in using all tools available to tackle the problem.
Addressing banks’ high NPLs remains essential in order to revive lending and increase the prospects for economic growth.
The legal framework for foreclosure and insolvency has been improved and relevant institutions and processes were set up and started to operate.
Banks have taken substantial steps to improve their internal management of loans in arrears in order to further increase the pace of NPL restructuring. For this purpose, the banks have created centralised arrears management units.
I would also like to make a special mention regarding the so-called “strategic defaulters”.
From an ongoing study at the CBC, which will be published soon, it is concluded that the main reason for the increase in the NPLs in Cyprus is the unprecedented economic crisis, which led to a dramatic decrease in income. Nevertheless, it seems that a small but non-negligible portion of households was (or still is) not servicing its loans despite the fact that they could do so with a reasonably manageable degree of difficulty. This alludes to possible strategic default behaviour by a proportion of borrowers.
Understanding the financial capacity of borrowers is key to designing effective prudential policies and for further fine-tuning loan restructuring strategies.
This highlights the importance of strengthening banks’ internal arrears management mechanisms and fully utilizing the tools provided by the new debt restructuring framework.
Restructuring Targets
Close monitoring is critical to swiftly identify operational bottlenecks and policy deficiencies, enhance transparency and take corrective measures. To this end, the Central Bank of Cyprus has set four specific bank-by-bank quarterly targets for NPL restructuring since June 2015 and began publishing the aggregate targets and their achievement in September 2015. Quarterly restructuring targets incentivize banks to further increase the volume and quality of their NPL restructurings. The targets set by the Central Bank relate to the following four indicators:
To monitor these targets, banks are required to submit reports to the Central Bank. The Central Bank of Cyprus revises up the banks’ targets when it considers that these targets are not sufficiently ambitious.
Preliminary results for 2016Q1 show that for all the banks that are subject to these restructuring targets, there is a small over-performance with respect to the first two indicators, while a small under-performance was observed for the other two indicators.
Notwithstanding the small deviations at the aggregate level, specific banks have significantly underperformed on the set targets and the CBC has identified supervisory priorities and bank-specific actions to address deficiencies.
Moving on to the last part of this presentation, I would like to refer to recent developments regarding the broader framework for managing NPLs.
A law was adopted in November 2015 allowing banks to sell individual loans or segments of their loan portfolio, while preserving the safeguards for small borrowers. Importantly, given the high concentration of distressed assets, the law allows large loans (above €1 million) to be sold with limited obligations imposed on the selling bank or the purchaser. In the case of smaller loans, the law does not significantly affect incentives for restructuring or materially increase moral hazard concerns (i.e. that borrowers would stop servicing their loans in order to buy them back at a discount).
A draft law on asset securitisation, with the aim of facilitating bank deleveraging and, eventually, unlocking additional sources of funding for the economy, is under preparation.
Implementation of the new insolvency and foreclosure frameworks has begun and should be accelerated in order to have a stronger impact on NPL reduction. Progress has been made in several areas, for example:
The new Insolvency Service is operational and has received a number of applications for the new procedures.
The first group of insolvency professionals, assisting debtors developing restructuring plans, has been authorised, and
A new IT system for facilitating processing of insolvency applications and communication with the courts is being developed.
However, more needs to be done to operationalise the insolvency framework, including:
Court rules for the new corporate reorganisation procedure.
Review of the Civil Procedure and other related laws should be accelerated to ensure that courts are in a position to effectively and timely implement the new legal framework, and
Reforms that facilitate the transfer of title deeds need to be finalised to improve the functioning of the property market and the debt restructuring framework. With respect to this, it is mentioned that a new law was adopted last September to facilitate title transfers for legacy cases relating to buyers of property from property developers.
The framework for new sales of property is being reviewed to enable the swift transfer of titles in transactions not covered by the earlier legislation (non-legacy cases) and work is being done to ensure the issuance of title deeds without delay.
As a closing remark, I would like to once again stress that our banking system has been through an enormous storm but has now stabilised and it is moving in the right direction. However, we need to remain vigilant to ensure that the path to recovery continues. We need to take the lessons learned from this recent crisis. Therefore, we must stand firm in implementing all the necessary laws and measures in order to address the major problem facing our banking system, i.e. the non-performing loans.
I want to emphasize, however, that international experience shows that economic recovery is the most important way. Anyway, the horizon over which the problem of non-performing loans will start to be resolved, is estimated to be 3 to 5 years. I feel confident that with intensive efforts from all involved parties we will succeed.