BAD debts in Cyprus and Greece will determine the size of the financing needs to be identified by troika.
The large group of technocrats from the European Commission, the European Central Bank and the International Monetary Fund will launch deliberations with the Cypriot government today on the basis of first estimates on the support that Cyprus will need.
The fiscal part is relatively easy, as the government declares that the financing needs by 2014 are more or less known and the only unknown factor is the size of the deficit.
The government places its needs close to €4.5 billion but this might change if deficit is higher than initial forecasts.
The biggest challenge for the island’s negotiating team, however, is the financial part of the assistance, the capital that the banks need.
Cyprus Popular already needs €2.5 billion and Bank of Cyprus €0.5 billion.
The needs will increase further on the basis of the Blackrock-type diagnostic checks in Cyprus and Greece.
The toughest part of the deliberation with troika is the methodological handling of bad debts.
Based on an established practice, Cypriot banks do not go to a provision for those loans that are in arrears beyond 90 days as soon as there is a complete guarantee (e.g. property).
Troika follows a different approach however. Their methodology is stricter. They believe that even if the loans are 100% secured, the full provision is required.
The European Commission, which allegedly has a better understanding of the particularities of Cyprus, has a more moderate approach and believes that banks can recover part of the borrowing by selling the property.
The methodological approach to be adopted will largely determine the capital needs to be identified by troika for the banking sector.
First IMF estimates talked about €10 billion while Standard and Poor’s and Fitch referred to €4.5 billion and €6 billion respectively.
The finalization of the needs will emerge after completion of diagnostic tests in the portfolios of banks in Cyprus and Greece. But due to a delay in the completion of tests, it is expected that support will be determined by the initial calculations of the troika.
Bad loans are the most important issue that the negotiating team faces and if troika’s calculations reach upper range, the debt will reach 130% of GDP, raising questions of sustainability.