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Cyprus banking idiosyncrasies laid bare

The PIMCO due diligence report on the island’s banking system reveals what the company refers to as idiosyncrasies that differentiate Cyprus from other international banking systems.

bank depositTHE Central Bank of Cyprus released the draft due diligence report on the island’s banking system produced by PIMCO on Friday, which determined that the banks will need approximately €8.9 billion for their recapitalisation.

The PIMCO report reveals what the company politely refers to as “idiosyncratic features” that differentiate Cyprus from other international banking systems:

Asset-based lending practices

“A key feature of the Cyprus banking system has been the practice of pursuing asset-based lending, meaning a high reliance on collateral in the underwriting of loans, often with less attention paid to a borrower’s ability to meet debt service payments on the loan.”

Extended foreclosure and legal resolution times

“The general timeline to receive a court judgment once a loan has been moved to recoveries can be three to four years. Following this, the borrower can appeal the process which can take another 18 months to two years. In total, the amount of time to reach a forced sale of property through auction historically has ranged between 10 to 12 years.”

Collateral used for many loans

“A single property can serve as collateral on multiple loans, or – even more complicated – multiple properties can serve as collateral on multiple loans.”

“Lenders are willing to extend additional loans to a borrower group on the pledging of additional collateral, rather than based strictly on an assessment of the borrower’s ability to service the new loan.”

Methodology for provisions and doubtful debts

“Provisioning methodology is a key differentiator between Cyprus banks and other European banks. In particular, the provisioning methodology used by a number of Participating Institutions does not capture expected loss in the financial statements to the same degree as alternative methodologies.”

Loan restructuring

“Modifications often extend loans beyond the contractual maturity, may be based on relationships and may not reflect the borrower’s current ability to repay. In other cases, modifications rely on third-party personal guarantees or simply result in extensions despite strong evidence suggesting the borrower’s inability to service the debt.”

High levels of unpaid interest

“Because loan-to-value ratios at origination have generally not been aggressive and because in some cases banks have assumed future property price appreciation up until the point of problem loan resolution, this has enabled banks to assume, in many cases, that some significant portion of unpaid but accrued interest eventually will be realized in the proceeds of a loan resolution.”

Dependence on international banking operations

“The Cyprus banking system has become an important centre of international banking operations over the last decade, and transaction revenues related to international banking have been and are likely to remain critical components of non-interest income for the large Cyprus banks. As is the case in many other centres of international banking, the bulk of these operations relate to transfer and settlement services for client transactions.”

Non-payment culture in the Co-operatives sector

“An essential difference between the co-operatives and the banks in Cyprus has been the relative reluctance of cooperative managements to pursue aggressive collection and work-out strategies on problem loans. This relative reluctance has been due in large part to management’s belief in the social function of the co-operatives, that is, the aim of the co-operatives is not to maximize profits but to serve their members.”

Further reading

Independent Due Diligence of the Banking System of Cyprus – March 2013

Readers' comments

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  • Richard Bourke says:

    (Hangs head in hands)

    Thanks for the excellent summary, Nigel. I’ll try and push out links to it on some UK live blogs – no guarantees it will work, detail on Cyprus tends to get lost.

    And even at that, the Pimco report is incredibly diplomatic.

    And the worse thing is, they tried to hold on to these practices, in the negotiations with the Troika. Because they wanted to massage the necessary recapitalisation figures.

    All they actually achieved was to convince the Troika that Cypriot politicians were not just reality-resistant, but under the thumb of their “risk-management-is-for-sissies” bankers, I expect.

    @Martyn:
    Regarding the question about how the Banks past the EBA stress-test. There are two types of stress-test. “Top-Down” and “Bottom-Up”.

    The difference is: the participating banks get to apply their own risk model (= “massage their figures”) in the Top-Down stress-test. In the bottom-up stress-test, they crunch the raw data of loans and assets,

    The EBA stress tests in 2010 and 2011 were top-down stress tests. Background on this here “Banks are safe, say Banks” (the economist).

    The Spanish stress test in September 2012 was a bottom-up one. And I do rather assume that the stress-tests, assets tests, balance-sheet tests that are being talked about as preconditions to the ECB becoming European Banking Regulator in 2014 are bottom-up stress tests too.

    But they’re way more expensive and time-consuming, and require complete cooperation from the national bank regulator. Which the EBA didn’t have – it’s pretty toothless.

  • Martyn says:

    Flagrant disregard across many key areas of ‘good banking practice’, FOR SURE.

    But hey, what happened to the EU/Eurozone ‘due diligence’ before Cyprus joined the EU – and then, later, the Euro? Most of these mail-practices have been going on for YEARS!

    And HEY, again!, what about the so-called Banking ‘Stress Tests’ – which it seems Cyprus banks, ‘passed’ 2 years ago?

    And now to refer to this collection of reckless and uncaring, un-customer focused malpractices as ‘idiosyncrasies’ simply piles insult onto injury.

    ECB, IMF, Troika – they all should share responsibility for this truly awful apology for ‘sound banking practice and regulation’!!

  • Pippa says:

    I assume this is another report that will be ignored and it will be business as usual. Unless the EU/IMF et al put some sort of regulator/monitor in place to insure that these “idiosyncratic features” are addressed in a timely fashion nothing will change. But as they have managed to ignore the problem so far what hope is there that the EU will actually take action now, and ensure that the ordinary EU citizen actually owns what they have paid for?

  • fred says:

    it is sad that the Cypriot public may never know this. Instead, we have defensive statements about the lack of EU solidarity and the destruction of a ‘system that works’.

    Since when would anyone give a loan of €10 billion on the basis of solidarity without preconditions? Even Russia is linking renegotiation of an expensive loan in exchange for the release of monies held in its bank.

  • Janner says:

    I’m sure the cypriot government will make a detailed press release answering all the points raised in the pimco report!

  • Andrew says:

    They say idiosyncracy, surely downright reckless is more apt. The real questions has to be, was it lawful since joining the EU in 2004? Why was this disgraceful practice allowed to continue for so long. Why were ordinary EU Citizens homes allowed to be used as collateral without their knowledge. Why did lawyers fail to inform and protect their clients from these dodgy banking practices.

  • Costas Apacket says:

    Or to put it another way. What a shambles!

  • MarkD says:

    Now sort it out!!!!

  • Gavin Jones says:

    I’ve always wanted to know what constituted “a casino economy” and the above would seem to fit the bill nicely…

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