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Arrears and NPLs at unprecedented levels

ARREARS and non-performing loans (NPLs) are rising to unprecedented levels in Cyprus, Central Bank (CBC) Governor Panicos Demetriadies said on Monday.

Speaking at a conference on Arrears Management and Loan Restructurings, organised by the CBC with Irish and EU experts, Demetriades said the IMF December 2013 Cyprus Second Review had provided valuable lessons from Ireland and Iceland as regards NPLs.

“As in the case of Cyprus, these countries entered the crisis with large private sector indebtedness accumulated in the decade preceding the crisis,” said Demetriades.  He said that private sector indebtedness peaked at over 500 per cent of GDP in Iceland, and 300 per cent in Ireland.

“By comparison, private sector indebtedness stands at 300 per cent in Cyprus. One should however place this in context and recognise that while the numbers are high, the problem can be addressed and defused once appropriate and targeted measures are taken, such as a targeted case-by-case approach to debt restructuring, an effective arrears management framework, and the strengthening of the legal framework,” said the Governor.

He said arrears management and loan restructuring was one of the most challenging issues currently facing the banking sector in Cyprus in its path to the restoration of financial soundness.

A reduction in the level of NPLs would result in lower provisioning requirements and this would contribute to the decline in interest rates in the long run, to the benefit of households and businesses.

Banks had started deleveraging and would focus their operations on domestic core banking products, said the Governor.

“Unfortunately, for many years the banking sector in Cyprus, in common with some other countries, adopted poor risk and credit management practices, dominated by asset based lending, and an overexpansion of the real estate market,” Demetriades said.

“The consequences of such practices can be disguised in periods of an expanding booming economy, even appearing as successful while real estate prices are rising, demand remains strong,  and income growth targets supersede the basic principles that should govern any basic business or lending transaction – the ability of borrowers to repay their debts.”

New directives from the CBC, he said, were designed to shift lending from asset based criteria (collateral) to assessing the ability to repay.

“Collateral should be just that, an added layer of security in case things do not evolve as expected, and should not be expected to be the primary source of repayment,” Demetriades said. But he added that a focus on the human factor, especially in cases of home owners, should remain. The emphasis now was on  restructuring loans on the basis of fair pricing in order to achieve a viable repayment schedule which would assist the borrowers’ business and financial condition, contribute to economic recovery and safeguard the interests of banks.

Demetriades said loan restructuring provided an opportunity for banks to strengthen their liquidity and profitability where an improvement in debt servicing performance can be achieved.

Steps taken to address arrears should adhere to the Code of Conduct for borrowers and creditors, with a case by case approach, he said.

“A distinction should be made by banks between those borrowers who are cooperative and willing to meet repayments in line with their financial capacity, and those who are able to repay but are unwilling,” said the Governor.

Decisive recovery measures “should be deployed for able but unwilling clients”, he added.

The CBC boss said that an assessment of the island’s credit institutions internal effectiveness, operational capacity, and arrears management policies, procedures and practices for the different sectors in the market would be conducted in the first half of this year.

The conference, which ends on Tuesday, will cover strategies, treatment of borrowers, and legalities.

Nonperforming loans in Cyprus at unprecedented level