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Call to reduce non-performing loans

The International Monetary Fund (IMF) has called on the Cypriot authorities to amend the foreclosures and insolvency laws to tackle the very high level of non-performing loans (NPLs).

Non-performing loansFOLLOWING the Troika’s mission to Cyprus to carry out a post-programme surveillance (PPS) mission following the country’s successful conclusion of its economic adjustment programme, the International Monetary Fund issued the following statement yesterday calling on Cyprus to improve payment discipline and reduce non-performing loans (NPLs):

Since our last visit, Cyprus’s economic growth has continued to accelerate, supported by construction, tourism and professional services. Unemployment has moderated further. The fiscal position has improved markedly and public debt has declined below 100 percent of GDP. Taking advantage of the declining cost of market-based financing, Cyprus made an early repurchase to the IMF in July 2017. However, despite a sizable and sustained improvement in macroeconomic conditions, private sector indebtedness remains extremely high and continued weak payment discipline has kept non-performing loans (NPLs) at very high levels. The need for additional provisions and limited opportunities for new lending continue to weigh on banks’ profitability.

The current rapid pace of economic expansion is forecast to continue. GDP is projected to grow by 4–4¼ percent during 2018–19, underpinned by a pipeline of mainly foreign-funded, large construction projects, notwithstanding somewhat slower growth in private consumption due to better compliance by households with regard to their contractual debt obligations. Over the medium term, growth is projected to ease to 2½ percent as construction projects are gradually completed. The high import content of domestic demand, especially for construction materials, is projected to keep the current account deficit around 6–7 percent of GDP. Tax revenue will benefit from the escalation in activity. Under this baseline scenario, capacity to repay the Fund is seen as adequate, with repayments funded by large fiscal primary surpluses and by newly issued market-based debt securities on relatively favourable terms. However, repayment capacity could be weakened if significant contingent liabilities from banks’ distressed assets materialize, an excess supply of luxury properties were to generate a new boom-bust cycle, or fiscal discipline were eroded by yielding to spending pressures.

Strengthening payment discipline, avoiding pro-cyclical policies and adopting macro-critical structural reforms would help preserve financial stability, protect the downward trajectory of public debt, and support balanced and durable growth. Doing so would also safeguard capacity to repay:

1. Improving payment discipline and reducing NPLs. A decisive and durable reduction in NPLs requires strengthening Cyprus’s payment culture. Amending the legal frameworks for insolvency and foreclosure can support this goal by incentivizing borrowers to engage with banks to reach mutually-agreeable restructuring solutions based on commercial terms. Limited, well-targeted fiscal support to lower-income distressed borrowers can strengthen their financial viability and promote payment compliance throughout the duration of the loan. Reliance on third-party loan servicing companies should continue and be made fully operational, and any NPLs transferred to nonbank entities should not be merely warehoused. The recently-announced search for strategic investors in the Cyprus Cooperative Bank is a welcome development and should proceed in a smooth manner.

2. Guarding against procyclical policies. Recent fiscal performance has benefited from the cyclical upswing and incentives supporting the construction sector. To avoid spending cyclical or transitory revenue and to create space to absorb possible contingent fiscal shocks, annual ceilings on nominal spending should increase in line with medium-term output growth, with downward adjustment to compensate for any future cuts in tax rates or narrowing of tax bases. Incentives supporting the construction sector should be withdrawn. A durable mechanism for keeping the public-sector wage bill in check should be instituted. A system for close monitoring of the fiscal costs of the new National Health Service should be adopted and well-designed spending safeguards should be introduced.

3. Restarting targeted structural reforms. The effectiveness of commercial claims enforcement and the efficiency of the courts should be strengthened to improve the payment culture and investment environment. Plans for expedited investment procedures while also phasing out incentives for construction could attract capital into innovative sectors and help diversify the sources of GDP growth. Corporate governance and operational efficiency should be strengthened in key semi-governmental and private entities to modernize the economy and make it more flexible.

We thank the Cypriot authorities, our European partners and our private sector interlocutors for informative discussions and their cooperation and generous hospitality.

Further reading

Cyprus: Staff Concluding Statement of the Second Post-Program Monitoring Mission

Readers' comments

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  • John says:

    How bizarre! or very convenient! there is no mention by this Troika/IMF MOB of that the one the most likely root causes of why Cyprus banks have NPL’s – is attributed to mis-selling CHF loans/Mortgages!

  • Deanna says:

    Every paragraph – 1,2 and 3 has a link with developers and money tied to harmful an unnecessary construction industry.

    Cyprus government needs to re-draw its plans and cut the umbilical cord with construction and all its spin-offs ie passports for building-investment. If not, in fifty years time there will be no tourists for an island which is 80% crumbling masonry.

    Ed: IMHO it will not take 50 years for the masonry to crumble; it will happen sooner than that.

  • Richard says:

    As I understand it (and correct me if I’m wrong) but John Hourican has just ended his term as CEO with the Bank of Cyprus? Whilst I’ve been critical of some of his comments in the past – researching the guy – he seems to be on the level. Certainly he seems to have a greater level of skill and ethical disposition than many senior (and some shadowy) figures in the banking sector.

    What shape and what influences he has left the Bank of Cyprus with is critical to know. In the past he’s been described as “charming with forensic accounting skills”. That’s certainly not been reflected in our dealings with the Cypriot bank who mis-sold us loans, who have managed to be both utterly charmless and (on occasions) innumerate (we’ll leave irresponsible & bureaucratically challenged for later).

    Putting steerage in the hands of the IMF does worry me. Several senior figures (including Christine Lagarde – found guilty of negligence in 2016 but never prosecuted) have dark shadows around them (Strauss-Kahn & Rato for starters). The IMF’s policies have been roundly criticised across many parts of the globe for being chronically out of touch with local economies.

    What matters now is slicing through the “statements” – some of which would win the “Sir Humphrey Appleby award” for non-clarity on specifics – and find out how this high level strategy will play out tactically over the forthcoming one to two years sorting out specific situations fairly on a ‘one-on-one’ basis at high street level. ‘One on one’s’ for ordinary Jo’s and Joanna’s not historically being the best, cleanest and fairest portion of the process by any means!

    Ed: John Hourican is staying at Bank of Cyprus until 2019. We’ll have to wait and see if he’s managed to change the culture permanently until after he’s left.

  • MartynG says:

    All very well & necessary that the Troika again point up the NPL situation. It remains Appalling and although some efforts will be made, it seems it is is no-ones Interests to tackle it.

    The Banks played Fast & Loose for far too long, many loans never carried detailed repayment arrangements, too many cost loans by over-friendly bank managers who must have known there was little ability to repay, or even service.

    So, huge Blots on the financial landscapes remain – yes some efforts will be made but we will likely see Trouka/IMF back again in another 3-5 years asking “What Happened’!

  • clive fletcher says:

    Behind all the words don’t you just feel the resultant news and actions aren’t going to be good for the people of Cyprus.

    Ed: Before the bail-in, banks were handing out money as if it grew on trees. I’m sure many realised that they would be unable to make repayments, but back in those days the banks didn’t care; they merely rescheduled the loan and/or extended the loan period. Now (to use a mixed metaphor) the sacred cows have come home to roost.

    The unsustainable good life has to come to an end sometime to avoid the banks and Cyprus ending up in the mire once again.

    John Hourican recently urged Cyprus’ business community to increase the legal and political pressure to move towards a faster solution to the issue of non-performing loans (NPLs).

    Although BoC is doing better, they must find it difficult to grant new loans to help successful businesses grow.

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