2024 would enter with a heavy burden if the divestment front remained open
2023 proved to be a demanding year for the Cyprus financial system, but it closed having left behind the issue of constant changes in the framework for the management of non-performing loans (NPLs). Over the past decade, Cyprus has achieved a substantial reduction in NPLs, but the problem has not been resolved, as smaller banks maintain a high stock of NPLs and Credit Recovery Companies (CRCs) manage a significant portfolio of NPLs. The over-indebtedness of the private sector constitutes a major vulnerability of the Cypriot economy and its limitation goes through the reduction of NEDs.
The latest legislative intervention, which provides additional restructuring tools to borrowers through the institution of the Financial Commissioner and gives a second – and final – chance to borrowers with terminated loans, puts an end to the long public debate and controversy over the foreclosures. Cyprus now has a legislative framework that can work in the interest of everyone. Additionally, the "Rent Against Installment" scheme comes to provide a solution to borrowers with a real inability to repay their loan.
Not in retreat
The closure of the pending divestment came at a time when messages had been multiplied not to disrupt the NED management framework. Improvements were always welcome, but the fear of rating agencies, the IMF, the European Commission and the European Stability Mechanism, was the introduction of procedures that would lead to inactivity of the divestment tool. The message had clearly reached the government and the President of the Republic, Nikos Christodoulidis, had made it clear that he would not sign a law that would expose the country to new risks.
We don't understand it now, but 2024 would come with a heavy burden if the divestment front remains open. In this context, a new legislative initiative on divestments should not be expected in the near future. What is important is the focus on the effective implementation of the latest changes and the stability of the institutional framework.
The European Commission's recent report on the results of the 15th post-programme monitoring mission to Cyprus identifies the remaining challenges for the Cypriot economy.
Regarding NPLs and their management, it is noted that the quality of assets has improved, mainly due to the sales of non-performing loans achieved in recent years by systemic banks. Further progress also depends on the ability of smaller banks to reduce leverage.
At the same time, the transfer of non-performing loans from the banking system to the balance sheets of the Credit Acquisition Companies has the result that NPLs continue to burden the economy through private debt, which is why the European Commission requests that the country have a functional framework for divestments.
"Further progress in the management of non-performing loans requires an effective enforcement framework (including foreclosures). This is important for legal certainty and maintaining payment discipline, as it gives lenders leverage over uncooperative borrowers. Repeated suspensions of the enforcement framework have hampered its effectiveness. This may affect efforts to reduce non-performing loans and therefore the soundness of the Cypriot banking sector. The effective implementation of the enforcement tool is also important for the success of schemes such as the 'Rent for Rent' scheme, which is designed to protect the first home of vulnerable households," the European Commission's report points out.
The Central Bank of Cyprus issued a similar warning about the importance of maintaining an effective framework for the management of NPLs in the Financial Stability Report.
“The existence of a stable legal framework for divestments remains vital to the management of both the legacy volume of MEX (non-performing loans) and potential new MEX. In particular, the foreclosure framework should be implemented seamlessly so that it functions as an effective tool to deal with strategic defaulters, but at the same time as a lever of pressure, so that creditors and borrowers end up in sustainable restructurings.
The Central Bank also notes the challenge of the high debt of the private, non-financial sector. "Despite the downward trend of recent years, it creates additional challenges due to high inflation, in relation to the ability of the sector, and especially vulnerable households and businesses, to repay its obligations."
The combination of high private debt and the erosion of the ability of households and businesses, due to high interest rates and inflation, to remain consistent in repaying their debt obligations increases the importance of an effective NPL management and restructuring framework.
"The high indebtedness of the private, non-financial sector, despite the downward trend of recent years, in relation to increases in lending rates and pressures on the cost of living due to prolonged high inflation, creates additional challenges in relation to the capacity of the sector, and especially vulnerable households and businesses, to repay its obligations. Considering the expected contraction in household disposable income, the possible decrease in the profitability of non-financial businesses, as well as the increase in lending rates, the risk of a new wave of insolvent households and businesses cannot be ignored. However, so far, there are no indications that this risk has materialized", the Central Bank's Financial Stability Report emphasizes.