Cyprus banking NPL cleanup leaves substantial private debt outside banks

Nicosia, Cyprus. Cyprus has largely cleaned up its banking sector’s non-performing loans, but a substantial private debt problem remains outside bank balance sheets, according to Xenios Socratous of the Central Bank of Cyprus’ risk analysis section.

In an analysis published on the Central Bank of Cyprus website, Socratous said the improvement in bank balance sheets did not mean that the underlying debt problem had disappeared.

Banking sector transformation

Socratous said Cyprus had undergone one of the most dramatic transformations in European banking, moving from non-performing loan levels approaching half of total lending to a banking system whose asset-quality indicators are now broadly aligned with the European Union average.

“The problem of NPLs was never simply a banking ratio. It was a macroeconomic constraint,” Socratous stated.

Large volumes of non-performing loans had tied up bank capital, consumed administrative resources and restricted banks’ ability to finance the economy, he said. He added that heavily indebted households and businesses tended to postpone investment and consumption.

Origins of the debt crisis

The roots of the crisis extended to before 2013, Socratous said, when rapid credit growth, rising deposits and a major expansion in property and housing finance followed Cyprus’ accession to the European Union and adoption of the euro.

This left banks heavily exposed to property developers, households and businesses linked to the construction and real estate sectors. The banking system also became disproportionately large relative to the economy and significantly exposed to Greece.

Lending and restructuring practices

Socratous pointed to lending practices that gave excessive weight to the value of property collateral rather than borrowers’ actual repayment capacity.

During the boom years, this created a false sense of security, while inadequate provisioning allowed loans to appear sound even after borrowers’ financial positions had deteriorated, he said.

He also cited the widespread use of “extend and pretend” restructuring practices, under which repayment periods were extended and additional collateral was sometimes obtained despite evidence that borrowers could no longer service their debt sustainably.