Cyprus Central Bank Statement

Author: | Published: 5 Sep 2017
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In the aftermath of the financial crisis, policy makers have faced serious challenges in their effort to strengthen the banking system's resilience. Proper governance, prudent measurement of risk and adequate loss absorbing capital are key issues that have had to be addressed from both the regulatory and business perspective.

The materialisation of credit risk during the recent crisis resulted in significant losses being recorded by banks. Credit risk continues to be the most important source of risk that has to be dealt with. Non–performing loans (NPLs), a legacy of the recent crisis, need to be addressed urgently and decisively. Banks need to either dispose of these distressed assets or manage them by setting up proper workout units, or through a combination of these methods. The European Central Bank (ECB), in cooperation with national competent authorities, has published a guidance to banks for the management of NPLs to facilitate the implementation of best practices in resolving this obstacle to sustained economic growth and clean bank balance sheets.

In Cyprus, NPLs have begun to benefit from the pick-up in pace of loan restructurings, which have benefited from the historic low levels of lending rates. While deleveraging is expected to continue correcting the balance sheet of the private sector, demand for new lending is also picking up. This is being facilitated by banks' surplus liquidity, which is enhanced by the continued increase in deposit flows both from domestic and foreign residents, and by the accommodative monetary policy at the euro area level.

In the long run, NPLs will be further reduced once the economy is on a path of sustainable growth. A steady return of confidence to the domestic economy has been evident since 2015. In 2016 the economy grew at the fastest rate in eight years, with growth expected to continue hovering at around 3% in the period 2017-2019, mainly driven by new investment and net exports. The positive performance is largely the result of structural reforms that took place following the onset of the crisis and the prudent policies of the authorities. Inflation is also picking up after three years of negative growth in prices and is expected to rise to levels closer to 2% in the coming years, which is in line with the ECB's policy goal of keeping inflation below but close to 2%.

On the issue of capital adequacy, supervisors and banks need to ensure that the loss absorption capacity of banks (both capital and provisions) is adequate to facilitate the swift resolution of NPLs and safeguard their solvency. Furthermore, macroprudential capital tools, such as the countercyclical and systemic buffers, have been introduced in order to address the procyclical nature of the capital rules and the too-big-to-fail problem faced during the financial crisis.

Another development in the area of credit risk, is the implementation of IFRS9. This represents a major shift from the existing incurred loss model to the expected loss model, where banks have to estimate and record, for a certain part of their loan portfolio, the life-time expected losses. Significant improvements in their IT and data quality systems is a prerequisite, while risk management departments will need to be enhanced and engaged accordingly.

I am confident that the euro area in general and Cyprus in particular will continue on their path to recovery and that the eurozone's banking union will be strengthened.




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