The reduction of the high stock of non-performing exposures (NPEs), the negative interest environment which compresses the banks` profitability as well as the forthcoming amendments in the regulatory framework, consist the three main challenges facing the banking system, the Central Bank of Cyprus said in a report released on Wednesday.
According to the CBC`s 2016 Financial Stability Report, NPEs by June 2016 declined to €25.3 billion representing 48.7% of the total loan book of the Cyprus banking system, reduced by €2.3 billion year on year.
The CBC notes that loan restructuring has gathered pace in the last year, while NPEs marked a reduction of €1.1 billion in the three months from March until June 2016.
However despite the “marked progress,” the CBC notes that “dealing with the high level of NPEs remains the basic priority for the restoration confidence and the return to growth.”
The CBC also adds “the effective implementation of the measures taken for this purpose is indispensable to reduce the NPEs and to stabilise the banking system.”
According to the CBC, total loans in June 2016 amounted to 238.2% of the Cypriot GDP, marking a reduction of 12 percentage points compared with the corresponding period of 2015.
Total private debt in June 2016 amounted to 282.4% of GDP (including special purpose vehicles) with non-financial institutions debt amounting to 155.2% of GDP and household debt 127.2%. Total debt including public debt amounted to 391.4% of GDP.
CBC notes that banks have increased liquidity levels due to the rising deposits, the increase in capital adequacy ratios, as well as provisions.
However, the Cypriot banking regulator points out that low interest rates, combined with the low provision of new credit represents a challenge to the banking sector`s profitability.
As ECB imposed negative rate on excessive liquidity, banks face a further challenge due to the rise of deposits, while the low level of new loans challenges their income, as 75% of the banks` income came from interest income.
“The credit institutions` profitability may, therefore, decline further if the banks are not able to offset the reduction of profitability with a rise in new lending and/or with reducing credit risk.”
Furthermore, the banks face further challenges from the changing supervisory environment, a new set of regulatory and supervisory changes from the Basel Committee on banking supervision which will increase the minimum capital requirements. Moreover new supervisory settings such as IFRS 9 will be implemented that imposes provisioning based on expected losses.
“The introduction of the above issues is expected to bring about significant increase in the bank`s funding costs,” the CBC points out, noting that low interest rates is expected also to affect the profitability of the insurance sector.