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Bankers’ Alert: Bloom or Wither? Revolutionise or Rationalise?

Posted by (Regular StockWatch Contributor) on May 26th, 2017 - 11 Comments

Part A

The Stagnation of Banking Conventionalism

There is a well-known axiom in the financial world which stipulates that no banking system, and as a matter of fact, no economy, can survive with non-performing loan (NPL) figures over fifty percent, as is the case in Cyprus; yes, they are stubbornly well over 50% when governmental and non-financial corporations are excluded!

And there is another well-known axiom which says that “as you sow, so shall you reap”.  And local banks are reaping, for the past few years now, the rotten fruit of the loan seeds they sowed ‘en masse’a decade ago.

As no juggler in the world can actually juggle with so many “air-borne balls” at the same time, no banker can actually handle so many problem loans, despite the valiant efforts that have taken place to date.  Much like the Lernaean Hydra, no matter how many loans are resolved, even more spring up.  And, heaven forbid, banks are not, cannot and should not become real estate clearing houses.  This is not their role in the modern economy!  Their role is none other than to diligently and rigorously assess new investment and financing propositions with a view to funding with caution the productive capacity of the economy, thus propelling real economic growth.

Juggling with so many balls, using only conventional ways, is simply “an accident waiting to happen”.  A potential “nuclear” accident to be honest.  The rationalized and conventional way of going about resolving the sizeable NPLs stock is not making sufficient progress inroads.

The process is slow and painful and banks possibly lack sufficient specialised resources.  In addition, banks may also carry embedded legacy structures, cultures, policies and procedures which give rise to decision-making cautiousness or hesitancy and operational capacity bottlenecks or even inertia.  All these constraints stifle efforts to swiftly and determinedly deal with the problem, which is exactly what is required in crisis situations.

Borrowers, on the other hand, may lack sufficient resolve to efficiently deal with the problem, whereas the local corporate world and households alike are excessively indebted and cannot sustainably service their debts at their present levels.

To complete the picture, the legal and enforcement frameworks for debt recovery and for the liquidation of collaterals is not yet mature or effective enough.

Banks’ ability to fund new investments and economic growth is, as a result, severely curtailed, prolonging the return of sustainable economic recovery.And our banks are in for yet more challenges:

-          IFRS 9 which comes in force in 2018 and will most likely lead to additional and / or faster provision requirements,

-          the new pan-European stress tests which are anticipated to take place in the second quarter of 2018,

-          the newly published guidance to banks by the European Central Bank on non-performing loans, the requirements of which will form an integral part of the annual Supervisory Review and Evaluation Process and may reasonably feed through to Pillar 2 capital requirements.  Detailed reporting requirements have been set down whereas the NPL strategy, plans and performance of high NPL banks will be diligently scrutinised by supervisors at frequent intervals.

Why Banking Conventionalism fuels the Threat of Crisis Re-ignition

The level of accumulated NPLs along with the other challenges facing banks are so critical to the extent that they make local banks extremely vulnerable to any sort of downturn or adverse development.  The risk of reigniting a 2013-like crisis cannot be completely overlooked.

No wonder, these are worrying times for local banks which find themselves operating in truly hostile surroundings:

a. As already touched upon, it is propounded that banks do not have sufficient or, in certain cases, expert enough resource capacity to deal with, and subsequently manage, the NPL avalanche arising from the sheer number of cases at hand.

To top it up, banks’ attempts to offer swift, long-term and truly sustainable solutions, may be deterred because of inflexible internal processes and corporate governance issues.

As a result, trying to work out all the non-performing loans inside the bank, only prolongs the healing process in the organisation.  Recent insolvency law reforms have yet to mature and it will typically take time to build capacity, develop uniform processes and test the rules in court.  Structural impediments, on the other hand, such as the slow progress insofar as the issuance of separate property title deeds is concerned and the heavy concentration in a saturated real estate sector, which presently lacks financing liquidity, are further factors which do not bode well for the future of the banking sector.

b. On another front, the local banking system is profoundly crowded both in terms of the number of commercial banks operating in this small economy and in terms of the number of bank branches per capita.

All financial institutions are in effect juggling with the same “balls” (or, chasing the same distressed, and healthy, borrowers) which leads to intense competition to get a bite of the small ‘healthy borrower’ pie against a backdrop of low net interest spreads and a largely inflexible cost base.  The already stressful business pressures facing banks are further exacerbated by the heavy load of supervisory, compliance and reporting requirements and resultant costs.

This low profitability environment, which is driven by all the above factors, may well call into question the viability and sustainability of certain banks’ business models.  Daniele Nouy, chair of the Single Supervisory Mechanism, has repeatedly stated that “low profitability is a concern for supervisors because it may impact the medium-term sustainability of some business models.  Certain institutions might struggle to generate capital while having limited access to financial markets.  The European Central Bank will carefully assess the sustainability of banks’ business models in the coming quarters, with a view to ensuring that they are able to withstand cyclical developments and structural challenges”.

c. Local businesses and households are typically multi-banked and excessively indebted, therefore many of the distressed borrowers are common to more than one banks, either as principal debtors or as guarantors.  Arguably, there is not much benefit in resolving some of these distressed borrowers’ loans with one or two banks whilst leaving borrowings with other banks unresolved.  Likewise, resolving these loans without actually adjusting the debt level to the amount which can be reasonably sustained by the borrower in the long-term is not of great help either.

The unresolved borrowings will one way or the other come back to haunt the resolved loans; it will only be a matter of time before the cleaned up loans get contaminated by the diseased loans.  Similarly, it will not be long before the unsustainable restructured debts re-default.

In conclusion then,

-          a joint bank effort for the restructuring of multiple creditor loans and

-          assertive action for the re-adjustment of the level of debt,

are called for on a number of occasions; neither action is, however, typical of the existing banking culture in Cyprus.

d. The distressed asset market for the sale of NPLs is anything but developed in Europe yet, exhibiting a steep bid-ask pricing gap between buyers – sellers that is making the sale of distressed debt unaffordable for banks and is thus blocking the NPLs secondary market across Europe.

Alarmingly, when we turn to the local market we find that the provisioning coverage of local NPL loans is still below the European Union average (39,7% coverage for Cyprus vs 44,6% weighted average for all EU countries, as at December 2016 as per the European Banking Authority), thereby limiting even further the potential for distressed debt sales which shall maintain banks in a capital-neutral position.  Even more worryingly though, the higher NPL countries in the EU (with ratios over 10%) are mostly much better covered, with coverage ratios closer to 50% or even higher.

What’s more, the local market is so small and hampered by so many structural constraints that one would not reasonable expect a flood of interest from international investors to buy a chunk of Cyprus’s problem loans. Interestingly, the first move to dispose of a portion of their NPL portfolio, which has been very recently publicised, relates to the sale of a very small fraction of a local bank’s portfolio to another local bank.

To sum up this first part of our analysis, it is only fair to say that traditional banking rationalism in the form of the conventional management of NPLs may not be the wisest choice in times of turbulence and business pressures on a number of fronts.

Doing business in crisis conditions requires, by its very nature, thinking outside the box in conjunction with pace and determination.

 Renos Ioannides

Financial Analyst


Categories → Οικονομία

  1. avatar
    Avenger on May 26, 2017 - (permalink)

    There is no doubt that the highly paid bankers in Cyprus were behaving in an amateurish manner during the last decade , starting from 2007 , with the cover of the CBC and our lawmakers.

    They based all their accounting profits by applying the unfair terms contained in their contracts to try and ripoff the borrowers. Now that the real truth prevails they are trying to face the avalanche of losses coming up every day from court decisions and the Financial Ombudsman investigations. I would suggest to them to reduce their salaries and salaries of bank employees who are very highly paid in Cyprus to try to balance things out.

    Give your customers a deep discount on their NPL’s and you will find out that many of them will be paid overnight. There is hidden cash under the mattress.

    • avatar
      Renos Ioannides on May 31, 2017 - (permalink)

      Dear Avenger,

      The private sector is indeed excessively indebted. See for example today’s Stockwatch article at

      It is true that there are many justifiable cases where banks will have to adjust the debt exposure of borrowers to a level which can be sustainably serviced.

      There are, however, other cases of strategic defaulters who simply (and unjustifiably) choose to channel their income to other uses rather than keep up with their loan repayments. These defaulters must feel the banks’ (and society’s, I may add) wrath. Regrettably, the legal tools at banks’ disposal are not yet effective or efficient enough to make this happen. Admittedly, these strategic defaulters are taking advantage of loopholes in the system at the expense of banks and society at large.

  2. avatar
    ... on May 26, 2017 - (permalink)

    Mr Ioannides, Thank you for this nuanced analysis of where things stand. I think a major parameter in the analysis – as you rightly albeit indirectly stated – is the changing regulatory environment, both local and European. Regulators are increasingly more demanding but also, less predictable. This adds to the uncertainty in the banking environment and to the challenges banks face, as they struggle to address changing regulatory concerns.

    • avatar
      Renos Ioannides on May 28, 2017 - (permalink)

      Thank you very much for your comment which is indeed spot on. This wave after wave of regulation, which is not anticpated to subside any time soon, invariably leads to uncertainty, increasing costs, resource and capability gaps and, as a result, less and less productive time, resources and attention to the true business issues facing banks. This is exactly the backdrop against which the subsequent recommendations, in Part C of this series, are based on, in what may be seen as ways of somewhat alleviating some of these challenges which are currently burdening our banks.

  3. avatar
    Erol Riza on May 28, 2017 - (permalink)

    Mr Ioannides,

    A very good analysis of what has been and continues to be a problem but we knew that real estate linked NPLs will take their time in a dysfunctional property market. The comments of the CBC Governor are both very didactic and revealing and reflect the new ECB approach and the comments were customised for Cyprus.

    A very interesting paper on the Resolving the NPL problem of the EU is the IMF’s discussion note dated Sept 2015 and which looks at the key obstacles and issues. Some key points to have in mind in your next narrative are listed below for your convenience;


    Accelerating NPL resolution in Europe requires a comprehensive approach based on three key pillars:
     Enhanced prudential oversight to incentivize banks to write off or restructure impaired loans, including efforts to foster more conservative provisioning and imposing time-bound restructuring targets on banks’ NPL portfolios. In EU countries the Single Supervisory Mechanism (SSM) and European Banking Authority (EBA) should spearhead this effort, while national regulators will need to take the lead in other jurisdictions.
     Reforms to enhance debt enforcement regimes and insolvency frameworks. Effective out-of-court restructuring frameworks and improved access to debtor information should be encouraged.
     Development of distressed debt markets by improving market infrastructure and, in some cases, using asset management companies (AMCs) to jump-start the market.

    A. Prudential supervision
    17. Accounting standards, as implemented across European countries, weaken the incentives to resolve NPLs. First, the incurred-loss approach to loan provisioning under International Financial Reporting Standards (IFRS) is backward-looking (this is expected to be addressed when IFRS 9 becomes effective in 2018)12 and leaves much room for judgment, which may result in insufficient provisions. Second, while IFRS explicitly permits loan write-downs for impairment losses, it does not provide details on write-off modalities, which are left to the supervisors. Third, IFRS allows for the accrual of interest income from NPLs, which tends to inflate profitability, and lowers the incentives to dispose of NPLs (Background Notes, Section VII). And fourth, while collateral is taken into account in impairment loss recognition, there is no guidance on its valuation. Remedying the disincentives and ambiguities listed above does not require a change in the accounting standard, but can be done through stricter implementation guidelines and a more rigorous regulatory overlay.

    According to the IMF survey, collateral-related issues are a greater concern than capital buffers. While bank capital buffers are deemed a medium concern in about half the countries surveyed, collateral-related issues elicit either medium or high concern in most of them. These rankings partly reflect thin real estate markets (as the most common type of collateral is real estate) and difficulties in estimating collateral recovery values given weak debt enforcement frameworks. With only a few exceptions, collateral valuations are reportedly based on market prices, although in many countries, deep and liquid markets for foreclosed properties are lacking.

    It is not regulation that is to blame in Cyprus but legislation which has watered down most of the processes to foreclose on loans and to prevent banks from working in accordance with how other countries resolved their NPLs. Conventional securitisation is not feasible as it requires granularity (wide dispersion) of risk which in Cyprus is not present and most importantly the recovery of loans is not easy to assess and hence there is a need for a liquidity provider to make up the payments off the senior notes (having in mind 2-3 tranches). The only scope is for the government, just like fin Italy, to participate either as liquidity provider or guarantor of the senior notes. This is not for the present and hence the advice of the Governor to expedite restructuring and to take a long term view with real estate linked loans is very significant. Ignore the Governor’s comments/advice at your peril I would say.

    • avatar
      Renos Ioannides on May 31, 2017 - (permalink)

      Dear Erol, thank you very much for your insightful intervention.

      I agree that distressed loans, particularly those which are related to real estate assets, do need a long time to satisfactorily resolve. Notwithstanding this, I don’t think that our banks can really hold on for another ten or so years, carrying this heavy burden on their balance sheets and squeezing their profitability and depleting their capital coffers.

      The article does acknowledge that a fire-sale of distressed sale is neither a wise decision as things currently stand nor indeed practically feasible.

      However, given the pressures facing banks from all directions, which go well beyond the NPLs front (be it in the form of intense direct and indirect competition, the low interest rate environment, or regulatory pressures and so forth) and the fact that the value of distressed debt is typically rapidly depleted as time goes by, I think it is perilous for our banks to prolong the status quo of conventional NPLs management.

      What this series of article is essentially proposing is that all affected banks ought to move the playing field outside conventional banking surroundings and thinking.

      Indeed, parts B and C of the series touch upon the possible options that might be utilised to this effect,
      as food for thought and discussion. There is certainly substantial cumulative international knowledge and expertise that can and must be put to good effect.

  4. avatar
    Loizos Solomou on May 28, 2017 - (permalink)

    Thanks for a comprehensive analysis. It accurately portrays the situation and the need for a holistic approach, in order to resolve this multifaceted problem. Unfortunate predicaments require bold plans out of them. You are right to suggest that recipes of the past pose many risks in the Cypriot economy of today. One has to look at the state of our price and non-price competitiveness, of almost all of our sectors. If I may add to your thorough analysis, the extent to which banks are failing in their restructuring targets should be determining their provisioning obligations. After some point in the future, this should become deterministically fixed and predictable. Given this sufficient warning to the banks, this could be a smooth way of generating provisions, consolidation and business model fine-tunings. Among the many other simultaneous initiatives, that should be launched to address other dimensions of this problem, you rightly point to “the joint-bank initiative”. This initiative is of particular importance for Cyprus, due to the legacy of the lack of credit registry, that allowed for the creation of a significant amount and number of multi-banked insolvent debtors. For these cases, all possible sources of info and analysis for the debtors’ solvency should be combined, in order to determine their individual level of cross-bank debt viability. This joint approach will overcome the first mover disadvantage, which prevents banks from being more decisive against these debtors. Since, we dont have an investment bank and since the supervisor cannot undertake such an initiative (without compromising their neutrality), to whom can we entrust such an important undertaking? The government can act as the ad hoc coordinator, through a specialist internationally renowned financial organization. The mandate for this intermediator should be determined by law and so should the mandatory participation of all the licensed banks upto certain past date. There are some moral hazard issues, which can be overcome by limiting the eligible loans for this scheme to be only loans upto certain past date.

    • avatar
      Renos Ioannides on May 31, 2017 - (permalink)

      Dear Loizo, thank you for your incisive comment about the much desired, yet so eluding, joint-bank approach.

      This is indeed one of the ‘out-of-the-box’ (insofar as local business ethics are concerned) recommendations that this series of articles (Part C in particular) is proposing as a way of shifting banks out of the deadlock they find themselves in.

      It is interesting to note, that the four Greek systemic banks are contemplating setting up a common debt servicing platform for the vast number of SME debt (in Greece) in an attempt to uniformly deal with these borrowers and share in the expertise, resources and costs. This effort is led by and revolves around the Association of Greek Banks. It is further reminded that ALPHA Bank and Eurobank have already ‘set up common shop’, in partnership with KKR Credit, for the management of large corporate debtors.

      It is perhaps equally interesting to note that the Greek banking system is still under the close scrutiny of the Troika…

  5. avatar
    MYLTON on May 29, 2017 - (permalink)

    Reducing NPLs in any country is by de facto a difficult mission. When you add complex products, taking into account national and international interventions, lack of capital in the social and economic cycle and adding the fact that there is no edifice to support insurgent and comprehensible valid international investment with absolute growth makes NPLs future in Cyprus the new future.

    • avatar
      Renos Ioannides on May 31, 2017 - (permalink)

      Dear Mylton,

      I too think that the way we, and our banks, handle the NPLs issue will to a large extent determine the future of our economy.
      We can either be patient and more rationalised in our approach (or, to be more accurate, be more ‘indulgent’ in our approach) and wish for the NPLs problem to ride the economic cycle, or we can be more proactive and try to work out more unconventional solutions to the problem.

  6. avatar
    Ex Banker on June 1, 2017 - (permalink)

    The current situation suits both the Banks and the borrowers who are not repaying their debts. Repossessing properties and selling them on the open market will reduce their value and increase the Banks provisions, requiring an increase in their capital, but the reduced values will attract overseas investors which can potentially increase job opportunities and increase wealth in the long run. Avoiding short term pain and allowing zombie Banks to continue trading as they are, does not help the economy, it just prolongs the inevitable pain. It is time that Banks and the economy at large start operating in the real world.

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