CBC warns of non-performing loan surge amid economic challenges

The Central Bank of Cyprus (CBC) issued a warning on Monday, cautioning about the potential influx of non-performing loans (NPLs) driven by high-interest rates and inflation, which are impacting households' disposable income and businesses' profitability.

In its 2022 Financial Stability Report, the CBC projects a GDP growth of 2.4%, with inflation expected to ease to 3.9% in 2023. Despite ongoing global challenges, including the prolonged war in Ukraine, the CBC anticipates the Cypriot economy to maintain a positive trajectory in 2023, with growth projected to accelerate to 2.7% in 2024 and 3.1% in 2025.

However, the CBC acknowledged that these projections were made before the outbreak of the war in the Middle East, introducing uncertainty about its potential impact on the Cypriot economy. The duration, intensity, and scope of the war will influence the economic consequences.

While recognizing the Cypriot financial sector's resilience, the CBC expressed concern that a prolonged war involving more countries could indirectly pose challenges for financial institutions.

Addressing high-interest rates, the CBC highlighted that loans linked to banks' basic interest rates, which are tied to deposit interest rates rather than ECB base rates, have not seen significant increases. Thus, households and businesses within this category are not expected to be significantly affected.

However, the full impact of prolonged high inflation and rising interest rates on the balance sheets of non-financial institutions is anticipated to become more pronounced over time. The report underscored that high private debt, despite decreasing in recent years, combined with interest rate hikes and pressures on living conditions due to prolonged high inflation, presents challenges for vulnerable households and businesses to repay their debt.

Considering the anticipated contraction of households' disposable income and potential reductions in non-financial corporations' profitability, the CBC warned of the potential for a new wave of NPLs. Notably, the CBC stated that, as of now, there are no signs that this risk has materialized.

While vulnerabilities in households and non-financial corporations have increased, the CBC pointed out that economic growth, fiscal support measures, and precautionary savings in the private sector are currently supporting the financial sector's resilience.

The CBC emphasized that a potential rise in NPLs could directly impact credit institutions' profitability, leading to increased provisions for credit losses. This, in turn, may affect their capital adequacy and asset quality, albeit to a lesser extent, their ability to provide new credit to the economy.

Despite these challenges, the positive projections for GDP growth, low unemployment, and projected wage growth may assist in mitigating these risks, according to the CBC's latest assessments.

[Information from CNA]