ECB warns of 'significant negative impact'

The European Central Bank (ECB) has warned of “significant negative impact” to the Cypriot banking system in case a new law amending the legal on foreclosures is implemented.

The ECB warnings are included in an email sent to the Governor of the Central Bank of Cyprus Constantinos Erodotou. A copy of the said email has been distributed to the House of Committee of Finance members.

“Foreclosures play an important role in the Cypriot financial system,” the ECB said, affecting the very high non-performing loans in the Cypriot banking system that amount to 30% compared with the 5% of the average of the banks supervised by the SSM.

Foreclosures the ECB added, affect the coverage ratio of such defaulted assets via loan loss provisions, which relies heavily on the repossession of collateral to avoid a higher coverage associated to aged vintages, that is, older NPLs.

Furthermore, the ECB said that the amendments to the framework on foreclosures will potentially obstruct future NPL sales by the Cypriot banks.

“Given the key role of asset sales in the strategic NPL resolution plans of the main Cypriot banks, we are very concerned that the envisaged amendments to the foreclosure framework will weigh on the prospects for successfully concluding NPL portfolio sales”, the ECB said.

Noting that investors request a clear legal framework that would enable them to price properly the envisaged deals, the ECB added “that the significantly extended timeframe to dispose of collateral under the envisaged new foreclosure framework will have a perceptible impact on the price for such portfolio sales.”

“If such adjustments are finally approved, the ECB noted, we expect a significant negative impact on loan loss that banks have to allocate under IFRS 9, extended recovery periods might have to be considered, reliance on the repossession of collateral might have to be reduced and the inflows of new NPLs might be accelerated, as the incentives to improve of payment culture and avoid strategic defaulters might be hindered,” the ECB said.

The ECB went the amendment of the law on foreclosures would affect strategies to reduce NPLs, potentially impacting the banks profitability, solvency, quality of assets and rating.

“While an exact estimate of the impact is difficult at this point in time, it will be important part of our supervisory examination programme for 2020, which has to follow a risk-based approach for all institutions we supervise,” the ECB concluded.

The warning by ECB came as the parliament approved a law amending the framework on foreclosures enabling borrowers to appeal to the court to halt an auction of the foreclosed asset pledged as collateral. The law was returned to the parliament by the President of the Republic. The parliament will decide next Friday on the President’s return.