Safeguarding against the cliff effect in NPLs amidst the pandemic

8 Apr 2021 | Andria Koukounis

Safeguarding against the cliff effect in NPLs amidst the pandemic

The current state of affairs

In Cyprus, the unconditional loan instalment payment moratorium ended three weeks ago leaving:

(a) just over half of the market’s borrowers, who as per the European Banking Authority’s (EBA) published data had not applied for a payment holiday within the June 2020 deadline, with the option to make use of the new payment moratorium announced earlier this month, provided they satisfy the qualifying criteria, and

(b) the rest of the market’s borrowers who have already made use of the payment holiday, with the option to apply for extension of their payment holiday under the new payment moratorium, this option being however, of limited use or application to them since the payment holiday must not exceed 9 months in total, such period counting from the time they exercised the right to suspend their loan instalments under the 2020 payment moratorium. Therefore, this category of borrowers is essentially looking at two courses of action, either start repaying their loans, or get in contact with their lender to initiate discussions for restructuring their loan.


Out of the 48% of the borrowers that applied for payment holiday in 2020, a significant percentage will not be able to restart paying their monthly instalments, and the reason lies in the extrinsic circumstances created by the second wave of the pandemic.

Some units in the HORECA industry across Cyprus took a brave decision to lift on their shoulders the heavy burden of operational expenses and resume operations last May, against a variety of measures taken by the government to cut the virus’ chain of spreading, including closing borders, curfews and suspension of certain business operations.

In construction projects for which funding was available, contractors continued their site operations to mitigate the loss they started incurring since the enactment of restrictive measures.

Other businesses in the food, clothing and real estate industry invested largely in making their products available on very interactive websites whereby clients can take a really convincing view of their products (and in the case of properties even a virtual tour).

It is doubtful, though, whether those businesses were profitable during the past 9 months to the extent that they would be able to start repaying their loan instalments.

It is also almost certain that businesses which decided the operational expenses burden was too heavy to lift and have suspended their operations throughout the pandemic, will not be able to start repaying their loan instalments. The same applies to the owners and the staff of such businesses who are under a housing loan, car financing and other unsecured credit such as an overdraft account and credit card.


A preventive response is required

Against this backdrop globally, the Chair of the Supervisory Board of the European Central Bank (ECB), Andrea Enria, has been setting the principles on which we will be able to drive our economies to recovery and allow them to flourish once again. Funding and pricing are catalysts to business activity. In order for banks to be able to offer the market with funding at low cost levels, they must have a healthy balance sheet and asset quality.

Delayed recognition and poor management of deteriorating asset quality can easily clog up bank balance sheets with non-performing loans (NPLs) for a fairly long period of time, thus making it more difficult for banks to support viable customers and underpin a faster economic recovery.

Due to the severity of the chain results that soaring NPLs could lead to, Mr. Enria has been contacting systemic banking institutions in each member state highlighting as the cornerstone of a robust response to the pandemic:

  • early identification of arrears,
  • case-by-case reclassifications,
  • prudent provisioning choices,
  • borrower-specific debt restructuring, and
  • effective forbearance practices to distinguish viable distressed borrowers from non-viable ones.

The Governor of the Central Bank of Cyprus (CBC) has also since late March been urging banks with a relevant Circular to continuously analyse their loan portfolio to establish as early as possible exposures which require restructuring in order for borrowers to be able to perform their loan repayment obligations.


The implementation framework

To implement the early recognition of deteriorating exposures, proactively engage with clients and prevent a cliff effect, Cyprus banks are armed with a number of tools.

Firstly, they have the 2015 CBC Directive on arrears management, a thorough breakdown of the practice in each stage before, during and post-arrears and the code of conduct they are expected to follow.

In addition, the EBA issued in 2018 its Guidelines on arrears and foreclosure and has more recently been issuing updated guidance on moratoria and NPL management.

The European Commission’s latest support initiative, announced in December, is the updated Tackling NPLs Action Plan, the pillars of which include:

  1. the development of secondary markets for distressed assets, key in cultivating such development being the improvement of data quality and data comparability;
  2. the establishment of asset management companies (bad banks) for transferring impaired assets mainly secured with commercial real estate and large exposures, and
  3. the enhancement of preventive restructuring frameworks that ensure action is taken before enterprises default on their loans, thereby helping to reduce the risk of loans becoming non-performing in cyclical downturns.

Banks have also developed their internal policies in line with the CBC Directive and guidance from the European institutions on the arrears management, restructuring and recovery roadmap.


Next steps

At the core of all the above tools are detection mechanisms and data quality. Borrower-reclassifications and loan restructurings can occur once borrowers’ deteriorating repayment ability is traced and based on accurate information. Banks must, thus, ensure their internal policies and systems are reinforced with efficient and effective processes enabling them to address the unprecedented challenges their loan portfolios are confronted with. Such challenges are undoubtedly an opportunity for banks to embrace transformation and elevate their traditional proposition to innovative value-added banking services.

Author: Andria Koukounis

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Andria Koukounis

Advocate / Partner

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