Confidence in Cyprus banks still lacking: IMF

AFP, Wednesday 18 Sep 2013

Net outflows had reached 12.6 percent of deposits and nearly half of GDP in August despite unprecedented capital controls slapped on the banks in March

Confidence in Cyprus's once-bloated banking sector is still running low despite a massive reorganisation imposed under a 10-billion-euro international bailout in March, the IMF said on Wednesday.

Despite unprecedented capital controls slapped on the banks in March, the International Monetary Fund said net outflows had reached eight billion euros ($10.6 billion), or 12.6 percent of deposits and nearly half of GDP, by August 21.

That has put pressure on banks' balance sheets, already hurt by 30 percent of their loans being classified as non-performing, and led to a sharp contraction in credit supply.

Corporate credit declined by nine percent year on year in June, while mortgage lending, already suffering from the effects of recession, was down three percent and consumer loans by seven percent.

The IMF report, issued after a first review of the bailout agreed with Cyprus by the Fund, European Commission and European Central Bank, said authorities were on track to fullfil a sweeping package of restructuring measures imposed in exchange for saving the island from bankruptcy.

"Nevertheless, risks to the programme remain substantial, given the uncertain impact of the crisis, the still-recovering banking system and ongoing challenges to policy implementation."

In May, the IMF forecast that GDP would contract by 8.7 percent this year and by 3.9 percent in 2014, before posting modest growth of 1.1 percent in 2015.

In its report, despite noting that second-quarter growth had been somewhat better than projected, it maintained its forecast in light of continuing uncertainties.

In contrast to growth, however, the IMF said the employment picture was worse than anticipated, with the jobless rate now expected to hit 17 percent in 2013 and 19.5 percent next year, before beginning a gradual decline.

Overall, the IMF said "risks (to the economy) remain substantial and tilted to the downside".

"Confidence in the banking sector is yet to be restored" and "the extent of the impact of the banking crisis on households and corporates, as well as on vital service sectors of the economy, could be larger than anticipated.

"These could result in a deeper and more prolonged recession, as well as in weaker long-run growth, with dramatic consequences for debt sustainability."

At the same time, the report noted that "continued economic weakness in the EU could dampen demand for Cypriot exports".

But, it added that tourism could benefit from political turmoil in competing destinations and stronger non-EU demand, such as from China and Russia, and that development of large offshore gas fields could also provide an upside to investment and growth over the longer term.

Central to a return of confidence will be the restructuring of the banks that began in March when the island's second-largest lender, Laiki, was wound up and its good assets folded in to the largest lender, Bank of Cyprus (BoC).

Deposits above 100,000 euros in both banks were subjected to so-called "bail-ins". Those amounts from Laiki were converted into BoC shares, and 47.5 percent of deposits already held in BoC were also converted.

The IMF said that while the subsequent restructuring of BoC is an important step toward rebuilding confidence, several steps still need to be taken to strengthen the overall banking sector.
In a conference call on the report, IMF mission chief for Cyprus Delia Velculescu said in Washington that the "largest challenge" facing the banks is to deal with deteriorating asset quality.

For that, they will need to "put in place restructuring plans that adequately address that and can return the banks... to profitability."

These include recapitalising Hellenic Bank, which was the third-largest lender, as well as the cooperative banks, and phasing out capital controls.

Separately on Wednesday, Cypriot Finance Minister Haris Georgiades said the government aims to lift all controls in early 2014, but he did not give a precise date.

Asked about that, Velculescu said "we do expect further relaxations to take place this year and next," with full relaxation depending on the "return of confidence."

There is still a daily 300 euro cash withdrawal ceiling from banks for individuals and 500 euros for businesses, while cheques cannot be cashed and central bank approval is needed for large business transactions.

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