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OPINION

NPLs, Bad Bank And Moral Hazard

NPLs, Bad Bank And Moral Hazard

"The high level of Non-Performing Loans (NPLs) is a challenge that must be addressed so as to increase the resilience of the economy. In addition to the high level of NPLs, Cyprus also has a high level of domestic debt estimated at 114% of GDP compared to 86% that was the EU average in 2019. Although lending to the domestic private sector supports business growth, at the same time, it poses risks for the banking and financial sector, affecting the resilience of the economy." This is clearly identified within the European Union (EU)-approved Recovery and Resilience Plan for the Cypriot economy.

Equally strong is the EU's emphasis on the management of NPLs in general. As it was pointed out in the Pandemic Impact Action Plan (2020), the Member States participating in Support Plans should, inter alia, implement the necessary tools for their timely handling and containment of any future built-up NPLs.

One of the actions proposed by the EU, concerns the establishment of National Asset Management Companies (AMCs) and their cooperation at an EU level. In Cyprus, the political intention to establish a national loan management body has been declared months ago. The rationale is for the Cyprus Asset Management Company (KEDIPES) to play the role of the national management body for the entire banking system, i.e. to become a type of national "Bad Bank". The institution of the so-called "bad bank" refers to the creation of a specialized entity for the non-performing loans (NPLs) in order for them to be kept off the banks’ balance sheets. So far it has been successfully tested in a number of countries within the EU, with Ireland and Spain being the most typical examples. Though, such an endeavor implies consultation and cooperation of technocrats with specialized knowledge on the subject and compliance with specific regulatory issues. Nonetheless, above all, there is a need for the cooperation of public and private sector, with all that that entails, especially since regulated entities are affected.

The transformation of KEDIPES into a company that will be obtaining non-performing loans, in addition to the supervisory regulatory approvals that will be needed, also requires a change in the commitments of the Republic of Cyprus towards the EU Directorate-General for Competition in relation to the terms and conditions of the Restructuring Agreement of the cooperative sector. At the same time, the role and approval of the Supervisory Authorities is crucial in order to ensure that the resulting business model will be in compliance with the requirements of EU for prudential supervision and that effective and wise risk management will be exercised. The specific principles are clarified in the European Central Bank (ECB) Guide on the supervisory approach for consolidation in the banking sector, published in January 2021.

Regardless of the technocratic aspect, it should never be forgotten, there is also the matter of ethics and moral hazard. Great care is needed and should be observed so as to reduce the risks associated with this NPLs model, as well as concerns about overall loan dues payments’ discipline within the financial system. The creation of the “bad bank” should not be perceived as a major relaxation and a chance for borrowers to default on their obligations. After all, we have witnessed various legislative regulations in recent years that promote a culture of loan default.

Finally, those who will make these decisions should not forget that KEDIPES resulted from the effort to save the Cooperative Bank's deposits, something that was achieved with public money, i.e. with the contribution of the taxpayers. According to official announcements, KEDIPES has so far managed to repay €510 million against the state aid of €3.5 billion it had received, while from time to time it was said publicly that it is possible for the full amount to be repaid. This automatically implies that any conversion of KEDIPES into a "bad bank" will affect this specific goal. The big bet is for the taxpayer to not be called once again to bear the financial cost of a publicly funded "bad bank". After all, a "bad bank" is anything but a charity.

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