Cypriot banks are well capitalised and have shown “remarkable” progress in reducing non-performing loans (NPLs), Claudia Buch the new chair of the ECB’s Single Supervisory Mechanism told CNA calling however for caution as banks, apart from the rising interest rate risks are faced with “novel risks” stemming from geopolitical tensions, climate change and cybersecurity.

In an interview with CNA, on the occasion of visit to Cyprus for the Single Supervisory Board meeting, Buch praised the progress in the reduction of delinquent loans, stressing however that there is still way to cover for the Cypriot banks NPL rate to converge with the Euro Area average.

The SSM chair refrained from commenting on the ongoing acquisition of Cyprus’ second largest lender, Hellenic Bank, by Greek Eurobank, while she pointed out that banks may by faced with periodical penalty payments should they fail to comply with the expectations of SSM concerning risks associated with climate change.

Noting that the situation in the Cypriot banking sector is very similar for many European banks, Buch said “the banks are well capitalized” whereas the specific feature for Cyprus, the share of non-performing loans has decreased quite significantly over the past years from around 50% to about 7%.

“This is a very big reduction. It's still higher, though, than the euro area average, so there's some way to go but this is a remarkable improvement,” she remarked.

The SSM chief acknowledged that “banks are profitable right now because we have higher interest rates and that's good for banks’ profits.”

In a bid to curtail rampant inflation, the European Central Bank has hiked its interest rates ten times since July 2022 with a cumulative increase of 450 basis points, boosting bank income.

However, replying to a question on the challenges clouding the outlook, Buch said “we haven't seen the full impact of higher interest rates on banks’ balance sheets yet,” pointing out there is more pass-through of higher interest rates on deposit rates and this will have negative implications for profitability. She also noted that banks may face difficulties to pass higher rates to corporate clients because in many areas, credit demand is weak.

“So that's certainly something to watch what happens to bank profitability going forward and there's of course the big issue about risks, novel risks, geopolitical risks, climate risk, this is really something which is at the focus of European supervisors,” she said, adding the supervisor works with “the banks to make sure that they're vigilant and they also do good forward-looking risk assessment as well as these novel risks.”

No comment over acquisition of Hellenic Bank

Asked on the acquisition of Hellenic Bank by Greek Eurobank, Buch refrained from commenting, noting as a general remark that the SSM along with the Central Bank of Cyprus will look into the prudential implication of the acquisition in process.

“We are neutral with regard to what types of business decisions banks take in terms of consolidation, whether they merge domestically or cross-border, supervisors really look at the prudential implications,” she said, explaining that prudential implications are associated with capital levels, the liquidity situation, governance and the business model.

NPLS: Small impact for far but new NPLs take time to materialize

Responding to a question over a potential inflow of new NPLs, Buch said that they have seen a small increase in NPLs with no big effect, noting that the supervisor is pressing for good forward-looking risk assessment as NPLs take time to materialize amid economic slowdown.

“We have a slowdown in the real economy, it takes time until non-performing loans materialize and this is why we're so much pushing for a good forward-looking assessment of risk,” she said.

Furthermore, the SSM chief pointed out that the current situation is different compared with the Covid-19 pandemic when banks we indirectly benefited by public support to the real economy and liquidity provided by Central Banks. Buch moreover recalled that during the Covid-19 pandemic corporate insolvencies declined despite the large decline in GDP growth.

“This in all likelihood is not the pattern that we will see in the future so we need the banks to do a forward-looking risk assessment. They need to make provisions also for potential future risks that had come from very different risks, it can be geopolitical risks, climate-related risks. So, this forward-looking scenario analysis, this is something that is very high on our agenda,” she went on to say.

On climate risks, the SSM Chair pointed out until recently many banks didn’t take these risks into account and are not sufficiently prepared.

“So, then we defined very clear supervisory expectations, and we followed up upon them so that banks have until the end of the year to meet our expectations,” Buch added.

Stating that many banks have adjusted whereas some are still lagging behind, Buch noted “we need to see how they meet our requirements and then we will use the regular toolkit that we have, we can impose periodic penalty payments also on the banks, but we need to see how they meet our expectations and how they've adjusted their behavior.”

On cybersecurity, Buch said the SSM is working with banks to make sure they're sufficiently resilient, adding that “we see that the frequency and the severity of cyber incidents is increasing.”

She also recalled that the ECB has carried out a cyber resilience stress test with the results expected in the summer with the results to be followed up during the Supervisory Review and Evaluation Process (SPREP).

“So, some things can't be remediated with higher capital, but they can also lead to quantitative requirements and that remains to be seen for the individual teams, what tools they are they using, but of course, if there's high risk, there also needs to be sufficient buffer sufficient resilience and that comes through capital,” the SSM chair concluded.