Fitch: Cypriot banks still vulnerable to Russian developments

Fitch rating agency expects Cypriot banks to remain vulnerable to economic and political developments in Russia. Political instability in Greece and Cyprus could also erode confidence and trigger foreign deposit outflows, the agency mentions in a special report on Cyprus published on Tuesday.

According to the report, the Cypriot economy is set to recover gradually after several years of recession. Fitch expects GDP to grow 1.5 percent in 2015 and 2 percent in 2016. However, the operating environment remains challenging for domestic banks with a high unemployment rate (16.1 percent versus a eurozone average of 11.4 percent) and a weak housing sector where prices Fitch expects to decline in 2015.

In April 2015 the Cypriot parliament approved an amendment to the country’s insolvency legislation. The new framework should facilitate corporate debt restructuring and accelerate repossession processes. Fitch views positively the insolvency reform but underlines that the implementation risks remain.

The rating agency mentions in its report that it expects Cypriot banks to focus on restructuring retail loans instead of foreclosures. According to the agency, the effectiveness of this reform to the insolvency laws is still subject to implementation risks, largely related to the political will to allocate the necessary resources, monitor the progress made and readjust the framework if required.

In April Cypriot authorities removed the remaining restrictions on the free movement of capital from Cyprus. Capital controls were gradually relaxed in the period from 2014 to first quarter of 2015 as the restructuring of the domestic banking sector progressed. Sector deposits have remained broadly stable from April to August 2015, suggesting that customer confidence has improved.

Cyprus has maintained its tax-related attractiveness as an investment platform. Fitch sees foreign-related deposits, primarily linked to Russian residents, still account for a large 30.4 percent of the Cypriot banking system’s total funding.

Fitch says that the current ratings of the Bank of Cyprus and Hellenic Bank reflect the persistent high vulnerabilities of their capital to exceptionally high bad loans and to a still-weak economy. The Bank of Cyprus rating is one notch below Hellenic Bank’s, largely due to its weaker funding and liquidity profile, Fitch explains. The Stable Outlook on Hellenic Bank reflects Fitch’s view that this bank’s credit profile is set to stabilize.