Banks made good progress during 2016 in cutting bad loans. By the end of the year, the stricter category of non-performing exposures (NPEs) had fallen year on year by €3.1bn to €24.2bn, while non-performing loans (NPLs) on a more than 90 days past due (90+ DPD) basis had declined by an even larger €3.8bn.
This produced an NPE ratio of 46.2% and an NPL ratio (90+ DPD) of 33.9%.
Under rules set by the Central Bank of Cyprus, banks are now implementing a range of measures to work out bad loans and prevent new ones from appearing.
However, hidden behind this overall positive trend is something a little puzzling, namely that bad loans among small-and medium-sized enterprises (SMEs) have been rising. NPEs rose year on year in December by €812m to €9.97bn.
This matters, because at just under €10bn, it means that SME bad loans account for 41% of the total.
The trend for NPEs was different from that of NPLs on a 90+ DPD basis. NPLs for SMEs actually fell in the same period, by €650m to €7.1bn.
NPLs are a better measure of new bad loan formation, while NPEs are a better measure of how well restructured loans are performing. Under the NPE definition, a restructured loan must continue to perform for at least another 12 months before it is counted as performing again.
The data suggests, therefore, that SMEs are beginning to pay back bad loans but that their ability to keep up repayments is uneven.
This is despite the fact that we had a bumper tourism season last year, construction is also rising rapidly from a low base, and wages and prices have only just started to rise. This means that business costs until now have probably not been a major issue.
There are, therefore, no obvious reasons why SMEs seem to be struggling to keep up with payments. However, I can speculate on a few reasons why.
Uneven revenues
The first is likely to be uneven revenue. As a micro business myself, I understand this issue. I am happy to say that the vast majority of my clients pay quickly, but one or two of them need to be chased constantly.
When you are a small business, waiting up to and beyond the EU’s 60-day limit without any income can be very painful, especially if you have dumped smaller revenue-earning opportunities to do the big contract.
Attempts to write pre-payments into the contract do not always work. With big companies especially, their bureaucracies are so large that you can end up finalising the contract the day you deliver, or worse, a few days afterwards.
Less collateral
The other likely issue for the rise in SME bad loans is that banks have fewer means to incentivise them to pay. With larger companies, banks have been able to swap debt for property collateral.
This is more difficult with SMEs. First, they are likely to have less property in the first place. Second, any property collateral that they do have may be needed to continue their business. The property could even be their primary residence, which is protected under the current legislation.
Yet all businesses in Cyprus have an interest in seeing bad loans come down. High NPLs are the primary reason why Cyprus is being held back from an investment grade rating.
While Standard & Poor’s now has Cyprus just one notch below investment grade, Moody’s Investor Service still has Cyprus four notches below investment grade and Fitch Ratings rates Cyprus three notches below.
As long as we have a junk rating, it will limit the amount of investment that will flow into Cyprus and this will affect all businesses.
If my hunch is correct – that the main reason for rising NPLs among small businesses is uneven payments – then it seems that both the banks and the government have an incentive to help small businesses get paid on time.
There are a number of ways of doing this. The quickest and easiest is for the Ministers of Finance, Commerce and Transport openly to encourage larger businesses to pay their contractors on time and perhaps to threaten to expose those who do not. This will help create the right climate.
More formal options are to create a quick and painless small claims process, ideally through arbitration, since the courts are already clogged up.
Another is a credit registers that penalise the bigger companies for holding back their payments.
Now is the time to do it. Bigger businesses are seeing growth in revenues but smaller businesses are seeing their electricity costs going up again. This is a risk to the banks and it needs to be tackled.