BRUSSELS--Cyprus should brace itself for further blows to its
banking sector, with ever-shrinking deposits and multiplying bad
loans expected, the European Commission warned Wednesday.
The European Union's executive, in its first review of the
country's 10 billion euro ($13.35 billion) bailout, said the
Cypriot government was doing what it should in terms of cutting
public spending.
But the radical shake-up of the banking sector coupled with
unprecedented restrictions on the movement of capital in and out of
tiny island have left it exposed to deep economic pitfalls.
Confidence in the banking sector has plunged after the bail-in
of depositors, culminating in the gradual flight of deposits from
the island despite the government's imposition of capital controls
to stem the outflow, the report said. It did not provide specific
data on the volume of fleeing deposits.
Cyprus's central bank and finance ministry are putting together
a fortified legal and practical framework to handle loans in the
red and requests to ease the terms on household and business loans,
the report said.
European experts stood by their spring forecast that the Cypriot
economy would shrink by 8.7% in 2013 and a further 3.9% in 2014,
but revised their unemployment forecasts sharply upward. They said
that 17% of the Cypriot workforce would be out of a job this year,
up from an original projection of 15.5%, while unemployment will
hit 19.6% in 2014, not 16.9% as previously thought.
"A further worsening of labour market conditions may lead to a
more prolonged loss of business and consumer confidence," the
report warned.
Cyprus's banking meltdown in March brought it to the brink of
leaving the euro and revived investor anxiety about the euro-zone
debt crisis. After tense, marathon negotiations between the
nation's government and its euro-zone peers and the International
Monetary Fund, which has contributed one-tenth of Cyprus's bailout,
a decision was reached to restructure the banking sector.
This involved shutting down the country's second-largest lender,
Cyprus Popular Bank, and appropriating all uninsured deposits above
EUR100,000 to pay for the bank's resolution. The biggest bank, Bank
of Cyprus, underwent a long, deep restructuring, during which 47.5%
of uninsured deposits were blocked and then converted into shares
in the new bank.
The country's third-largest bank, Hellenic Bank, was able to
raise capital and shield itself without bailout cash. Dozens of
co-operative banks--small local lenders--are about to undergo a
series of closures and mergers to shrink the entire sector
dramatically. A total of EUR1.5 billion from the bailout will be
used to recapitalize them.
The commission's review said bank credit was bound to continue
shrinking in future quarters, but that this was a "necessary
adjustment of the previous excessive credit expanions." It said the
process of turning the Cypriot banking sector around had taken
"more time than initially foreseen due to the complexity of the
situation."
It did acknowledge that lending to small and medium-sized
enterprises and households has all but dried up, while pointing out
that "almost all businesses in Cyprus are SMEs."
Euro-zone finance ministers approved the disbursement of EUR1.5
billion from the bailout to Cyprus last week, while the IMF
unblocked its contribution of EUR84.7 million Monday.
Write to Matina Stevis at matina.stevis@wsj.com
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