Cyprus’s banking sector is among the best capitalised in Europe, with high levels of liquidity. It provides a cushion of resilience for the country, but is also weighed down by a significant lack of dynamism.

The large volume of non-performing loans (NPL) outside bank balance sheets, together with a justice system that continues to act as an obstacle to their restructuring, is the main reason the sector does not have a stronger impact on the Cypriot economy.

This is the central conclusion of the IMF staff report on Cyprus’s 2026 Article IV consultation.

‘The banking sector shows resilience, with strong capital buffers and liquidity and improving asset quality. While risks appear contained, strong links with the real estate sector require continued vigilance.

At a more structural level, legacy non-performing loans outside the banking system remain high, while financial intermediation is limited in a highly concentrated banking system,’ the report notes.

According to the report, the total capital adequacy ratio has reached close to 30%, while liquidity and readily realisable assets remain among the highest in the EU.

The non-performing loan ratio within the banking system fell to around 3.2% at the end of 2025, from nearly 50% in 2016, alongside a significant increase in provisioning coverage — with more than 77% of NPLs now covered.

At the same time, profitability remains high, with returns on equity among the strongest in Europe.

However, behind the ‘strong’ balance sheet picture, the IMF sees a sector showing ‘limited dynamism’.

The loans-to-deposits ratio is around 50%, compared with over 100% in the EU on average, indicating that banks lend far less than they could given their liquidity.

Continued deleveraging by non-financial corporations, low overall credit levels and a reluctance among both depositors and banks to take on risk following the 2013 crisis create an environment in which the banking sector operates more as a ‘store’ of liquidity than as an engine of economic financing.

NPLs and justice system

There is concern regarding non-performing loans. By mid‑2025, NPLs outside banks amounted to around €18.5 billion, or roughly 51% of GDP, with more than 30% of household and business debt held by credit-acquiring companies.

While this has helped banks clean up their balance sheets, the real economy continues to carry a heavy private debt burden.

The IMF notes that the large stock of NPLs and the slow pace of justice are among the main reasons the Cyprus banking market remains cautious in lending to households and businesses.

Lengthy court proceedings, significant delays, limited specialisation within the courts and insufficient digitalisation hinder the timely enforcement of collateral, insolvency procedures and, ultimately, the resolution of NPLs.

Recent legislative initiatives to amend the foreclosure framework are seen by the IMF as a step backwards.

Expanding borrowers’ ability to challenge and delay procedures, introducing additional procedural stages and allowing multiple levels of judicial appeal create legal uncertainty.

According to the Fund, this undermines payment discipline, weakens foreclosures as a deterrent that encourages restructuring and further slows the resolution of legacy NPLs.

The result is reduced lending to businesses and households.

Credit-acquiring companies face difficulties managing the ‘red loans’ they hold, while banks recognise that enforcement and judicial procedures are slow and uncertain.

As a result, they remain far more cautious in issuing new loans, particularly to households and small and medium-sized enterprises.

According to the IMF, this largely explains why the loans-to-deposits ratio remains low despite the system’s strong capital position.

IMF recommendations

The IMF calls on Cypriot authorities to maintain an effective foreclosure framework and avoid interventions that weaken its credibility, stressing that this is not only about disciplining strategic defaulters but also a prerequisite for restoring credit intermediation and investment.

At the same time, it links NPL reduction to broader judicial reform, calling for more judges and support staff, full operation of the commercial court, upgraded case management systems and greater specialisation in commercial and financial cases.

The report recalls that the average time needed to resolve civil and commercial cases in Cyprus remains the longest in the EU.

Although the backlog of cases has decreased compared with the past, it still significantly limits the courts’ ability to handle new waves of disputes.

Any changes to the foreclosure framework that increase appeals and procedures, without strengthening judicial capacity, simply prolong delays further, the IMF warns.

Government response

Cypriot authorities acknowledge that changes to the foreclosure framework carry risks for payment discipline and may encourage prolonged legal procedures.

However, they stress that their objective is to enhance protection for vulnerable borrowers through tools such as the ‘mortgage-to-rent’ scheme and legislation for ‘trapped buyers’.

They also emphasise that improving judicial efficiency remains a priority, through digitalisation, strengthening the judiciary and the gradual specialisation of courts.

At the same time, they view the banking sector as an ‘important buffer’ against external shocks.

As for credit growth, they note that it has started from a very low base, interpret the growth rate of new lending as a sign of dynamism and believe that credit expansion has been broad-based and subject to high standards.

High capital levels and liquidity allow the system to absorb shocks without transmitting instability to the real economy.

Nonetheless, the government agrees that improving the efficiency of the judicial system — particularly in the context of foreclosure reforms — would be a key factor in deepening the credit market.

Lending #