Panayiotis Rougalas
The concealment, or "camouflage," of non-performing loans (NPLs) in commercial banks before 2013 and their subsequent explosion have been, and may continue to be, the most significant challenge for the Cypriot economy. Initially, they heavily contributed to Laiki Bank's collapse, and later, they became the primary cause of the Cooperative's downfall due to its inability to manage the ongoing need for provisions. This peculiar case of the Cooperative serves as a crucial reminder, particularly for those in positions of power, including politicians.
The lack of an effective framework to address NPLs, especially regarding foreclosures, prompted European supervisors to nullify the collateral value of a substantial portion of their troubled loan portfolios. This move played a decisive role in the Cooperative's demise, as it struggled under the weight of making provisions worth hundreds of millions of euros. Furthermore, the prevalence of NPLs significantly delayed lending rates in pre-pandemic Cyprus due to the high borrowing risk.
Moreover, NPLs and the continuous demand for provisions by supervisors compelled bank shareholders to inject more capital or witness a decrease in their control percentage in the banks. Simultaneously, NPLs and the resulting high private debt-burdened banks with unutilized liquidity. This interconnected system explains why deposit rates remain low, despite the noticeable rise in lending rates, precisely because of the surplus liquidity.
Property vs Debt
Cyprus faced a staggering level of non-performing loans (NPLs) after the 2013 crisis, reaching the highest in the world. This condition hindered the establishment of a "national bad bank" that would have assumed responsibility for managing these problem loans. The economic strain, both then and now, was too overwhelming, particularly for public finances.
In response, banks initially prioritized organic solutions, with asset-for-debt swaps being the primary approach. This strategy proved successful for corporate loans across various industries. Nonetheless, a significant inventory of real estate remained with the banks, which was not considered part of their core business and needed swift disposition.
Unfortunately, NPLs have persisted at nearly the same level as in previous years, particularly concerning retail loans, especially those secured by mortgages on family homes. As of the first quarter of 2023, the total NPLs at banks and Credit Acquisition Companies (CACs) amounted to approximately 25 billion. According to data presented to Parliament by the Central Bank, out of the 22.5 billion managed by the ECPs, a staggering 21 billion, equivalent to 93% of the total, remains overdue for over five years. It's important to note that non-performing loans secured by a main residence worth up to 350 thousand within the banking system are approximately 530 million. However, it does not necessarily indicate that these borrowers are vulnerable.
Difficult to handle
Dealing with non-performing loans (NPLs) secured by the main residence has been proven to be the most challenging and time-consuming, as indicated by international literature and research.
In the context of Cyprus, managing these loans presented even greater difficulties. Firstly, it marked the country's first-ever financial crisis. Secondly, being a closed society, implementing drastic measures had never been a viable option. Lastly, the general justice system has encountered and continues to face significant problems, particularly in terms of the time required to conclude cases. Consequently, the resolution of lending contracts through involuntary restructuring took an unusually long time, surpassing 10 years in some instances. The absence of a legal framework governing this matter prevented any clear timeframe from being established for the completion of the process.
Downgrading of legislation
The legislative framework for foreclosures in Cyprus was eventually passed due to the pressure of losing a substantial amount of money from international Troika lenders. Nevertheless, borrowers were assured that the first homes of 'vulnerable' borrowers would not be at risk. In essence, both strategic defaulters and other borrowers received, and continue to receive, a message that there would be no foreclosures or forced evictions. Consequently, there have been no recorded evictions of families from their primary residences.
However, the functioning of the foreclosure law effectively undermines the concept of mortgage lending, which is based on using the mortgaged asset to cover part or all of the borrowed amount. This is a fundamental aspect of secured financing and a basic requirement for a functioning mortgage market. In Cyprus, where a considerable portion of mortgage loans has been transferred from banks to asset acquisition and management companies, the issue arises. These companies purchased these loans at a significant discount with the intention of making a profit, in line with market principles. However, certain conditions were attached to some transactions involving the acquisition of non-performing loans. Now, the State (represented by parliamentary parties) is attempting to fundamentally alter these conditions through legislation, primarily citing abusive clauses.
Nevertheless, it is important to consider that if a loan has remained unpaid for an extended period, typically over five or ten years, the problem does not solely lie with the clauses themselves. Rather, it mainly stems from the borrower's inability or strategic refusal to fulfill their contractual obligations.
Many strategic defaulters
Regrettably, the phenomenon of strategic defaulters has not undergone thorough analysis in Cyprus. Nonetheless, strong indications suggest that a significant portion of inconsistent borrowers likely falls within this particular group. For instance, the insolvency framework saw minimal usage, and interest in schemes like the Estia Scheme remained subdued. It is also anticipated that the Rent vs Instalment Scheme will not garner substantial interest. Moreover, the government's criteria for vulnerable borrowers only encompasses a small percentage of the total. These trends indicate that schemes requiring the submission of evidence regarding assets and family income had limited impact, hinting that many affected borrowers are hesitant to reveal their true financial situations.
According to the International Monetary Fund's (IMF) study titled "A Strategy for Resolving Europe's Problem Loans," the duration of the foreclosure process correlates directly with the level of non-performing loans (NPLs) in each country. In Cyprus, the protracted foreclosure process, regardless of the intentions behind it, has contributed to maintaining capital concerns for the credibility of the Cypriot economy. The persistently high private debt looms over the nation, especially during periods of elevated interest rates and inflation. While there are no magical solutions exclusively for defaulters, responsible borrowers have started to question whether the government's priorities lie more with those responsible for creating the problem in the first place than with those who have diligently upheld their commitments and respected their guarantors.
[This article was first published in Oikonomiki's printed edition and translated from its Greek original]
